“While a small component of current revenue, HP's Indigo digital publishing unit also showed strong growth in its active customer base and average page volumes per press. During the quarter, R.R. Donnelly announced its commitment to the HP Indigo Press as part of its new book-on-demand production systems.” PALO ALTO, Calif.--Aug. 27, 2002-- HP today reported financial results for its third fiscal quarter ended July 31, 2002. This is the company's first earnings report that includes the merger transaction with Compaq Computer Corp., which was completed May 3, 2002. (Results and comparisons in this release are stated on a combined company basis and reflect Compaq's prior fiscal quarter results as if combined with HP at the start of HP's prior fiscal quarters.(1)) The company reported third quarter revenue of $16.5 billion, compared to $18.2 billion on a combined company basis in the prior quarter. Sequentially, combined company revenue declined 9%, while pro forma gross margin increased from 25.5% to 25.7%. Pro forma operating expenses were up sequentially from 21.0% to 22.5% of net revenue, reflecting normal seasonality and merger-related sales training and product rollouts. Operating expenses were down 10% year over year, equivalent to $400 million on an absolute dollar basis. "Throughout our first 100 days, we've kept our eye on the ball," said Carly Fiorina, HP chairman and chief executive officer. "We're hitting all our integration milestones and are on track to meet our second-half targets. The top 50 contracts we won in the quarter totaled $2 billion in new long-term revenue, and we exit the quarter with almost $12 billion in cash and equivalents. While we have more work ahead, given the tough economy and a major integration, we've accomplished a great deal." Summary of Combined Company Financial Results ---------------------------------------------------------------------- Q3 FY2002 Q2 FY2002 Q3 FY2001 ---------------------------------------------------------------------- Revenues $16.5 billion $18.2 billion $18.6 billion ---------------------------------------------------------------------- Pro Forma Operating Margin 3.2% 4.5% 1.9% ---------------------------------------------------------------------- Pro Forma EPS - Fully Diluted $0.14 $0.19 $0.11 ---------------------------------------------------------------------- GAAP EPS ($0.67) n/a n/a ---------------------------------------------------------------------- Pro forma earnings per share (EPS) for the quarter was 14 cents, compared to 19 cents in the second quarter and 11 cents in the year-ago period, in both cases on a pro forma combined company basis. This represents a year-over-year net profit improvement of 31%. (All pro forma numbers have been adjusted to exclude certain acquisition-related charges and inventory write-downs, in-process research and development charges, amortization of goodwill and purchased intangibles, restructuring charges, net investment losses, net losses on divestiture, and litigation expense.) Reported GAAP EPS was ($0.67) per diluted share. Pro-forma EPS reflects a $2.4 billion adjustment on an after-tax basis. The pre-tax charges consist of a $1.6 billion restructuring charge; $735 million of in-process R&D; $322 million for merger-related retention; and $340 million for other merger-related items. "All of the careful merger planning that allowed us to meet our commitments and launch the company so seamlessly on May 7 is now focused on integration execution and meeting our business milestones," said Fiorina. "The merger gives us an opportunity to simultaneously reduce our cost structure, advance our market position and increase our ability to invest in key technologies. The pattern of our revenue declines in personal and enterprise systems is consistent with our merger planning assumptions. "As we approach the one-year mark of our merger announcement, the competitive landscape has, indeed, been transformed. We acted early and are moving through implementation, while our competitors are just now coming to grips with their own strategic and business model shifts. With our unique combination of standards-based platforms, advanced technologies, imaging and printing leadership, and world-class infrastructure services, we are more confident than ever of HP's opportunity to lead the industry." HP's integration progress was reflected in key third-quarter milestones, consistent with the company's targets and commitments made in June: * On track for synergies of $500 million in 2002, $2.5 billion in 2003 -- a year ahead of plan -- and $3 billion in 2004. * Completed nearly 4,740 net workforce reductions and remain on track to meet 10,000 target reductions by end of fiscal 2002; * Achieved $419 million in annualized direct procurement savings (76% of 2003 target), plus $52 million in annualized indirect procurement savings (21% of 2004 target); * Successfully integrated key financial IT systems, on track to meet $45 million goal in IT-related