UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

(Mark One)

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

For the quarterly period ended: January 31, 2007

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)

 


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 x   No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x  Accelerated filer o  Non-accelerated filer 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 x

The number of shares of HP common stock outstanding as of February 28, 2007 was 2,676,446,604 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, 2007 and 2006 (Unaudited)

 

 

3

 

 

 

 

 

Consolidated Condensed Balance Sheets as of January 31, 2007 (Unaudited) and as of October 31, 2006 (Audited)

 

 

4

 

 

 

 

 

Consolidated Condensed Statements of Cash Flows for the three months ended January 31, 2007 and 2006 (Unaudited)

 

 

5

 

 

 

 

 

Notes to Consolidated Condensed Financial Statements (Unaudited)

 

 

6

 

 

 

Item 2.

 

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

 

 

38

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

71

 

 

 

Item 4.

 

Controls and Procedures

 

 

71

 

Part II.

 

Other Information

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

 

72

 

 

 

Item 1A.

 

Risk Factors

 

 

72

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

72

 

 

 

Item 6.

 

Exhibits

 

 

73

 

Signature

 

 

74

 

Exhibit Index

 

 

75

 

 

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 or other financial items; any statements of the plans, strategies and objectives of management for future operations, including the execution of any cost reduction programs and restructuring plans; any statements concerning expected development, performance or market share relating to products or services; 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 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 any cost reduction programs and restructuring plans; the outcome of pending legislation and accounting pronouncements; 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, 2006. HP assumes no obligation and does not intend to update these forward-looking statements.

2




PART I

Item 1. Financial Statements.

HEWLETT-PACKARD COMPANY AND SUBSIDIARIES

Consolidated Condensed Statements of Earnings

(Unaudited)

 

 

 

Three months ended
January 31

 

 

 

2007

 

2006

 

 

 

In millions, except
per share amounts

 

Net revenue:

 

 

 

 

 

Products

 

$

20,363

 

$

18,337

 

Services

 

4,628

 

4,236

 

Financing income

 

91

 

86

 

Total net revenue

 

25,082

 

22,659

 

Costs and expenses:

 

 

 

 

 

Cost of products

 

15,466

 

13,938

 

Cost of services

 

3,602

 

3,395

 

Financing interest

 

68

 

59

 

Research and development

 

877

 

871

 

Selling, general and administrative

 

2,908

 

2,692

 

Amortization of purchased intangible assets

 

201

 

147

 

In-process research and development charges

 

167

 

50

 

Restructuring

 

(41

)

15

 

Pension curtailment

 

(9

)

 

Total operating expenses

 

23,239

 

21,167

 

Earnings from operations

 

1,843

 

1,492

 

Interest and other, net

 

111

 

38

 

Gains (losses) on investments

 

10

 

(2

)

Earnings before taxes

 

1,964

 

1,528

 

Provision for taxes

 

417

 

301

 

Net earnings

 

$

1,547

 

$

1,227

 

Net earnings per share:

 

 

 

 

 

Basic

 

$

0.57

 

$

0.43

 

Diluted

 

$

0.55

 

$

0.42

 

Cash dividends declared per share

 

$

0.16

 

$

0.16

 

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

 

 

 

 

 

Basic

 

2,705

 

2,822

 

Diluted

 

2,801

 

2,893

 

 

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,
2007

 

October 31,
2006

 

 

 

In millions, except par value

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

10,057

 

 

 

$

16,400

 

 

Short-term investments

 

 

306

 

 

 

22

 

 

Accounts receivable

 

 

10,403

 

 

 

10,873

 

 

Financing receivables

 

 

2,511

 

 

 

2,440

 

 

Inventory

 

 

8,380

 

 

 

7,750

 

 

Other current assets

 

 

10,862

 

 

 

10,779

 

 

Total current assets

 

 

42,519

 

 

 

48,264

 

 

Property, plant and equipment

 

 

7,045

 

 

 

6,863

 

 

Long-term financing receivables and other assets

 

 

7,392

 

 

 

6,649

 

 

Goodwill

 

 

20,074

 

 

 

16,853

 

 

Purchased intangible assets

 

 

4,284

 

 

 

3,352

 

 

Total assets

 

 

$

81,314

 

 

 

$

81,981

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Notes payable and short-term borrowings

 

 

$

3,337

 

 

 

$

2,705

 

 

Accounts payable

 

 

11,360

 

 

 

12,102

 

 

Employee compensation and benefits

 

 

2,120

 

 

 

3,148

 

 

Taxes on earnings

 

 

1,673

 

 

 

1,905

 

 

Deferred revenue

 

 

4,750

 

 

 

4,309

 

 

Accrued restructuring

 

 

324

 

 

 

547

 

 

Other accrued liabilities

 

 

11,480

 

 

 

11,134

 

 

Total current liabilities

 

 

35,044

 

 

 

35,850

 

 

Long-term debt

 

 

2,438

 

 

 

2,490

 

 

Other liabilities

 

 

5,789

 

 

 

5,497

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Common stock, $0.01 par value (9,600 shares authorized; 2,692 and 2,732 shares issued and outstanding, respectively)

 

 

27

 

 

 

27

 

 

Additional paid-in capital

 

 

17,569

 

 

 

17,966

 

 

Prepaid stock repurchase

 

 

(165

)

 

 

(596

)

 

Retained earnings

 

 

20,604

 

 

 

20,729

 

 

Accumulated other comprehensive income

 

 

8

 

 

 

18

 

 

Total stockholders’ equity

 

 

38,043

 

 

 

38,144

 

 

Total liabilities and stockholders’ equity

 

 

$

81,314

 

 

 

$

81,981

 

 

 

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

 

 

 

2007

 

2006

 

 

 

In millions

 

Cash flows from operating activities:

 

 

 

 

 

Net earnings

 

$

1,547

 

$

1,227

 

Adjustments to reconcile net earnings to net cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

643

 

563

 

Stock-based compensation expense

 

163

 

144

 

Provision for bad debt and inventory

 

77

 

102

 

(Gains) losses on investments

 

(10

)

2

 

In-process research and development charges

 

167

 

50

 

Restructuring

 

(41

)

15

 

Pension curtailment

 

(9

)

 

Deferred taxes on earnings

 

91

 

55

 

Excess tax benefit from stock-based compensation

 

(100

)

(65

)

Other, net

 

(3

)

77

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts and financing receivables

 

548

 

1,193

 

Inventory

 

(698

)

89

 

Accounts payable

 

(759

)

(1,291

)

Taxes on earnings

 

131

 

(72

)

Restructuring

 

(281

)

(162

)

Other assets and liabilities

 

(1,488

)

(81

)

Net cash (used in) provided by operating activities

 

(22

)

1,846

 

Cash flows from investing activities:

 

 

 

 

 

Investment in property, plant and equipment

 

(718

)

(427

)

Proceeds from sale of property, plant and equipment

 

139

 

