Exhibit 99.1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Compaq Computer Corporation
We have audited the accompanying consolidated balance sheet of Compaq Computer
Corporation as of December 31, 2000, and the related consolidated statement of
income, stockholders' equity, and cash flows for the year ended December 31,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Compaq Computer
Corporation at December 31, 2000, and the consolidated results of its operations
and its cash flows for the year ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 2 to the consolidated financial statements, effective
January 1, 2000, the Company changed its method of accounting for certain
product shipments.
/s/ Ernst and Young LLP
Houston, Texas
January 23, 2001
1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors
of Compaq Computer Corporation
In our opinion, the consolidated balance sheet as of December 31, 1999 and the
related consolidated statements of income, of cash flows and of stockholders'
equity for each of the two years in the period ended December 31, 1999 present
fairly, in all material respects, the financial position, results of operations
and cash flows of Compaq Computer Corporation and its subsidiaries at December
31, 1999 and for each of the two years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion. We have not audited the
consolidated financial statements of Compaq Computer Corporation for any period
subsequent to December 31, 1999.
/s/ PricewaterhouseCoopers LLP
Houston, Texas
January 25, 2000
2
COMPAQ COMPUTER CORPORATION
CONSOLIDATED BALANCE SHEET
December 31 (In millions, except par value) 2000 1999
-------- --------
ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 2,569 $ 2,666
Short-term investments .............................................. -- 636
Trade accounts receivable, net ...................................... 6,715 5,622
Leases and other accounts receivable ................................ 1,677 1,063
Inventories ......................................................... 2,161 2,008
Other assets ........................................................ 1,989 1,854
-------- --------
Total current assets ............................................ 15,111 13,849
Property, plant and equipment, net ..................................... 3,431 3,249
Other assets, net ...................................................... 6,314 10,179
-------- --------
Total assets..................................................... $ 24,856 $ 27,277
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term borrowings ............................................... $ 711 $ 453
Accounts payable .................................................... 4,233 4,380
Deferred income ..................................................... 1,089 972
Other liabilities ................................................... 5,516 6,033
-------- --------
Total current liabilities ....................................... 11,549 11,838
-------- --------
Long-term debt ......................................................... 575 --
-------- --------
Postretirement and other postemployment benefits ....................... 652 605
-------- --------
Commitments and contingencies
-------- --------
Stockholders' equity:
Preferred stock, $.01 par value
Shares authorized: 10 million shares; shares issued: none ....... -- --
Common stock and capital in excess of $.01 par value
Shares authorized: 3 billion
Shares issued: 2000 - 1,742 million; 1999 - 1,715 million ...... 8,039 7,627
Retained earnings ................................................... 5,347 4,948
Accumulated other comprehensive income .............................. 27 2,919
Treasury stock (shares: 2000 - 53 million; 1999 - 21 million) ...... (1,333) (660)
-------- --------
Total stockholders' equity ...................................... 12,080 14,834
-------- --------
Total liabilities and stockholders' equity....................... $ 24,856 $ 27,277
======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
3
COMPAQ COMPUTER CORPORATION
CONSOLIDATED STATEMENT OF INCOME
Year ended December 31 (In millions, except per share amounts) 2000 1999 1998
-------- -------- --------
Revenue:
Products ................................................... $ 35,667 $ 31,902 $ 27,372
Services ................................................... 6,716 6,623 3,797
-------- -------- --------
Total revenue .......................................... 42,383 38,525 31,169
-------- -------- --------
Cost of sales:
Products ................................................... 27,624 25,263 21,383
Services ................................................... 4,793 4,535 2,597
-------- -------- --------
Total cost of sales .................................... 32,417 29,798 23,980
-------- -------- --------
Selling, general and administrative expense .................... 6,044 6,341 4,978
Research and development ....................................... 1,469 1,660 1,353
Restructuring and related activities ........................... (86) 868 393
Purchased in-process technology ................................ -- -- 3,196
Other (income) expense, net .................................... 1,664 (1,076) (69)
-------- -------- --------
9,091 7,793 9,851
-------- -------- --------
Income (loss) before income taxes .............................. 875 934 (2,662)
Provision for income taxes ..................................... 280 365 81
-------- -------- --------
Income (loss) before cumulative effect of accounting change .... 595 569 (2,743)
Cumulative effect of accounting change, net of tax ............. (26) -- --
-------- -------- --------
Net income (loss) .............................................. $ 569 $ 569 $ (2,743)
======== ======== ========
Earnings (loss) per common share:
Basic:
Before cumulative effect of accounting change .............. $ 0.35 $ 0.35 $ (1.71)
Cumulative effect of accounting change, net of tax ......... (0.02) -- --
-------- -------- --------
$ 0.33 $ 0.35 $ (1.71)
======== ======== ========
Diluted:
Before cumulative effect of accounting change .............. $ 0.34 $ 0.34 $ (1.71)
Cumulative effect of accounting change, net of tax ......... (0.01) -- --
-------- -------- --------
$ 0.33 $ 0.34 $ (1.71)
======== ======== ========
Shares used in computing earnings (loss) per common share:
Basic ...................................................... 1,702 1,693 1,608
======== ======== ========
Diluted .................................................... 1,742 1,735 1,608
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
4
COMPAQ COMPUTER CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Cash flows from operating activities:
Net income (loss) ................................................... $ 569 $ 569 $ (2,743)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization ................................. 1,407 1,402 893
Investment impairment ......................................... 1,756 -- --
Gain on sale of businesses .................................... -- (1,182) --