savings by fiscal year-end; * Reduced facilities square footage by 2% in third quarter and on track for targeted 19% reduction by 2004. In the midst of significant integration progress, HP also maintained its focus on customers. In recent weeks, HP has closed a number of very large contracts, including some key strategic win-backs. HP's 50 largest new business contracts -- with an average value of approximately $40 million each -- together represent $2 billion in incremental long-term revenue for the company. Highlights are included by business segment below. Business Segment Results "Despite the dual challenges of a weak IT market and a complex integration, our third quarter performance reflects an unwavering focus on customers and solid execution of our plans," said Michael Capellas, HP president. "We delivered product roadmaps, established our management structure, and have sales teams in place in every region. Imaging and printing posted strong year-over-year revenue, gross margin improvements and record operating margin. Personal systems revenue reflected product transitions in a difficult market. We remain focused on returning to profitability by further structural cost reductions, ramping our direct sales capabilities, and driving further penetration in the small-to-medium business market. "Clearly the most difficult product transitions were in the enterprise space. We made tough decisions in all areas, from servers to storage to software. Our industry-standard server and storage businesses sustained market leadership, and our services business continued to contribute significantly to the company's profitability. While we believe we have the industry's most compelling enterprise portfolio, we must accelerate our cost reductions. It's a promising start, and we're in a strong position to take the fight to the streets even harder, but we're mindful that there's much more to do." Imaging and Printing Revenue in HP's imaging and printing systems segment, which includes printer hardware, digital imaging devices, digital publishing equipment and associated supplies, increased 10% year-over-year and decreased 3% sequentially to $4.7 billion. Year-over-year increases in home printer product revenue were offset by declines in business hardware revenue due to continued weakness in IT spending. Year-over-year revenue for HP Photosmart photo printers grew 107%; all-in-one printer revenue grew 59%; and personal LaserJet revenue grew 14%. Combined company supplies revenue declined 4% sequentially and grew 19% year-over-year, driven by fast adoption of a new ink platform, new laser toner cartridges, and Premium Plus Photo paper. HP's strong gains in the photo media market have moved HP ahead of Kodak as the top supplier in U.S. retail share during the second calendar quarter, according to NPD Intellect (June 2002). The quarter's highlights include strong response to the largest consumer launch in the company's history, reflecting $1.2 billion in investment that will yield more than 50 new imaging and printing products worldwide, which feature new patented technologies that make it easier for people to capture, share and enjoy rich images. While a small component of current revenue, HP's Indigo digital publishing unit also showed strong growth in its active customer base and average page volumes per press. During the quarter, R.R. Donnelly announced its commitment to the HP Indigo Press as part of its new book-on-demand production systems. Combined company operating margin for the segment was 17.2%, compared to 15.7% last quarter and 7.9% in the prior year's quarter. This margin performance reflects a higher mix of supplies revenue; increased manufacturing efficiencies; and favorable hardware pricing in some markets. Personal Systems The personal systems segment includes commercial and consumer PCs, workstations, notebooks and personal appliances (smart handhelds and DVD+RW drives). Combined company revenue in this segment was $4.8 billion, down 18% sequentially and 19% year over year. Consumer PC revenue was down 31% sequentially and 20% year over year, whilecommercial PC revenue declined 11% sequentially and 15% year over year. Revenue decreases reflect poor macroeconomic conditions, intense price competition and post-merger product transitions. Combined company operating margin was negative 4.2%, compared to negative 2.8% last quarter and negative 6.4% a year ago. The year-over-year margin improvement in part reflects advances in HP's direct business, which represented 26% of PC shipments in the Americas and 53% of commercial PC shipments in the United States. In addition, commercial channel inventories were among the lowest ever for the business. During the quarter, the company streamlined the personal systems product portfolio and introduced new Compaq Evo desktop PCs, five new notebook platforms and the world's first Itanium(TM) 2-based workstations. Key customer wins included a $45 million contract to become Renault-Nissan's