105

 

Purchases of available-for-sale securities and other investments

 

(13

)

(13

)

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

 

92

 

21

 

Payments made in connection with business acquisitions, net

 

(4,464

)

(653

)

Net cash used in investing activities

 

(4,964

)

(967

)

Cash flows from financing activities:

 

 

 

 

 

Issuance (repayment) of commercial paper and notes payable, net

 

1,263

 

(68

)

Issuance of debt

 

69

 

81

 

Payment of debt

 

(1,056

)

(231

)

Issuance of common stock under employee stock plans

 

797

 

647

 

Repurchase of common stock

 

(2,312

)

(1,401

)

Prepayment of common stock repurchases

 

 

(1,722

)

Excess tax benefit from stock-based compensation

 

100

 

65

 

Dividends

 

(218

)

(227

)

Net cash used in financing activities

 

(1,357

)

(2,856

)

Decrease in cash and cash equivalents

 

(6,343

)

(1,977

)

Cash and cash equivalents at beginning of period

 

16,400

 

13,911

 

Cash and cash equivalents at end of period

 

$

10,057

 

$

11,934

 

Supplemental schedule of noncash financing activities:

 

 

 

 

 

Net issuances of restricted stock

 

$

26

 

$

17

 

Issuance of options assumed in business acquisitions

 

$

132

 

$

7

 

 

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, 2007, and its results of operations and cash flows for the three months ended January 31, 2007 and 2006. The Consolidated Condensed Balance Sheet as of October 31, 2006 is derived from the October 31, 2006 audited financial statements. Certain reclassifications have been made to prior year amounts in order to conform to the current year presentation.

The results of operations for the three months ended January 31, 2007 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 “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 7, 7A and 8, respectively, of the Hewlett-Packard Company Annual Report on Form 10-K for the fiscal year ended October 31, 2006.

The preparation of financial statements in accordance with U.S. generally accepted accounting principles 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.

Recent Pronouncements

Updates to recent accounting standards as disclosed in HP’s Annual Report on Form 10-K for the fiscal year ended October 31, 2006 are as follows:

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB No. 87, 88, 106 and 132(R)” (“SFAS 158”). SFAS 158 requires that the funded status of defined benefit postretirement plans be recognized on the company’s balance sheet, and changes in the funded status be reflected in comprehensive income, effective for fiscal years ending after December 15, 2006, which HP expects to adopt effective October 31, 2007. SFAS 158 also requires companies to measure the funded status of the plan as of the date of its fiscal year end, effective for fiscal years ending after December 15, 2008. HP expects to adopt the measurement provisions of SFAS 158 effective October 31, 2009. Based upon the most recent actuarial measurement for the fiscal year ended October 31, 2006, the adoption of SFAS 158 is expected to result in a decrease in assets of $821 million, a decrease in liabilities of $138 million and a pretax increase in the accumulated other comprehensive loss of $683 million. The actual impact of the adoption of SFAS 158 may differ from these estimates due to changes to actual plan assets and liabilities in fiscal 2007.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. Under SFAS 159, a company may elect to use fair value to measure accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees and issued debt. Other eligible items include firm commitments

6




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

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

for financial instruments that otherwise would not be recognized at inception and non-cash warranty obligations where a warrantor is permitted to pay a third party to provide the warranty goods or services. If the use of fair value is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred, e.g., debt issue costs. The fair value election is irrevocable and generally made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of SFAS 159, changes in fair value are recognized in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007 and is required to be adopted by HP in the first quarter of fiscal 2009. HP currently is determining whether fair value accounting is appropriate for any of its eligible items and cannot estimate the impact, if any, which SFAS 159 will have on its consolidated results of operations and financial condition.

During the first quarter of 2007, HP adopted the following accounting standards, none of which had a material effect on HP’s consolidated results of operations or financial condition:

·  SFAS No. 154, “Accounting for Changes and Error Corrections”;

·  Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”; and

·  Emerging Issues Task Force (“EITF”) 05-5, “Accounting for Early Retirement or Postemployment Programs with Specific Features (Such as Terms Specified in Altersteilzeit Early Retirement Arrangements)”

Note 2: Stock-Based Compensation

Effective November 1, 2005, HP adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method. The total stock-based compensation expense before taxes associated with HP stock-based employee compensation plans was $163 million, excluding a $14 million credit adjustment in restructuring charges as disclosed below, and $144 million for the three months ended January 31, 2007 and 2006, respectively. HP allocated stock-based compensation expense under SFAS 123R as follows:

 

 

Three months
ended
January 31, 2007

 

Three months
ended
January 31, 2006

 

 

 

In millions

 

Cost of sales

 

 

$ 45

 

 

 

$ 39

 

 

Research and development

 

 

19

 

 

 

18

 

 

Selling, general and administrative

 

 

99

 

 

 

87

 

 

Stock-based compensation expense before income taxes

 

 

163

 

 

 

144

 

 

Income tax benefit

 

 

(48

)

 

 

(43

)

 

Total stock-based compensation expense after income taxes

 

 

$ 115

 

 

 

$ 101

 

 

 

7




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 2: Stock-Based Compensation (Continued)

In addition, as part of its fiscal 2005 restructuring plans, HP accelerated the vesting of options held by terminated employees and included a one-year post-termination exercise period on the options. This modification resulted in compensation expense of $107 million that HP included in its fiscal 2005 restructuring charges. HP recorded an adjustment of $14 million in the first quarter of fiscal 2007 and an adjustment of $14 million in the fourth quarter of fiscal 2006 as reductions to the $107 million restructuring charges to reflect actual stock-based compensation expense related to employees who left the company.

HP estimated the fair value of share-based payment awards using the Black-Scholes option pricing model with the following weighted-average assumptions and weighted-average fair values:

 

 

Stock Options(1)

 

 

 

Three months ended
January 31

 

 

 

2007

 

2006

 

Weighted-average fair value of grants

 

$ 12.87

 

$ 9.28

 

Risk-free interest rate

 

4.69

%

4.31

%

Dividend yield

 

0.76

%

1.02

%

Expected volatility

 

28

%

29

%

Expected life in months

 

59

 

57

 

 


(1)                The fair value calculation was based on stock options granted during the period.