Restructuring and related activities .......................... (86) 868 393
Purchased in-process technology ............................... -- -- 3,196
Deferred income taxes and other ............................... (26) 21 (53)
Changes in assets and liabilities, net of effects of
acquired and divested businesses:
Receivables ................................................ (1,920) 185 (1,736)
Inventories ................................................ (72) (97) 857
Accounts payable ........................................... (228) 135 589
Other assets and liabilities ............................... (835) (598) (518)
-------- -------- --------
Net cash provided by operating activities .............. 565 1,303 878
-------- -------- --------
Cash flows from investing activities:
Capital expenditures, net .......................................... (1,133) (1,185) (600)
(Increase) decrease in short-term investments ...................... 636 (636) 344
Acquisition of businesses, net of cash acquired .................... (370) (517) (1,413)
Other investing activities, net .................................... (364) (131) (798)
-------- -------- --------
Net cash used in investing activities .................. (1,231) (2,469) (2,467)
-------- -------- --------
Cash flows from financing activities:
Increase in short-term borrowings .................................. 258 453 --
Issuance (repayment) of long-term debt ............................. 575 -- (788)
Common stock transactions, net ..................................... (365) (93) 23
Dividends to stockholders .......................................... (170) (136) (95)
Payments to retire Digital preferred stock ......................... -- (400) --
Other financing activities ......................................... -- -- (18)
-------- -------- --------
Net cash provided by (used in) financing activities .... 298 (176) (878)
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents ............. 271 (83) 140
-------- -------- --------
Net decrease in cash and cash equivalents .............. (97) (1,425) (2,327)
Cash and cash equivalents at the beginning of the year ................... 2,666 4,091 6,418
-------- -------- --------
Cash and cash equivalents at the end of the year ......................... $ 2,569 $ 2,666 $ 4,091
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
5
COMPAQ COMPUTER CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL CASH FLOW INFORMATION
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Interest paid ........................ $ 288 $ 152 $ 175
Income taxes paid .................... $ 488 $ 415 $ 259
ACQUISITION OF BUSINESSES
Fair value of:
Assets acquired ................ $ 499 $ 811 $ 16,124
Liabilities assumed ............ (129) (201) (7,109)
Stock issued ................... -- -- (4,284)
Options issued ................. -- (60) (249)
-------- -------- --------
Cash paid ............................ 370 550 4,482
Less: Cash acquired .................. -- (33) (3,069)
-------- -------- --------
Net cash paid for acquisitions ....... $ 370 $ 517 $ 1,413
======== ======== ========
SALE OF BUSINESSES
Fair value of:
Equity proceeds ................ $ -- $ 1,597 $ --
Note receivable ................ -- 204 --
Cash received .................. -- 70 --
-------- -------- --------
-- 1,871 --
Less: Basis in net assets sold ....... -- (689) --
-------- -------- --------
Gain on sale of businesses ........... $ -- $ 1,182 $ --
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
6
COMPAQ COMPUTER CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
COMMON STOCK
------------------------ ACCUMULATED
PAR VALUE AND OTHER TOTAL
NUMBER OF CAPITAL IN RETAINED COMPREHENSIVE TREASURY STOCKHOLDERS'
(In millions) SHARES EXCESS OF PAR EARNINGS INCOME (LOSS) STOCK EQUITY
--------- ------------- -------- ------------- -------- -------------
Beginning balance, December 31, 1997 .............. 1,519 $ 2,096 $ 7,351 $ (18) $ -- $ 9,429
Comprehensive income:
Net loss ....................................... (2,743) (2,743)
Foreign currency translation adjustment ........ 20 20
Minimum pension liability adjustment ........... (38) (38)
-------------
Total comprehensive loss .......................... (2,761)
-------------
Issuance pursuant to stock option plans ........ 36 407 407
Issuance pursuant to acquisitions .............. 141 4,533 4,533
Stock option tax benefits and other ............ 2 234 234
Cash dividends ................................. (107) (107)
Repurchase treasury stock, at cost ............. (384) (384)
--------- ------------- -------- ------------- -------- -------------
Ending balance, December 31, 1998 ................. 1,698 $ 7,270 $ 4,501 $ (36) $ (384) $ 11,351
Comprehensive income:
Net income ..................................... 569 569
Changes in unrealized gains and losses on
investments, net of reclassifications ........ 2,978 2,978
Foreign currency translation adjustment ........ (26) (26)
Minimum pension liability adjustment ........... 3 3
-------------
Total comprehensive income ........................ 3,524
-------------
Issuance pursuant to stock option plans ........ 17 183 183
Issuance pursuant to acquisitions .............. 32 32
Stock option tax benefits ...................... 142 142
Gain on redemption of Digital preferred stock .. 22 22
Cash dividends ................................. (144) (144)
Repurchase of treasury stock, at cost .......... (276) (276)
--------- ------------- -------- ------------- -------- -------------
Ending balance, December 31, 1999 ................. 1,715 $ 7,627 $ 4,948 $ 2,919 $ (660) $ 14,834
Comprehensive income:
Net income ..................................... 569 569
Changes in unrealized gains and losses on
investments, net of reclassifications ........ (2,904) (2,904)
Foreign currency translation adjustment ........ (12) (12)
Minimum pension liability adjustment ........... 24 24
-------------
Total comprehensive loss .......................... (2,323)
-------------
Issuance pursuant to stock plans ............... 27 308 308
Stock option tax benefits ...................... 104 104
Cash dividends ................................. (170) (170)
Repurchase of treasury stock, at cost .......... (673) (673)
--------- ------------- -------- ------------- -------- -------------
Ending balance, December 31, 2000 ................. 1,742 $ 8,039 $ 5,347 $ 27 $ (1,333) $ 12,080
========= ============= ======== ============= ======== =============
The accompanying notes are an integral part of these
consolidated financial statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS. Founded in 1982, Compaq Computer Corporation ("Compaq")
is a leading global provider of enterprise technology and solutions. Compaq
designs, develops, manufacturers and markets hardware, software, solutions and
services, including industry-leading enterprise computing solutions,
fault-tolerant business-critical solutions, communication products, and desktop
and portable personal computers that are sold in more than 200 countries.