exclusive supplier of desktops and notebooks worldwide; Walt Disney Feature Animation's selection of Linux-based HP workstations for its next-generation digital animation; and a $35 million U.S. Internal Revenue Service contract to provide more than 12,000 desktop PCs and 11,000 notebooks. Enterprise Systems The enterprise systems segment includes a broad range of IT infrastructure systems and solutions for business, including UNIX, Linux and Windows-based servers, multi-platform storage and management software. Combined company revenue in this segment declined 8% sequentially and 22% year over year to $3.8 billion. This reflects continued weakness in global IT spending, aggressive competitive discounting and product transitions. Overall, business-critical servers revenue was down 31% over last year and down 13% sequentially. Industry-standard servers revenue was down 18% over last year and down 4% sequentially. Revenue in storage was down 15% year over year, less than half the decline of HP's nearest competitor, and down 10% sequentially. Revenue in software was down 21% year over year and 5% sequentially. Highlights included continued strong Superdome adoption, up 9% sequentially in unit shipments; the 17th quarter of Linux market-share leadership for HP ProLiant servers; and announcement of a strategic partnership with BEA Systems for middleware solutions. Key customer wins included: selection by Kookmin Bank in Korea of HP Superdome servers and storage to support a consolidated Internet banking system; a joint $200 million contract with Reuters, Intel and Red Hat to make Reuters Market Data Systems available on Linux; and with partner Lockheed Martin, a $70 million contract with Air Force Material Command for technical services and data storage solutions. Combined company operating margin was negative 11.2%, compared to negative 5.7% last quarter and positive 0.4% a year ago for the combined company. Services The HP Services segment includes customer support, managed services, and consulting and integration. Combined company revenue for the segment declined 7% year over year and 3% sequentially to $3.0 billion, largely due to declining consulting and integration demand. Combined company support revenue was down 1%, both sequentially and year over year, due to a slight slowdown in hardware sales and pressure on reducing service levels. Managed services revenue was up 2% sequentially and up 7% year-over-year, as customers turn to outsourcing to reduce their IT costs. Meanwhile, consulting and integration was down 9% sequentially and 25% year over year, as customers took on fewer large projects. Combined company operating margin for the IT services segment was 9.2%, compared to 11.7% for the last quarter and 12.0% for the same period last year. Highlights included strong demand for Microsoft services, storage services and printing services. Key wins included a multi-million dollar managed services contract with Microsoft to provide global technical support for 61,000 Microsoft employees; a major outsourcing contract with US Gypsum Corporation to host a .NET project; a three-year managed services contract with Agere Systems to provide nationwide service and support; and a managed services contract with Sonera Corporation in Europe. Financial Services HP Financial Services offers leasing and financial asset management services to HP customers worldwide, operating as a wholly owned subsidiary. Revenue was $510 million, up 1% sequentially and down 5% year over year, reflecting strong results in North America. Combined company operating margin was negative 4.7%, compared to negative 1.4% last quarter and negative 15.7% in the prior year. Total assets were slightly down quarter to quarter, reflecting a slower market and relative maturity of legacy HP portfolio. Asset Management HP exited the quarter with $11.7 billion in cash and short- and long-term equivalents. Inventory ended the quarter at $5.6 billion. Cash generated from operations for the quarter was $159 million, despite $327 million for retention bonuses, $227 million from payout of first-half performance bonuses and $113 million for pension funding. In addition, HP paid down nearly $2 billion in short-term commercial paper throughout the quarter. HP also issued $1.5 billion in long-term debt via its June Global Notes offering. HP's dividend of $0.08 in the third quarter resulted in a cash use of $245 million. In addition, HP spent $342 million on the repurchase of stock via its share buy-back programs. Trade receivables declined to $8.2 billion. Net property, plant and equipment ended at $7.1 billion. Outlook HP re-affirmed its second-half integration targets provided in June. For the fourth quarter 2002, HP affirmed Wall Street consensus estimates of $17.4 billion in revenues and $0.22 earnings per share on a pro forma basis. More information on this quarter's earnings is available on HP's Investor Relations site at http://www.hp.com/hpinfo/investor/financials/quarters/.