Option activity as of January 31, 2007 and changes during the three months ended January 31, 2007 were as follows:

 

 

Shares
(in thousands)

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contractual
Term
(in years)

 

Aggregate
Intrinsic
Value
(in millions)

 

Outstanding at October 31, 2006

 

 

445,740

 

 

 

$ 31

 

 

 

 

 

 

 

 

 

 

Granted and assumed through acquisitions

 

 

38,983

 

 

 

$ 42

 

 

 

 

 

 

 

 

 

 

Exercised

 

 

(25,526

)

 

 

$ 25

 

 

 

 

 

 

 

 

 

 

Forfeited/cancelled/expired

 

 

(6,109

)

 

 

$ 42

 

 

 

 

 

 

 

 

 

 

Outstanding at January 31, 2007

 

 

453,088

 

 

 

$ 32

 

 

 

4.8

 

 

 

$ 6,033

 

 

Vested and expected to vest at January 31, 2007

 

 

444,676

 

 

 

$ 32

 

 

 

4.7

 

 

 

$ 5,906

 

 

Exercisable at January 31, 2007

 

 

306,277

 

 

 

$ 34

 

 

 

3.9

 

 

 

$ 3,823

 

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between HP’s closing stock price on the last trading day of the first quarter of fiscal 2007 and the exercise price, multiplied by the number of in-the-money options) that option holders would have received had all option holders exercised their options on January 31, 2007. This amount changes based on the fair market value of HP’s stock. Total intrinsic value of options exercised for the three months ended January 31, 2007 and 2006 was $416 million and $235 million, respectively.

8




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 2: Stock-Based Compensation (Continued)

HP expects to recognize, as of January 31, 2007, $962 million of total unrecognized compensation cost related to stock options over a weighted-average period of 2.4 years.

Nonvested restricted stock awards as of January 31, 2007 and changes during the three months ended January 31, 2007 were as follows:

 

 

Number of
shares
(in thousands)

 

Weighted-
Average Grant
Date Fair Value

 

Nonvested at October 31, 2006

 

 

6,365

 

 

 

$ 24

 

 

Granted

 

 

702

 

 

 

$ 42

 

 

Vested

 

 

(395

)

 

 

$ 26

 

 

Forfeited

 

 

(333

)

 

 

$ 24

 

 

Nonvested at January 31, 2007

 

 

6,339

 

 

 

$ 26

 

 

 

As of January 31, 2007, there was $99 million unrecognized stock-based compensation expense related to nonvested restricted stock awards. HP expects to recognize that cost over a weighted-average period of 1.5 years.

Note 3: Net Earnings Per Share (“EPS”)

HP calculates basic EPS using net earnings and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes the effect from potential issuance of common stock, such as stock issuable pursuant to the exercise of stock options and the assumed conversion of convertible notes.

9




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 3: Net Earnings Per Share (“EPS”) (Continued)

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

 

 

Three months ended
January 31

 

 

 

2007

 

2006

 

 

 

In millions, except
per share amounts

 

Numerator:

 

 

 

 

 

Net earnings

 

$ 1,547

 

$ 1,227

 

Adjustment for interest expense on zero-coupon subordinated convertible notes, net of taxes

 

2

 

2

 

Net earnings, adjusted

 

$ 1,549

 

$ 1,229

 

Denominator:

 

 

 

 

 

Weighted-average shares used to compute basic EPS

 

2,705

 

2,822

 

Effect of dilutive securities:

 

 

 

 

 

Dilution from employee stock plans

 

88

 

64

 

Zero-coupon subordinated convertible notes

 

8

 

7

 

Dilutive potential common shares

 

96

 

71

 

Weighted-average shares used to compute diluted EPS

 

2,801

 

2,893

 

Net earnings per share:

 

 

 

 

 

Basic

 

$ 0.57

 

$ 0.43

 

Diluted

 

$ 0.55

 

$ 0.42

 

 

In the first quarter of fiscal 2007 and 2006, HP excluded options with exercise prices that were greater than the average market price for HP’s common stock to purchase approximately 117 million shares and 223 million shares, respectively, from the calculation of diluted EPS because their effect was anti-dilutive. Also, as a result of adopting SFAS 123R on November 1, 2005, HP excluded an additional 4 million options and 3 million options, respectively, in the first quarter of fiscal 2007 and 2006, 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 as their effect was also anti-dilutive.

10




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 4: Balance Sheet Details

Balance sheet details were as follows:

Accounts and Financing Receivables

 

 

January 31,
2007

 

October 31,
2006

 

 

 

In millions

 

Accounts receivable

 

 

$ 10,618

 

 

 

$ 11,093

 

 

Allowance for doubtful accounts

 

 

(215

)

 

 

(220

)

 

 

 

 

$ 10,403

 

 

 

$ 10,873

 

 

Financing receivables

 

 

$ 2,555

 

 

 

$ 2,480

 

 

Allowance for doubtful accounts

 

 

(44

)

 

 

(40

)

 

 

 

 

$ 2,511

 

 

 

$ 2,440

 

 

 

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 approximately $486 million as of January 31, 2007. HP sold approximately $658 million of trade receivables during the first quarter of fiscal 2007. Fees associated with these facilities do not generally differ materially from the cash discounts offered to these customers under the previous alternative prompt payment programs. As of January 31, 2007, there was approximately $173 million available under these programs.

Inventory

 

 

January 31,
2007

 

October 31,
2006

 

 

 

In millions

 

Finished goods

 

 

$ 5,709

 

 

 

$ 5,424

 

 

Purchased parts and fabricated assemblies

 

 

2,671

 

 

 

2,326

 

 

 

 

 

$ 8,380

 

 

 

$ 7,750

 

 

 

Note 5: Acquisitions

In the first quarter of fiscal 2007, HP acquired two companies. The largest of these transactions was the acquisition of Mercury Interactive Corporation (“Mercury”), which is described below. The second acquisition, Knightsbridge Solutions Holdings Corporation (“Knightsbridge”), is a privately held services company specializing in the information management areas of business intelligence, data warehousing, data integration and information quality. Knightsbridge is included in HP Services.

HP has recorded these acquisitions using the purchase method of accounting and, accordingly, included the results of operations in HP’s consolidated results as of the date of each acquisition. HP allocates the purchase price of its acquisitions to the tangible assets, liabilities and intangible assets acquired, including in-process research and development (“IPR&D”), based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill.  HP has not presented the pro forma results of operations because the results are not material to HP’s consolidated results of operations on either an individual or an aggregate basis.

11




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 5: Acquisitions (Continued)

Mercury Acquisition

On November 2, 2006, HP completed its tender offer for Mercury, a leading IT management software and services company, and acquired approximately 96% of Mercury common shares for cash consideration of $52 per share. On November 6, 2006, HP acquired the remaining outstanding common shares, and Mercury became a wholly owned subsidiary of HP. This acquisition combines Mercury's application management, application delivery and IT governance capabilities with HP's broad portfolio of management solutions.

The aggregate purchase price of approximately $4.9 billion consisted of cash paid for outstanding stock, vested in-the-money stock options and direct transaction costs. In addition, the purchase price also included the estimated fair value of earned unvested stock options and out-of-the-money vested stock options assumed by HP.

The preliminary purchase price allocation as of the date of acquisition is as follows:

 

In millions

 

Cash and short term investments

 

 

$  831

 

 

Other tangible assets

 

 

372

 

 

Notes payable

 

 

(303

)

 

Other liabilities assumed.

 

 

(883

)

 

Total net assets

 

 

17

 

 

Amortizable intangible assets

 

 

1,080

 

 

Goodwill

 

 

3,648

 

 

IPR&D

 

 

167

 

 

Total purchase price.