Compaq completed the acquisition of Digital Equipment Corporation
("Digital"), Shopping.Com ("SDC") and Zip2 Corp. ("Zip2") and purchased certain
assets and liabilities of InaCom Corp. ("Inacom") in June 1998, February 1999,
April 1999 and February 2000, respectively. These acquisitions were accounted
for as purchases. In August 1999, Compaq sold a majority interest in SDC, Zip2
and the AltaVista Company, a business acquired in the Digital acquisition
(collectively "AltaVista") to CMGI, Inc. ("CMGI"). Accordingly, Compaq's
consolidated financial statements include the results of operations from the
respective dates of acquisition through divestiture or December 31, 2000, as
applicable.
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the
accounts of Compaq and its controlled subsidiaries. All significant intercompany
transactions and balances have been eliminated.
USE OF ESTIMATES. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. Actual results could differ from those estimates.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS. Cash equivalents include highly
liquid, temporary cash investments having original maturity dates of three
months or less. Short-term investments include certificates of deposit,
commercial paper and other investments not qualifying as cash equivalents. For
reporting purposes, such cash equivalents and short-term investments are stated
at cost plus accrued interest which approximates fair value.
INVENTORIES. Inventories are stated at the lower of cost or market, cost being
determined on a first-in, first-out basis.
LONG-LIVED ASSETS. Property, plant and equipment are stated at cost less
accumulated depreciation. Major renewals and improvements are capitalized; minor
replacements, maintenance and repairs are charged to current operations.
Depreciation is computed by applying the straight-line method over the estimated
useful lives of the buildings (ten to thirty years) and by applying the
straight-line or accelerated methods over the estimated useful lives of
machinery and equipment (two to ten years). Leasehold improvements are amortized
over the shorter of the useful life of the improvement or the life of the
related lease. Compaq performs reviews for the impairment of long-lived assets
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.
LONG-TERM INVESTMENTS. Compaq holds minority equity investments in companies
having operations or technology in areas within Compaq's strategic focus.
Certain of the investments carry restrictions on immediate disposition.
Investments in public companies with restrictions of less than one year are
classified as available-for-sale and are adjusted to their fair market value
with unrealized gains and losses recorded as a component of accumulated other
comprehensive income. Upon disposition of these investments, the specific
identification method is used to determine the cost basis in computing realized
gains or losses. Declines in value that are judged to be other than temporary
are reported in other income and expense.
8
INTANGIBLE ASSETS. Intangible assets primarily relate to the value of the
installed customer base, proven research and development, and trademarks of
companies acquired, as well as capitalized software and goodwill. The cost of
the installed customer base, proven research and development, trademarks,
capitalized software and goodwill is amortized on a straight-line basis over the
estimated lives of fifteen years, five years, five years, up to three years and
up to ten years, respectively. Intangible assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable.
REVENUE RECOGNITION. Compaq recognizes revenue when persuasive evidence of an
arrangement exists, delivery has occurred, the sales price is fixed or
determinable and collectibility is probable. Generally, these criteria are met
at the time product is shipped. Provision is made at the time the related
revenue is recognized for estimated product returns, price protection and other
offerings which may occur under programs Compaq has with its customers. Compaq
provides for the estimated cost of product warranties upon shipment. When other
significant obligations remain after products are delivered, revenue is
recognized only after such obligations are fulfilled. Revenue from fixed price,
long-term contracts is generally recognized over the contract term using the
percentage of completion method, based on the achievement of external
milestones. Losses on fixed price contracts are recognized during the period in
which the loss first becomes apparent. Revenue in excess of billings on service
contracts is recorded as unbilled receivables and is included in trade accounts
receivable. Billings in excess of revenue recognized on service contracts are
recorded as deferred income until revenue recognition criteria are met. Revenue
earned from services is recognized ratably over the contractual period or as the
services are performed. Shipping and handling costs are included in cost of
goods sold.
FINANCING TRANSACTIONS. Compaq offers customer financing to assist customers in
their acquisition of Compaq's products through its leasing subsidiary, Compaq
Financial Services Corporation ("CFS"). At the time a financing transaction is
consummated, which qualifies as either a sales-type or direct financing lease,
Compaq records the total lease receivable net of unearned income and the
estimated residual value of the equipment. The non-current portion of lease
receivables and the residual value, net of unearned income, are included in
long-term other assets. Unearned income is recognized as finance income using
the interest method over the term of the lease. Leases not qualifying as either
sales-type or direct financing leases are accounted for as operating leases. The
underlying equipment is depreciated on a straight-line basis over the initial
term of the operating lease to its estimated residual value.
ADVERTISING COSTS. Advertising costs are charged to operations when incurred.
Advertising expenses for 2000, 1999 and 1998 were $370 million, $385 million and
$336 million, respectively.
FOREIGN CURRENCY. Compaq's foreign subsidiaries predominately have the U.S.
dollar designated as their functional currency. Financial statements of these
foreign subsidiaries are remeasured to U.S. dollars for consolidation purposes
using current rates of exchange for monetary assets and liabilities and
historical rates of exchange for nonmonetary assets and related elements of
expense. Revenue and other expense elements are remeasured at rates that
approximate the rates in effect on the transaction dates. Remeasurement gains
and losses are included in other income and expense. Certain foreign
subsidiaries designate the local currency as their functional currency and
related cumulative translation adjustments are included as a component of
accumulated other comprehensive income.
INCOME TAXES. Compaq accounts for income taxes under Statement of Financial
Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES. The asset and
liability approach is used to recognize deferred tax assets and liabilities for
the expected future tax consequences of temporary differences between the
carrying amounts and the tax bases of assets and liabilities. Compaq records a
valuation allowance to reduce the deferred tax assets to the amount that is more
likely than not to be realized.
9
EARNINGS PER COMMON SHARE. Basic earnings (loss) per common share is computed
using the weighted average number of common shares outstanding during the
period. Diluted earnings per common share is computed using the combination of
dilutive common share equivalents and the weighted average number of common
shares outstanding during the period. Incremental shares of 40 million and 42
million in 2000 and 1999, respectively, were used in the calculation of diluted
earnings per common share. Diluted loss per common share for 1998 is based only
on the weighted average number of common shares outstanding during the period,
as the inclusion of 60 million common share equivalents would have been
antidilutive. Stock options to purchase 107 million, 66 million and 13 million
shares of common stock in 2000, 1999 and 1998, respectively, were outstanding
but not included in the computation of diluted earnings (loss) per common share
because the option exercise price was greater than the average market price of
the common shares. For the year ended December 31, 1999, net income used in the
calculation of earnings per common share was adjusted to include a $22 million
gain on redemption of Digital preferred stock.
STOCK-BASED COMPENSATION. Compaq measures compensation expense for its
stock-based employee compensation plans using the intrinsic value method, and
has provided in Note 8 the pro forma disclosure of the effect on net income
(loss) and earnings (loss) per common share as if the fair value based method
had been applied in measuring compensation expense.
COMPREHENSIVE INCOME (LOSS). Other comprehensive income (loss) refers to
revenues, expenses, gains and losses that under accounting principles generally
accepted in the United States are included in comprehensive income (loss) but
are excluded from net income (loss) as these amounts are recorded directly as an
adjustment to stockholders' equity, net of tax. Compaq's other comprehensive
income (loss) is composed of unrealized gains and losses on available-for-sale
securities, foreign currency translation adjustments and adjustments made to
recognize additional minimum liabilities associated with Compaq's defined
benefit pension plans. Amounts relating to realized investment gains and losses
and investment impairment charges are reclassified from other comprehensive
income as they are included in net income.
SEGMENT DATA. Compaq reports segment data based on the management approach which
designates the internal reporting that is used by management for making
operating decisions and assessing performance as the source of Compaq's
reportable operating segments. Compaq also discloses information about products
and services, geographical areas and major customers.
RECENT PRONOUNCEMENTS. Effective January 1, 2001, Compaq adopted Statement of
Financial Accounting Standards No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS
AND HEDGING ACTIVITIES, as amended ("FAS 133"). This statement establishes a new
model for accounting for derivatives and hedging activities. Under FAS 133, all
derivatives must be recognized as assets and liabilities and measured at fair
value. The impact of the adoption will be based on factors such as specific
derivative and hedging activities, market conditions and contractual
arrangements at the date of adoption. The effect of the adoption will not have a
significant impact on Compaq's financial position or results of operations in
2001.
RECLASSIFICATIONS. Certain prior year amounts have been reclassified to conform
to the current year presentation.
NOTE 2. ACCOUNTING CHANGE
Effective January 1, 2000, Compaq adopted Staff Accounting Bulletin No.
101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, as amended ("SAB 101"), issued
by the Securities and Exchange Commission in December 1999. Compaq's adoption of
SAB 101 resulted in a change in method of accounting for certain revenue product
shipments. The cumulative effect of this accounting change was $38 million ($26
million, net of tax). The accounting change did not have a material effect on
revenue
10
and quarterly earnings during 2000. Compaq has restated its results for the
first three quarters of the year ended December 31, 2000, as reflected in the
Selected Quarterly Financial Data on page 27. Pro forma results for prior years
are not disclosed due to immateriality.
NOTE 3. ACQUISITIONS AND DIVESTITURES
In February 2000, Compaq acquired certain configuration and distribution
assets of Inacom, a provider of information technology services and products,
for approximately $370 million in cash and the assumption of certain related
liabilities. This acquisition was accounted for as a purchase. The estimated
purchase price was allocated to the assets acquired and liabilities assumed,
including goodwill of $230 million which is being amortized on a straight-line
basis over a period of ten years. Pro forma statements of operations reflecting
this acquisition are not shown as such disclosure is not material.
In August 1999, Compaq sold an 81.5 percent equity interest in AltaVista
for approximately 38 million CMGI common shares, CMGI preferred shares
convertible into 3.6 million CMGI common shares and a $220 million three-year
note receivable. In October 1999, CMGI converted the CMGI preferred shares held
by Compaq into 3.6 million CMGI common shares. The CMGI common shares acquired
by Compaq in this transaction carry certain restrictions whereby Compaq may not
sell more than 50 percent (20.8 million) of such shares prior to August 2001.
Total consideration received from CMGI was valued at $1.8 billion. After
adjusting for the net assets sold and for the expenses associated with the
divestiture, Compaq realized a gain of approximately $1.2 billion ($670 million,
net of tax). Compaq accounts for its minority investments in CMGI and AltaVista
under the cost method. All CMGI share information reflects CMGI's two-for-one
stock split, effective January 2000.