 

 

$ 4,912

 

 

 

Note 7 contains information related to the cost of restructuring programs for Mercury employees, which was also included as part of other liabilities assumed.

The purchase price allocation was based on management’s preliminary valuation and the estimates and assumptions used are subject to change. The primary areas of the purchase price allocation that are not yet finalized relate to restructuring costs, certain income tax-related balances, certain legal matters and residual goodwill.

12




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 5: Acquisitions (Continued)

HP has included Mercury in the OpenView business within the HP Software segment. Goodwill, which represents the excess of the purchase price over the net tangible and intangible assets acquired, is not deductible for tax purposes. The amortizable intangible assets are being amortized over their estimated useful lives as follows:

 

In millions

 

Weighted-average
useful life

 

Technology

 

 

$  575

 

 

 

4.2 years

 

 

Customer relationships

 

 

237

 

 

 

7.0 years

 

 

Maintenance contracts

 

 

264

 

 

 

6.8 years

 

 

Trademarks

 

 

4

 

 

 

6.0 years

 

 

Total amortizable intangible assets

 

 

$ 1,080

 

 

 

5.5 years

 

 

 

IPR&D expense of $167 million was recorded in HP’s results of operations for the quarter ended January 31, 2007. Projects that qualify for IPR&D represent those that have not yet reached technological feasibility and have no alternative use. Technological feasibility is defined as being equivalent to a beta-phase working proto-type in which there is no remaining risk relating to the development.

Pending and Completed Acquisitions

In February 2007, HP agreed to acquire PolyServe, Inc., a leading provider of storage software for application and file serving utilities. The transaction is subject to certain closing conditions and is expected to be completed in the second quarter of fiscal 2007. Following the close of the acquisition, the business will be included in the Storage business unit within the Enterprise Storage and Servers segment.

In February 2007, HP completed the acquisitions of Bitfone Corporation (“Bitfone”) and Bristol Technology, Inc. (“Bristol”). Bitfone is a privately held global software and services company that develops software solutions for mobile device management for the wireless industry. Bitfone will be included in the Handhelds business unit within HP’s Personal Systems Group. Bristol’s solutions help companies monitor complex business transactions, complimenting Mercury’s software solutions. Bristol will be included in the OpenView business within the HP Software segment.

13




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 6: Goodwill and Purchased Intangible Assets

Goodwill

Goodwill allocated to HP’s business segments as of January 31, 2007 and changes in the carrying amount of goodwill for the three months ended January 31, 2007 were as follows:

 

 

 

Enterprise

 

 

 

 

 

Imaging

 

 

 

 

 

 

 

 

 

Storage

 

 

 

Personal

 

and

 

HP

 

 

 

 

 

HP

 

and

 

HP

 

Systems

 

Printing

 

Financial

 

 

 

 

 

Services

 

Servers

 

Software

 

Group

 

Group

 

Services

 

Total

 

 

 

In millions

 

Balance at October 31, 2006

 

 

$ 6,339

 

 

 

$ 5,091

 

 

 

$ 1,098

 

 

 

$ 2,322

 

 

 

$ 1,853

 

 

 

$ 150

 

 

$ 16,853

 

Goodwill acquired during the period

 

 

96

 

 

 

 

 

 

3,648

 

 

 

 

 

 

 

 

 

 

 

3,744

 

Goodwill adjustments

 

 

(202

)

 

 

(176

)

 

 

(19

)

 

 

(85

)

 

 

(36

)

 

 

(5

)

 

(523

)

Balance at January 31, 2007

 

 

$ 6,233

 

 

 

$ 4,915

 

 

 

$ 4,727

 

 

 

$ 2,237

 

 

 

$ 1,817

 

 

 

$ 145

 

 

$ 20,074

 

 

The goodwill adjustments relate primarily to the reversal of Compaq Computer Corporation’s income tax reserves for pre-merger tax years. These tax years have been audited and agreed upon with the Internal Revenue Service and the statute of limitations for them has expired. Accordingly, the reserves have been reclassified as a reduction of goodwill.

Purchased Intangible Assets

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

 

January 31, 2007

 

October 31, 2006

 

 

 

 

 

Accumulated

 

 

 

 

 

Accumulated

 

 

 

 

 

Gross

 

Amortization

 

Net

 

Gross

 

Amortization

 

Net

 

 

 

In millions

 

Customer contracts, customer lists and distribution agreements

 

$ 3,137

 

 

$ (1,389

)

 

$ 1,748

 

$ 2,586

 

 

$ (1,293

)

 

$ 1,293

 

Developed and core technology and patents

 

2,499

 

 

(1,409

)

 

1,090

 

1,923

 

 

(1,307

)

 

616

 

Product trademarks

 

109

 

 

(85

)

 

24

 

103

 

 

(82

)

 

21

 

Total amortizable purchased intangible assets

 

5,745

 

 

(2,883

)

 

2,862

 

4,612

 

 

(2,682

)

 

1,930

 

Compaq trade name

 

1,422

 

 

 

 

1,422

 

1,422

 

 

 

 

1,422

 

Total purchased intangible assets

 

$ 7,167

 

 

$ (2,883

)

 

$ 4,284

 

$ 6,034

 

 

$ (2,682

)

 

$ 3,352

 

 

Estimated future amortization expense related to finite lived purchased intangible assets at January 31, 2007 is as follows:

Fiscal year:

 

 

 

In millions

 

2007 (remaining 9 months)

 

 

$  566

 

 

2008

 

 

698

 

 

2009

 

 

616

 

 

2010

 

 

509

 

 

2011

 

 

267

 

 

Thereafter

 

 

206

 

 

Total

 

 

$ 2,862

 

 

 

14




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 7: Restructuring Charges

Fiscal 2007 Mercury Plan

In connection with the acquisition of Mercury, HP’s management approved and initiated plans to restructure the operations of Mercury to eliminate certain duplicative activities, reduce cost structure and better align product and operating expenses with existing general economic conditions. HP recorded $25 million in severance-related costs associated with the elimination of approximately 230 positions primarily in the U.S. and Israel. These positions are expected to be substantially eliminated and the related severance payments are expected to be substantially paid by the end of fiscal 2007. HP expects there will be additional positions eliminated, but HP does not expect to meet the accrual criteria relating to these eliminations until the second quarter of fiscal 2007. HP also recorded $21 million related to costs of vacating duplicative leased facilities. The costs for the facilities are expected to be paid through 2014. These costs are reflected in the purchase price of Mercury in accordance with EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” These costs are subject to change based on the actual costs incurred. Changes to these estimates could increase or decrease the amount of the purchase price allocated to goodwill.