In April 1999, Compaq acquired Zip2 for an aggregate purchase price of
$341 million consisting of $307 million in cash, the issuance of employee stock
options to purchase AltaVista stock with a fair value of $28 million and other
acquisition costs. In February 1999, Compaq acquired SDC for an aggregate
purchase price of $257 million consisting of $219 million in cash, the issuance
of employee stock options to purchase Compaq stock with a fair value of $32
million and other acquisition costs. These transactions were accounted for as
purchases.
In June 1998, Compaq consummated its acquisition of Digital for an
aggregate purchase price of $9.1 billion. The purchase price consisted of
approximately $4.5 billion in cash, the issuance of approximately 141 million
shares of Compaq common stock valued at approximately $4.3 billion and the
issuance of approximately 25 million options to purchase Compaq common stock
valued at approximately $249 million. This acquisition was accounted for as a
purchase. The unaudited consolidated pro forma information for 1998 as if Compaq
and Digital had been combined as of the beginning of 1998 included revenue and
net income of $36.4 billion and $275 million, respectively, and basic and
diluted earnings per common share of $0.16 each.
NOTE 4. CERTAIN BALANCE SHEET COMPONENTS
Compaq's trade accounts receivable are reported net of allowance for
doubtful accounts of $211 million and $222 million at December 31, 2000 and
1999, respectively. Other current assets include deferred tax assets of $1.7
billion and $1.5 billion at December 31, 2000 and 1999, respectively. The net
investment in lease receivables consisted of the following:
11
December 31 (In millions) 2000 1999
------- -------
Minimum lease payment receivable ............... $ 1,868 $ 1,160
Unguaranteed residual values ................... 122 59
Initial direct costs ........................... 21 12
Allowance ...................................... (27) (12)
Unearned income ................................ (217) (118)
------- -------
$ 1,767 $ 1,101
======= =======
Contractual maturities of Compaq's lease receivables at December 31, 2000
were $866 million in 2001, $601 million in 2002, $328 million in 2003, $66
million in 2004 and $7 million in 2005. Compaq also leases its products to
customers under operating leases. Minimum future rentals under operating leases
at December 31, 2000 were $426 million in 2001, $244 million in 2002 and $48
million in 2003.
Inventories consisted of the following:
December 31 (In millions) 2000 1999
------ ------
Raw material ............................. $ 540 $ 448
Work-in-progress ......................... 298 394
Finished goods ........................... 1,323 1,166
------ ------
$2,161 $2,008
====== ======
Property, plant and equipment consisted of the following:
December 31 (In millions) 2000 1999
-------- --------
Land ................................................. $ 342 $ 342
Buildings and leasehold improvements ................. 1,493 1,572
Machinery and equipment .............................. 3,786 3,095
Equipment leased to third parties .................... 1,166 741
Construction-in-process .............................. 261 301
-------- --------
7,048 6,051
Less: Accumulated depreciation ....................... (3,617) (2,802)
-------- --------
$ 3,431 $ 3,249
======== ========
Depreciation expense totaled $1.1 billion, $839 million and $606 million
in 2000, 1999 and 1998, respectively. Accumulated depreciation related to
equipment leased to third parties was $422 million and $224 million at December
31, 2000 and 1999, respectively.
Other non-current assets consisted of the following:
December 31 (In millions) 2000 1999
-------- --------
Investments .................................. $ 864 $ 6,617
Intangible assets ............................ 2,637 2,351
Deferred income taxes ........................ 1,604 342
Other assets ................................. 2,032 1,442
-------- --------
7,137 10,752
Less: Accumulated amortization ............... (823) (573)
-------- --------
$ 6,314 $ 10,179
======== ========
Amortization expense related to intangible assets totaled $313 million,
$563 million and $287 million in 2000, 1999 and 1998, respectively. The cost
basis and fair value of Compaq's available-for-sale securities at December 31,
2000 was $350 million and $461 million, respectively. Gross unrealized gains and
gross unrealized losses related to these investments at December 31, 2000 were
$132 million ($86 million, net of tax) and $21 million ($14 million, net of
tax), respectively. At December 31, 1999, the cost basis and fair value of
available-for-sale securities was $857 million and $5.4 billion, respectively,
and the cumulative unrealized gain was $4.6 billion ($3.0 billion, net of tax).
Compaq made
12
cash purchases of investments of approximately $480 million and $89 million
during 2000 and 1999, respectively.
Other current liabilities consisted of the following:
December 31 (In millions) 2000 1999
-------- --------
Salaries, wages and related items ...................... $ 922 $ 644
Accrued restructuring costs ............................ 343 1,002
Income taxes payable ................................... 769 992
Accrued warranties ..................................... 938 937
Other accrued liabilities .............................. 2,544 2,458
-------- --------
$ 5,516 $ 6,033
======== ========
NOTE 5. BORROWINGS
Compaq has a $2.2 billion revolving credit facility that expires in
September 2001 and a $3.0 billion revolving credit facility that expires in
October 2002. The facilities bear interest at LIBOR plus 0.625 percent and LIBOR
plus 0.325 percent, respectively. Fees associated with these facilities are
immaterial. Both of these facilities were unused at December 31, 2000 and 1999.
Compaq also operates two short-term commercial paper programs: a $1.5 billion
program in the name of Compaq Computer Corporation and a $1.0 billion program in
the name of CFS. Both programs are supported by the $3.0 billion credit
facility. Outstanding commercial paper reduces available borrowings under this
credit facility. At December 31, 2000, Compaq had $418 million and $218 million
in commercial paper outstanding under the Compaq and CFS programs, respectively,
with a weighted average interest rate of 7.5 percent. The carrying amounts of
the borrowings under the commercial paper program approximate their fair value.
Additionally, Compaq maintains various uncommitted lines of credit, which
totaled approximately $275 million at December 31, 2000. There were no
outstanding borrowings against these lines at December 31, 2000 and 1999.
Compaq filed a $2.0 billion shelf registration statement for debt
securities with the Securities and Exchange Commission during the second quarter
of 2000. In August 2000, Compaq placed under the registration statement $300
million of unsecured 7.65 percent notes that mature on August 1, 2005, and $275
million of unsecured 7.45 percent notes that mature on August 1, 2002
(collectively, the "Notes"), unless previously redeemed. Interest will be paid
on the Notes on February 1 and August 1 of each year, beginning on February 1,
2001. The fair value of the Notes approximates carrying value. The financing is
for general corporate purposes (including investments in CFS and other
subsidiaries), capital expenditures and repayment of outstanding indebtedness
(including commercial paper issued for working capital purposes). Compaq has the
capacity to issue an additional $1.4 billion of debt securities under the shelf
registration statement.
NOTE 6. OTHER INCOME AND EXPENSE
Other (income) expense consisted of the following:
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Investment (income) loss, net .............. $ 1,568 $ (67) $ (9)
Gain on sale of businesses ................. -- (1,182) --
Interest and dividend income ............... (276) (196) (287)
Interest expense ........................... 273 211 166
Currency losses, net ....................... 75 136 16
Other, net ................................. 24 22 45
-------- -------- --------
$ 1,664 $ (1,076) $ (69)
======== ======== ========
Net investment loss in 2000 included a $1.8 billion ($1.1 billion, net of
tax) impairment charge for certain equity investments judged to have experienced
an other than temporary decline in value, a $252 million ($164 million, net of
tax) realized gain on the sale of available-for-sale securities and a $77
13
million loss from investments accounted for under the equity method. Net
investment income in 1999 included a $126 million ($82 million, net of tax)
realized gain on the sale of available-for-sale securities and a $52 million
loss from investments accounted for under the equity method. Proceeds associated
with the sale of available-for-sale securities were $264 million and $149
million in 2000 and 1999, respectively.
NOTE 7. PROVISION FOR INCOME TAXES
The components of income (loss) before provision for income taxes were as
follows:
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Domestic ........................... $ 200 $ 94 $ (4,782)
Foreign ............................ 675 840 2,120
-------- -------- --------
$ 875 $ 934 $ (2,662)
======== ======== ========
The provisions for income taxes charged to operations were as follows:
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Current tax expense (benefit)
U.S. federal ............................. $ (91) $ 1 $ (92)
State and local .......................... 5 11 (9)
Foreign .................................. 353 460 312
-------- -------- --------
Total current ......................... 267 472 211
-------- -------- --------
Deferred tax expense (benefit)
U.S. federal ............................. (91) 47 (429)
State and local .......................... (2) 43 (11)
Foreign .................................. 106 (197) 310
-------- -------- --------
Total deferred ........................ 13 (107) (130)
-------- -------- --------
Total provision ....................... $ 280 $ 365 $ 81
======== ======== ========
The reasons for the differences between income tax expense and amounts
calculated using the U.S. statutory rate of 35 percent were as follows:
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Tax expense (benefit) at U.S. statutory rate. $ 306 $ 327 $ (932)
Foreign tax effect, net ..................... -- (31) (40)
Non-deductible purchased in-process
technology ................................ -- -- 1,119
Release of valuation allowance .............. -- -- (77)
Disposition of businesses ................... -- 77 --
Recovery of operating subsidiary stock basis. (61) -- --
Other, net .................................. 35 (8) 11
-------- -------- --------
Total provision........................ $ 280 $ 365 $ 81
======== ======== ========
Compaq's 2000 effective tax rate was primarily affected by the recovery of
tax basis in the stock of Microcom, Inc., a former operating subsidiary which
was acquired in 1997. In addition, Compaq decreased the level of activity of its
Singaporean manufacturing subsidiary which, when considered with other foreign
effects, reduced the beneficial foreign tax effect as had occurred in previous
years.
The Singapore tax holiday for manufacturing operations will continue
through August 2001 and could be extended through August 2004 if cumulative
investment levels and other conditions are maintained. Compaq ceased utilization
of a portion of its Singaporean manufacturing subsidiary's production capacity
during 2000. Consequently, the profitability of this facility has decreased
14
significantly resulting in a corresponding decrease in the impact of the tax
holiday on Compaq's effective tax rate during 2000.
Compaq's 1999 effective tax rate was primarily affected by benefits from
its Singaporean manufacturing subsidiary's tax holiday and by incremental taxes
resulting from the disposition of AltaVista. In connection with the 1998
acquisition of Digital, Compaq recorded non-recurring, non-tax-deductible
charges for purchased in-process technology of approximately $3.2 billion.
Compaq has determined that the undistributed earnings of certain foreign
subsidiaries will be permanently reinvested. As a result of these
determinations, no incremental tax is reflected for the earnings of Compaq's
Singaporean manufacturing subsidiary or for the earnings of certain other
foreign subsidiaries. These earnings would become subject to incremental Foreign
withholding, federal and state income tax if they were actually or deemed to be
remitted to the U.S. Compaq estimates an additional tax provision of
approximately $2.1 billion would be required if the full amount of approximately
$6.2 billion in accumulated earnings were actually or deemed distributed to the
U.S.