Fiscal 2007 U.S. Enhanced Early Retirement Program

On February 20, 2007, HP announced that it is offering an option for eligible employees to participate in a 2007 U.S. Enhanced Early Retirement program (the “2007 EER”). The employee severance and other benefits cost for the 2007 EER will be recorded in the second quarter of fiscal 2007 as restructuring charges. The cost is expected to approximate a curtailment gain of approximately $500 million resulting from the U.S. defined benefit pension and post-retirement plan changes, also announced on February 20, 2007. HP expects approximately 3,000 employees to exit the company by May 2007 under the 2007 EER. For more information, see Note 13 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference.

Fiscal 2005 Restructuring Plans

In the fourth quarter of fiscal 2005, HP’s Board of Directors approved a restructuring plan designed to simplify HP’s structure, reduce costs and place greater focus on its customers. HP included original estimates of 15,300 positions in the fiscal 2005 restructuring plan. Subsequent to the initial estimate, HP reduced the number of total positions to 15,040. As of January 31, 2007, 14,790 positions have been eliminated and the remaining 250 positions are expected to be eliminated by the end of fiscal 2007. The initial charge for these actions totaled $1.6 billion. During the three months ended January 31, 2007, HP recognized a credit of approximately $46 million to reduce total restructuring expense. The credit was due primarily to severance adjustments for employees who were expected to be terminated but found new positions within HP, a non-cash stock-based compensation expense adjustment, and a curtailment gain relating to the HP subsidized U.S. retiree medical program. HP expects to pay out the majority of the remaining costs relating to severance and other employee benefits before the end of fiscal 2007.

15




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 7: Restructuring Charges (Continued)

In the third quarter of fiscal 2005, HP’s management approved a restructuring plan and HP recorded restructuring charges of $109 million related to severance and related costs associated with the termination of approximately 1,450 employees, all of whom left HP as of October 31, 2005. HP has paid all of the initial restructuring amount as of January 31, 2007.

Fiscal 2003, 2002 and 2001 Restructuring Plans

The 2003, 2002 and 2001 restructuring plans are substantially complete, although HP records minor revisions to previous estimates as necessary. In the first quarter of fiscal 2007, HP recorded adjustments of $5 million in additional restructuring charges. The aggregate $104 million restructuring liability with respect to these plans as of January 31, 2007 relates primarily to facility lease obligations and severance. HP expects to pay substantially all of these obligations over the life of the related obligations, which extend to the end of fiscal 2010.

Summary of Restructuring Plans

The activity in the accrued restructuring balances related to all of the plans described above for the three months ended January 31, 2007 was as follows:

 

 

 

 

Three months

 

 

 

 

 

 

 

 

 

As of January 31, 2007

 

 

 

Balance,
October 31,
2006

 

ended
January 31,
2007 charges
(reversals)

 

Goodwill
adjustments

 

Cash
payments

 

Non-cash
settlements
and other
adjustments

 

Balance,
January 31,
2007

 

Total
costs and
adjustments
to date

 

Total
expected
costs and
adjustments

 

 

 

In millions

 

Fiscal 2007 Mercury plan:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee severance and other benefit charges

 

 

 

 

 

 

 

 

 

 

$ 25

 

 

 

 

 

 

 

 

 

 

 

$ 25

 

 

 

$     25

 

 

 

$     25

 

 

Infrastructure

 

 

 

 

 

 

 

 

 

 

21

 

 

 

 

 

 

 

 

 

 

 

21

 

 

 

21

 

 

 

21

 

 

Total employee severance and other benefits.

 

 

 

 

 

 

 

 

 

 

46

 

 

 

 

 

 

 

 

 

 

 

46

 

 

 

46

 

 

 

46

 

 

Fiscal 2005 Plans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee severance and other benefits charges (by
segment)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise Storage and Servers

 

 

 

 

 

 

$ (16

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$  168

 

 

 

$  168

 

 

HP Services

 

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

579

 

 

 

579

 

 

HP Software

 

 

 

 

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

52

 

 

 

52

 

 

Personal Systems Group

 

 

 

 

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

57

 

 

 

57

 

 

Imaging and Printing Group

 

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

148

 

 

 

148

 

 

HP Financial Services

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

33

 

 

 

33

 

 

Other infrastructure

 

 

 

 

 

 

(11

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

697

 

 

 

697

 

 

Total employee severance and other benefits

 

 

$ 521

 

 

 

$ (46

)

 

 

$ —

 

 

 

$ (263

)

 

 

$ 35

 

 

 

$ 247

 

 

 

$ 1,734

 

 

 

$ 1,734

 

 

Fiscal 2003, 2002 and 2001 plans

 

 

$ 117

 

 

 

$     5

 

 

 

$ —

 

 

 

$   (18

)

 

 

$ —

 

 

 

$ 104

 

 

 

$ 4,127

 

 

 

$ 4,127

 

 

Total restructuring plans

 

 

$ 638

 

 

 

$ (41

)

 

 

$ 46

 

 

 

$ (281

)

 

 

$ 35

 

 

 

$ 397

 

 

 

$ 5,907

 

 

 

$ 5,907

 

 

 

At January 31, 2007 and October 31, 2006, HP included the long-term portion of the restructuring liability of $73 million and $91 million, respectively, in Other Liabilities in the accompanying Consolidated Condensed Balance Sheets.

16




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 8: 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 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,
2007

 

October 31,
2006

 

 

 

In millions

 

Minimum lease payments receivable

 

 

$

5,148

 

 

 

$

5,010

 

 

Allowance for doubtful accounts

 

 

(87

)

 

 

(80

)

 

Unguaranteed residual value

 

 

287

 

 

 

289

 

 

Unearned income

 

 

(448

)

 

 

(439

)

 

Financing receivables, net

 

 

4,900

 

 

 

4,780

 

 

Less current portion, net

 

 

(2,511

)

 

 

(2,440

)

 

Amounts due after one year, net

 

 

$

2,389

 

 

 

$

2,340

 

 

 

Equipment leased to customers under operating leases was $2.1 billion at January 31, 2007 and at October 31, 2006 and is included in property, plant and equipment in the accompanying Consolidated Condensed Balance Sheets. Accumulated depreciation on equipment under lease was $0.6 billion at January 31, 2007 and at October 31, 2006.

Note 9: Guarantees

Indemnifications

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.

Warranty

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

17




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 9: Guarantees (Continued)

The changes in HP’s aggregate product warranty liability were as follows:

 

 

In millions

 

Product warranty liability at October 31, 2006

 

 

$

2,248

 

 

Accruals for warranties issued

 

 

636

 

 

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

 

 

(33

)

 

Settlements made (in cash or in kind)

 

 

(604

)

 

Product warranty liability at January 31, 2007

 

 

$

2,247

 

 

 

Deferred Revenue

The components of deferred revenue were as follows:

 

 

January 31,
2007

 

October 31,
2006

 

 

 

In millions

 

Deferred support contract services revenue

 

 

$

3,817

 

 

 

$

3,598

 

 

Other deferred revenue

 

 

2,866

 

 

 

2,461

 

 

Total deferred revenue

 

 

6,683

 

 

 

6,059

 

 

Less current portion

 

 

4,750

 

 

 

4,309

 

 

Long-term deferred revenue

 

 

$

1,933

 

 

 

$

1,750

 

 

 

Deferred support contract services revenue represents amounts received or billed in advance primarily for fixed-price support or maintenance contracts. These services include stand-alone product support packages, routine maintenance service contracts, upgrades or extensions to standard product warranty, as well as high availability services for complex, global, networked, multi-vendor environments. These service amounts are deferred at the time the customer is billed and then recognized ratably over the contract life or as the services are rendered.