Compaq recorded a gross deferred tax asset of approximately $2.8 billion
in conjunction with the acquisition of Digital in 1998. This gross deferred tax
asset was reduced by a valuation allowance of $562 million, resulting in a net
increase in the deferred tax asset of approximately $2.2 billion in 1998. The
valuation allowance consisted principally of pre-acquisition tax loss
carryforwards and credit carryforwards incurred by Digital which management has
determined are more likely than not to expire unused. The valuation allowance
was reduced by $95 million during 2000 and $152 million during 1999 as a result
of tax loss and credit carryforward expirations.
During 1998, Compaq recorded $65 million of other tax loss and credit
carryforwards for which a full valuation allowance was provided due to
uncertainty surrounding their realizability. In addition, the valuation
allowance was reduced by $77 million to reflect Tandem Computers Incorporated
("Tandem") credit carryforwards which, as a result of the liquidation of the
U.S. Tandem parent company at the close of 1998, are now believed more likely
than not to be realized. This reduction in the valuation allowance resulted in a
tax benefit in the 1998 deferred income tax provision.
Deferred tax assets (liabilities) were as follows:
December 31 (In millions) 2000 1999
-------- --------
Loss carryforwards .................................... $ 379 $ 1,230
Credit carryforwards .................................. 1,109 960
Accrued liabilities ................................... 748 655
Tax versus financial reporting year-end ............... 446 --
Capitalized research and development costs ............ 349 449
Receivable allowances and related reserves ............ 278 380
Inventory adjustments ................................. 347 341
Other ................................................. 514 273
-------- --------
Gross deferred tax assets ......................... 4,170 4,288
-------- --------
Equity investments .................................... (46) (1,604)
Intangible assets ..................................... (333) (382)
Other ................................................. (87) (27)
-------- --------
Gross deferred tax liabilities .................... (466) (2,013)
-------- --------
Deferred tax asset valuation allowance ................ (434) (529)
-------- --------
Total deferred tax assset.......................... $ 3,270 $ 1,746
======== ========
Tax loss carryforwards will generally expire between 2001 and 2020. Credit
carryforwards will generally expire between 2001 and 2014. U.S. tax laws limit
the annual utilization of tax loss and credit
15
carryforwards of acquired entities. These limitations should not materially
impact the utilization of the tax carryforwards.
NOTE 8. EMPLOYEE STOCK PLANS
Compaq maintains various stock plans for its employees. Options to
employees are generally granted at the fair market value of the common stock at
the date of grant and generally vest over two to five years. Options granted to
employees under Compaq's stock option plans must be exercised no later than ten
years from the date of grant. The vesting period and option life for grants to
employees are at the discretion of the Board of Directors (the "Board").
Compaq also maintains plans under which it offers stock options to
non-employee directors. Pursuant to the terms of the plans under which directors
are eligible to receive options, each non-employee director is entitled to
receive options to purchase common stock upon initial appointment to the Board
(initial grants) and upon subsequent reelection to the Board (annual grants).
Initial grants are exercisable during the period beginning one year after
initial appointment to the Board and ending ten years after the date of grant.
Annual grants vest over two years and are exercisable thereafter until the tenth
anniversary of the date of grant. Both initial grants and annual grants have an
exercise price equal to the fair market value of Compaq's common stock on the
date of grant. Additionally, directors may elect to receive stock options in
lieu of all or a portion of the annual retainer to be earned. Such options are
granted at 50 percent of the price of Compaq's common stock at the date of grant
and are exercisable during the period beginning one year after the grant date
and ending ten years after the grant date. The expense resulting from options
granted at 50 percent of the price of Compaq's common stock at the grant date is
charged to operations over the vesting period.
Compaq had approximately 2 million shares of restricted stock outstanding
at December 31, 2000. Compaq records unearned compensation equal to the market
value of the restricted shares on the date of grant and charges the unearned
compensation to expense over the vesting period.
At December 31, 2000, there were 336 million shares of common stock
reserved for issuance under all of Compaq's stock option plans. For all plans,
options of 107 million, 101 million and 88 million shares were exercisable at
December 31, 2000, 1999 and 1998 with a weighted average exercise price of
$20.16, $16.13 and $11.76, respectively. There were 31 million, 123 million and
217 million shares available for grant under the plans at December 31, 2000,
1999 and 1998, respectively.