Other deferred revenue represents amounts received or billed in advance for contracts related primarily to consulting and integration projects, outsourcing services start-up or transition work, product sales and minor amounts for training.

18




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 10: Borrowings

Notes Payable and Short-Term Borrowings

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

 

 

January 31, 2007

 

October 31, 2006

 

 

 

Amount
Outstanding

 

Weighted-
Average
Interest Rate

 

Amount
Outstanding

 

Weighted-
Average
Interest Rate

 

 

 

 

 

In millions

 

 

 

Current portion of long-term debt

 

 

$

1,448

 

 

 

5.3

%

 

 

$

2,081

 

 

 

5.7

%

 

Commercial paper

 

 

1,309

 

 

 

5.1

%

 

 

190

 

 

 

3.3

%

 

Notes payable to banks, lines of credit and other

 

 

580

 

 

 

5.1

%

 

 

434

 

 

 

4.6

%

 

 

 

 

$

3,337

 

 

 

 

 

 

 

$

2,705

 

 

 

 

 

 

 

Notes payable to banks, lines of credit and other includes deposits associated with HP’s banking-related activities of approximately $497 million and $393 million at January 31, 2007 and October 31, 2006, respectively.

Long-Term Debt

Long-term debt was as follows:

 

 

January 31,
2007

 

October 31,
2006

 

 

 

In millions

 

U.S. Dollar Global Notes

 

 

 

 

 

 

 

 

 

$1,000 issued December 2001 at 5.75%, matured and paid December 2006

 

 

$

 

 

 

$

1,000

 

 

$1,000 issued June 2002 at 5.5%, due July 2007

 

 

1,000

 

 

 

999

 

 

$500 issued June 2002 at 6.5%, due July 2012

 

 

499

 

 

 

498

 

 

$500 issued March 2003 at 3.625%, due March 2008

 

 

499

 

 

 

499

 

 

$1,000 issued May 2006 at floating interest rate, due May 2009

 

 

1,000

 

 

 

1,000

 

 

 

 

 

2,998

 

 

 

3,996

 

 

Series A Medium-Term Notes

 

 

 

 

 

 

 

 

 

$50 issued December 2002 at 4.25%, due December 2007

 

 

50

 

 

 

50

 

 

 

 

 

50

 

 

 

50

 

 

Other

 

 

 

 

 

 

 

 

 

$505, U.S. dollar zero-coupon subordinated convertible notes, issued in October and November 1997 at an imputed rate of 3.13%, due 2017 (“LYONs”)

 

 

362

 

 

 

360

 

 

$283, U.S. dollar notes, assumed in November 2006 at 4.75%, due 2007

 

 

283

 

 

 

 

 

Other, including capital lease obligations, at 3.75%-15%, due 2006-2029

 

 

253

 

 

 

228

 

 

 

 

 

898

 

 

 

588

 

 

Fair value adjustment related to SFAS No. 133

 

 

(60

)

 

 

(63

)

 

Less current portion

 

 

(1,448

)

 

 

(2,081

)

 

 

 

 

$

2,438

 

 

 

$

2,490

 

 

 

HP may redeem some or all of the Global Notes and the Series A Medium-Term Notes (collectively, the “Notes”), as set forth in the above table, at any time at the redemption prices described in the prospectus supplements relating thereto. The Notes are senior unsecured debt.

19




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 10: Borrowings (Continued)

In May 2006, HP filed a shelf registration statement (the “2006 Shelf Registration Statement”) with the Securities and Exchange Commission (the “SEC”) to enable HP to offer and sell, from time to time, in one or more offerings, debt securities, common stock, preferred stock, depositary shares and warrants. On May 23, 2006, HP issued $1.0 billion in Floating Rate Global Notes under this registration statement. The Floating Rate Global Notes bear interest at a floating rate equal to the three-month USD LIBOR plus 0.125% per annum. HP used a portion of the proceeds received to repay its 5.25% Euro Medium-Term Notes due July 2006 at maturity and the remainder of the net proceeds for general corporate purposes. On February 22, 2007, HP issued an additional $2.0 billion of global notes under this registration statement. The global notes included $600 million of notes due March 2012 with a floating interest rate equal to the three-month USD LIBOR plus 0.11% per annum, $900 million of notes due March 2012 with a fixed interest rate of 5.25% per annum and $500 million of notes due March 2017 with a fixed interest rate of 5.40% per annum. The $600 million notes were issued at par, while the $900 million notes and $500 million notes were issued at discounts to par at 99.938% and 99.694%, respectively. HP plans to use the net proceeds from these note offerings for general corporate purposes, including up to $289 million to fund the repurchase of the notes assumed in connection with the Mercury acquisition as described in detail below and to repay short-term commercial paper maturing in February and March of 2007.

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 in March 2002 (the “2002 Shelf Registration Statement”). In December 2002, HP filed a supplement to the 2002 Shelf Registration Statement, which allows HP to offer from time to time up to $1.5 billion of Medium-Term Notes, Series B, due nine months or more from the date of issuance (the “Series B Medium-Term Note Program”). As of January 31, 2007, HP has not issued Medium-Term Notes pursuant to the Series B Medium-Term Note Program.

HP registered the sale of up to $3.0 billion of Medium-Term Notes under its Euro Medium-Term Note Programme filed with the Luxembourg Stock Exchange. HP can denominate these notes in any currency, including the euro. These notes have not been and will not be registered in the United States. In July 2006, HP repaid the previously issued 750 million euro notes at maturity under this programme.

The LYONs are convertible by the holders at an adjusted rate of 15.09 shares of HP common stock for each $1,000 face value of the LYONs, payable in either cash or common stock at HP’s election. At any time, HP may redeem the LYONs at book value, payable in cash only. In December 2000, the Board of Directors authorized a repurchase program for the LYONs that allowed HP to repurchase the LYONs from time to time at varying prices. The last repurchase under this program occurred in fiscal 2002.

In November 2006, in connection with the Mercury acquisition, HP assumed notes issued by Mercury (the “Mercury Notes”) with a face value of $300 million, maturing on July 1, 2007 and bearing interest at a rate of 4.75% per annum. As of January 31, 2007, HP repurchased $17 million in principal amount of the Mercury Notes assumed by HP, leaving $283 million in principal amount outstanding. On March 1, 2007, HP repurchased an additional $281 million in principal amount of Mercury Notes.

HP has a U.S. commercial paper program with a $6.0 billion capacity. Its 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.

20




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 10: Borrowings (Continued)

HP has a $3.0 billion 5-year credit facility. Commitment fees, interest rates and other terms of borrowing under the credit facility vary, based on HP’s external credit ratings. The credit facility is a senior unsecured committed borrowing arrangement primarily to support the issuance of U.S. commercial paper. No amounts are outstanding under the credit facility.

HP also maintains lines of credit of approximately $2.4 billion from a number of financial institutions that are uncommitted and available through various foreign subsidiaries.

Included in Other, including capital lease obligations, are borrowings that are collateralized by certain financing receivable assets. As of January 31, 2007, the carrying value of the assets approximated the carrying value of the borrowings of $13 million.

At January 31, 2007, HP had up to $11.6 billion of available borrowing resources under the 2002 Shelf Registration Statement and other programs described above. HP also may issue additional debt securities, common stock, preferred stock, depositary shares and warrants under the 2006 Shelf Registration Statement.

Note 11: Income Taxes

Provision for Taxes

HP’s effective tax rate was ­­­21.2% and 19.7% for the three months ended January 31, 2007 and January 31, 2006, respectively. HP’s effective tax rate generally differs from the U.S. federal statutory rate of 35% due to the tax rate benefits of certain earnings from HP’s operations in lower-tax jurisdictions throughout the world for which HP has not provided U.S. taxes because HP plans to reinvest such earnings indefinitely outside the U.S. There were no material discrete items affecting the tax rate for the three months ended January 31, 2007 and January 31, 2006, respectively.

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

 

 

January 31,
2007

 

October 31,
2006

 

 

 

In millions

 

Current deferred tax assets

 

 

$

3,549

 

 

 

$

4,144

 

 

Current deferred tax liabilities

 

 

(122

)

 

 

(138

)

 

Long-term deferred tax assets

 

 

2,144

 

 

 

1,475

 

 

Long-term deferred tax liabilities

 

 

(421

)

 

 

(291

)

 

Total deferred tax assets

 

 

$

5,150

 

 

 

$

5,190

 

 

 

In December 2006, the Tax Relief and Health Care Act of 2006, which included a retroactive reinstatement of the research and development credit, was signed into law. HP recorded the retroactive amount of research and development credit in the first quarter of fiscal 2007. This amount did not have a material impact on HP’s consolidated results of operations and financial conditions.

21




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 12: Stockholders’ Equity

Stock Repurchase Program

HP’s share repurchase program authorizes both open market and private repurchase transactions. HP paid $2.3 billion and $1.4 billion in connection with share repurchases of 57 million shares and 48 million shares during the three months ended January 31, 2007 and January 31, 2006, respectively.

In addition to the above transactions, HP entered into a prepaid variable share purchase program (“PVSPP”) with a third-party investment bank during the first quarter of 2006 and prepaid $1.7 billion in exchange for the right to receive a variable number of shares of its common stock weekly over a one year period beginning in the second quarter of fiscal 2006 and ending during the second quarter of fiscal 2007. HP recorded the payment as a prepaid stock repurchase in the stockholders’ equity section of its Consolidated Condensed Balance Sheet, and the payment was included in the cash flows from financing activities in the Consolidated Condensed Statement of Cash Flows. In connection with this program, the investment bank has purchased and will continue to trade shares of HP’s common stock in the open market over time. The prepaid funds will be expended ratably over the term of the program.

Under the PVSPP, the prices at which HP purchases the shares are subject to a minimum and maximum price that was determined in advance of any repurchases being completed under the program, thereby effectively hedging HP’s repurchase price. The minimum and maximum numbers of shares HP could receive under the program are 52 million shares and 70 million shares, respectively. The exact number of shares to be repurchased is based upon the volume weighted-average market price of HP’s shares during each weekly settlement period, subject to the minimum and maximum price as well as regulatory limitations on the number of shares HP is permitted to repurchase. HP decreases its shares outstanding each settlement period as shares are physically received. HP will retire all shares repurchased under the PVSPP, and HP will no longer deem those shares outstanding. In the first quarter of fiscal 2007, HP had received 13 million shares for an aggregate price of $431 million under the PVSPP. As of January 31, 2007, HP had cumulatively received approximately 47 million shares for an aggregate price of $1.5 billion since the inception of the PVSPP. HP completed all repurchases under the PVSPP on March 9, 2007. As of that date, HP had cumulatively received a total of 53 million shares under the PVSPP.

As of January 31, 2007, HP had remaining authorization of $3.3 billion for future share repurchases in addition to the previously authorized share repurchases made under the PVSPP in the second quarter of fiscal 2007.

22




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 12: Stockholders’ Equity (Continued)

Comprehensive Income

The changes in the components of other comprehensive income, net of taxes, were as follows:

 

 

Three months ended
January 31

 

 

 

    2007    

 

    2006    

 

 

 

In millions

 

Net earnings

 

 

$

1,547

 

 

 

$

1,227

 

 

Change in net unrealized (losses) gains on available-for-sale securities

 

 

(2

)

 

 

8

 

 

Change in net unrealized losses on cash flow hedges

 

 

(9

)

 

 

(26

)

 

Change in cumulative translation adjustment

 

 

2

 

 

 

34

 

 

Change in additional minimum pension liability

 

 

(1

)

 

 

 

 

Comprehensive income

 

 

$

1,537

 

 

 

$

1,243

 

 

 

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

 

 

January 31,
2007

 

October 31,
2006

 

 

 

In millions

 

Net unrealized gains on available-for-sale securities

 

 

$

14

 

 

 

$

16

 

 

Net unrealized losses on cash flow hedges

 

 

(55

)

 

 

(46

)

 

Cumulative translation adjustment

 

 

69

 

 

 

67

 

 

Additional minimum pension liability

 

 

(20

)

 

 

(19

)

 

Accumulated other comprehensive income

 

 

$

8

 

 

 

$

18

 

 

 

Note 13: Retirement and Post-Retirement Benefit Plans

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

 

 

 

2007

 

2006

 

2007

 

2006

 

  2007  

 

  2006  

 

 

 

 

 

 

 

In millions

 

 

 

 

 

Service cost

 

$

41

 

$

60

 

$

66

 

$

72

 

 

$

9

 

 

 

$

9

 

 

Interest cost

 

66

 

70

 

90

 

79

 

 

19

 

 

 

20

 

 

Expected return on plan assets

 

(87

)

(93

)

(142

)

(120

)

 

(9

)

 

 

(8

)

 

Amortization and deferrals:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Actuarial loss

 

(3

)

 

22

 

33

 

 

6

 

 

 

11

 

 

Prior service cost (benefit)

 

 

 

(2

)

(1

)

 

(13

)

 

 

(15

)

 

Net periodic benefit cost

 

17

 

37

 

34

 

63

 

 

12

 

 

 

17

 

 

Curtailment gain

 

 

 

(9

)

 

 

(9

)

 

 

(13

)

 

Net benefit cost

 

$

17

 

$

37

 

$

25

 

$

63

 

 

$

3

 

 

 

$

4

 

 

 

23




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 13: Retirement and Post-Retirement Benefit Plans (Continued)

Plan design changes

In the first quarter of fiscal 2007, HP recognized a net curtailment gain of $9 million for the Pre-2003 HP U.S. Retiree Medical Program. This gain reflects the reduction in the eligible plan population stemming from the U.S. Enhanced Retirement Program and the restructuring plans implemented in fiscal 2005. HP recorded such gain as a reduction of restructuring charges in the first quarter of fiscal 2007.

In the first quarter of fiscal 2007, HP recognized a net curtailment gain of $9 million for its non-U.S. pension plans. The net gain primarily reflects a plan design change in Mexico where HP ceased pension accruals for current employees who did not meet defined criteria based on age and years of service (calculated as of December 31, 2006).

On February 20, 2007, HP announced it will modify its U.S. defined benefit pension plan for those employees currently accruing benefits under the program, effective January 1, 2008. The final pension benefit amount will be calculated based on pay and service through December 31, 2007. In addition, future eligibility for the Pre-2003 HP Retiree Medical Program will be limited to those employees who are within five years of satisfying the program’s eligibility criteria on June 30, 2007. These actions will result in reductions to the U.S. defined benefit and post-retirement plan obligations. The company estimates that it will record a one-time curtailment gain of approximately $500 million in the second quarter of fiscal 2007. As part of this announcement, HP is offering an option for eligible U.S. employees to participate in the 2007 EER. The cost for the 2007 EER is expected to be recorded in the second quarter of fiscal 2007 as restructuring charges. HP expects approximately 3,000 employees to exit the company by May 2007. Employees not wishing to take advantage of the 2007 EER will benefit from an increased company 401(k) match from 4 percent to 6 percent of eligible earnings. HP expects the curtailment gain to approximate the cost of the 2007 EER.

Employer Contributions and Funding Policy

HP previously disclosed in its Consolidated Financial Statements for the year ended October 31, 2006 that it expected to contribute approximately $120 million to its pension plans, approximately $15 million to cover benefit payments to U.S. non-qualified plan participants and approximately $80 million to cover benefit claims for HP’s post-retirement benefit plans. As of January 31, 2007, HP has made approximately $42 million and $13 million of contributions to non-U.S. pension plans and U.S. non-qualified plan participants, respectively, and paid $14 million to cover benefit claims for post-retirement benefit plans. HP presently anticipates making additional contributions of between $60 million and $80 million to its pension plans and expects to pay $58 million to cover benefit claims for post-retirement benefit plans during the remainder of fiscal 2007.

In August 2006, the Pension Protection Act of 2006 (the “Act”) was enacted into law. HP does not expect it to have a material impact on its current funding strategy for its U.S. pension plans.

Note 14: 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, which arise in the ordinary course of business. In accordance with SFAS No. 5,

24




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 14: Litigation and Contingencies (Continued)

“Accounting for Contingencies,” HP records a provision for a liability when management believes that it is both probable that a liability has been incurred and HP can reasonably estimate the amount of the loss. 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.

Pending Litigation, Proceedings and Investigations

Copyright levies. As described below, proceedings are ongoing against HP in certain European Union (“EU”) member countries, including litigation in Germany, seeking to impose levies upon equipment (such as multifunction devices (“MFDs”) and printers) and alleging that these devices enable producing private copies of copyrighted materials. The total levies due, if imposed, would be 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 are opposing the extension of levies to the digital environment and advocating compensation to rights holders through digital rights management systems.

VerwertungsGesellschaft Wort (“VG Wort”), a collection agency representing certain copyright holders, instituted non-binding arbitration proceedings against HP in June 2001 in Germany before the arbitration board of the Patent and Trademark Office. The proceedings relate to whether and to what extent copyright levies for photocopiers should be imposed in accordance with copyright laws implemented in Germany on MFDs that allegedly enable the production of copies by private persons. Following unsuccessful arbitration, VG Wort filed a lawsuit against HP in May 2004 in the Stuttgart Civil Court in Stuttgart, Germany seeking levies on MFDs sold from 1997 to 2001. On December 22, 2004, the court held that HP is liable for payments regarding MFDs sold in Germany and ordered HP to pay VG Wort an amount equal to 5% of the outstanding levies claimed plus interest on MFDs sold in Germany up to December 2001. VG Wort appealed this decision. On July 6, 2005, the Stuttgart Court of Appeals ordered HP to pay VG Wort levies based on the published tariffs for photocopiers in Germany (which range from EUR 38.35 to EUR 613.56 per unit) plus interest on MFDs sold in Germany up to December 2001. HP has appealed the Stuttgart Court of Appeals’ decision to the Bundesgerichtshof (the German Federal Supreme Court). On September 26, 2005, VG Wort filed an additional lawsuit against HP in the Stuttgart Civil Court in Stuttgart, Germany seeking levies on MFDs sold in Germany between 1997 and 2001, as well as for products sold from 2002 onwards. HP filed a response rejecting the claim in January 2006.

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

25




HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Notes to Consolidated Condensed Financial Statements (Continued)
(Unaudited)

Note 14: Litigation and Contingencies (Continued)

using ASCII code sold in Germany but did not determine the amount payable per unit. HP appealed this decision in January 2005 to the Higher Regional Court of Baden Wuerttemberg. On May 11, 2005, the Higher Regional Court issued a decision confirming that levies are due. On June 6, 2005, HP filed an appeal to the German Supreme Court in Karlsruhe.

In September 2003, VG Wort filed a lawsuit against Fujitsu Siemens Computer GmbH (“FSC”) in Munich State Court seeking levies on PCs. This is an industry test case in Germany, and HP has undertaken to be bound by a final decision. On December 23, 2004, the Munich State Court held that PCs are subject to a levy and that FSC must pay 12 euros plus compound interest for each PC sold in Germany since March 2001. FSC appealed this decision in January 2005 to the Higher Regional Court of Bavaria. On December 15, 2005, the Higher Regional Court affirmed the Munich State Court decision. FSC filed a notice of appeal with the German Supreme Court in February 2006.

On December 29, 2005, ZPU, a joint association of various German collection societies, instituted non-binding arbitration proceedings against HP before the arbitration board of the Patent and Trademark Office demanding reporting of every PC sold by HP in Germany from January 2002 through December 2005 and seeking a levy of 18.42 euros plus tax for each PC sold during that period. HP filed a notice of defense in connection with these proceedings in February 2006 and the grounds for its defense in May 2006.

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, 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.

Alvis v. HP is a defective product consumer class action filed in the District Court of Jefferson County, Texas in Ap