The following table summarizes stock option activity for each of the three
years ended December 31:
SHARES WEIGHTED AVERAGE
IN MILLIONS PRICE PER SHARE PRICE PER SHARE
----------- -------------------- ----------------
OPTIONS OUTSTANDING, DECEMBER 31, 1997............. 171 $ 13.63
Options granted in the acquisition of Digital.. 25 $ 5.94 - $ 39.23 22.23
Options granted................................ 13 $ 14.44 - $ 42.00 33.35
Options lapsed or canceled..................... (16) 21.84
Options exercised.............................. (36) $ 1.30 - $ 39.23 11.39
----------- ----------------
OPTIONS OUTSTANDING, DECEMBER 31, 1998............. 157 16.37
Options granted................................ 118 $ 3.36 - $ 47.63 31.42
Options lapsed or canceled..................... (24) 28.18
Options exercised.............................. (17) $ 1.30 - $ 39.23 9.66
----------- ----------------
OPTIONS OUTSTANDING, DECEMBER 31, 1999............. 234 23.37
Options granted................................ 119 $ 15.04 - $ 34.08 22.74
Options lapsed or canceled..................... (30) 29.99
Options exercised.............................. (23) $ 1.58 - $ 31.25 10.40
----------- ----------------
OPTIONS OUTSTANDING, DECEMBER 31, 2000............. 300 $ 23.45
=========== ----------------
16
The following table summarizes significant ranges of outstanding and
exercisable options at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- -----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
RANGES OF SHARES REMAINING EXERCISE SHARES EXERCISE
EXERCISE PRICES IN MILLIONS LIFE IN YEARS PRICE IN MILLIONS PRICE
- ---------------- ----------- ------------- --------- ----------- --------
under $5.00 15 1.8 $ 3.20 15 $ 3.20
5.01 to 10.00 20 3.7 8.82 20 8.82
10.01 to 15.00 8 4.3 12.40 8 12.36
15.01 to 20.00 77 9.0 17.67 13 16.22
20.01 to 25.00 20 7.5 23.25 10 23.27
25.01 to 30.00 122 8.7 26.54 22 26.61
over $30.00 38 7.1 43.34 19 42.34
----------- ------------- --------- ----------- --------
300 7.7 $ 23.45 107 $ 20.16
=========== ============= ========= =========== ========
In April 1999, Compaq's stockholders approved the Compaq Computer
Corporation Employee Stock Purchase Plan (the "ESPP") which became effective in
April 2000. Most employees are eligible to participate. Employees who choose to
participate are granted an option to purchase common stock at 85 percent of
market value on the first or last day of the six month purchase period,
whichever is lower. The ESPP authorizes the issuance, and the purchase by
employees, of up to 25 million shares of common stock through payroll
deductions. No employee is allowed to buy more than $25,000 of common stock in
any year, based on the market value of the common stock at the beginning of the
purchase period. During 2000, employees purchased approximately 2 million shares
for approximately $61 million under the ESPP. At December 31, 2000, there were
approximately 23 million shares available for future purchases under the ESPP.
The weighted average fair value per share of options granted during 2000,
1999 and 1998 was $11.80, $13.22 and $12.95, respectively. The weighted average
fair value per share of options granted under the ESPP during 2000 was $8.62.
The fair value for these options was estimated using the Black-Scholes model
with the following weighted average assumptions:
STOCK OPTIONS ESPP
-------------------------------- --------
Year ended December 31 2000 1999 1998 2000
-------- -------- -------- --------
Expected option life (in years)......... 6 5 5 0.5
Risk-free interest rate ................ 5.0% 5.5% 4.6% 6.3%
Volatility ............................. 49.7% 39.8% 33.5% 55.9%
Dividend yield ......................... 0.4% 0.3% 0.2% 0.4%
The table that follows summarizes the pro forma effect on net income
(loss) in the year presented if the fair values of stock-based compensation had
been recognized as compensation expense on a straight-line basis over the
vesting period of the grant. The following pro forma effect on net income (loss)
for the years presented is not representative of the pro forma effect on net
income (loss) in future years because it does not take into consideration pro
forma compensation expense related to grants made prior to 1995.
17
Year ended December 31 (In millions, except per share amounts) 2000 1999 1998
-------- -------- --------
Income (loss) before income taxes:
As reported ...................................................... $ 875 $ 934 $ (2,662)
Pro forma ........................................................ 293 623 (2,832)
Net income (loss):
As reported ...................................................... 569 569 (2,743)
Pro forma ........................................................ 191 367 (2,854)
Diluted earnings (loss) per share:
As reported ...................................................... 0.33 0.34 (1.71)
Pro forma ........................................................ 0.11 0.23 (1.77)
NOTE 9. STOCKHOLDERS' EQUITY
On December 29, 2000, the Board approved a cash dividend of $0.025 per
share of common stock, or approximately $43 million, to stockholders of record
as of December 31, 2000 to be paid in 2001. Total dividends declared in 2000,
1999 and 1998 were $170 million ($0.10 per share), $144 million ($0.085 per
share) and $107 million ($0.065 per share), respectively.
During 1998, a systematic common stock repurchase program was authorized
by the Board and implemented by Compaq. Compaq repurchased approximately 10
million shares during 2000, for a cost of approximately $303 million under this
program. The program was implemented to reduce the dilutive impact of common
shares issued under Compaq's equity incentive plans. On December 1, 2000, the
Board authorized a new program for the repurchase of up to $1 billion of Compaq
common shares. The systematic repurchase program initiated in 1998 has been
suspended while this new program is in effect. During 2000, total shares
repurchased to date under the new plan were 22 million, for a cost of
approximately $370 million. Compaq accounts for treasury stock using the cost
method.
In April 1999, Compaq redeemed the four million outstanding shares of the
Digital Series A 8-7/8 percent Cumulative Preferred Stock, par value $1.00 per
share. The redemption price was $400 million, plus accrued and unpaid dividends
of $9 million. Compaq realized a gain of $22 million on the redemption that was
recorded directly to retained earnings.
NOTE 10. PENSION AND OTHER BENEFIT PROGRAMS
Compaq sponsors a number of defined benefit and other postretirement
employee benefit plans ("OPEB Plans") that were acquired in the Digital
acquisition. Benefits under the defined benefit pension plans are generally
based on pay and service. In the U.S., the defined benefit plan is a cash
balance plan, under which the benefit is usually paid as a lump sum.
Compaq recorded an additional minimum liability as of December 31, 2000
and 1999 totaling $33 million and $78 million, respectively, for plans where the
accumulated benefit obligation exceeded the fair market value of assets.
The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for which the accumulated benefit obligations exceed plan
assets approximated $401 million, $324 million and $154 million, respectively,
for the year ended December 31, 2000, and $353 million, $332 million and $161
million for the year ended December 31, 1999. The measurement dates of the plans
were October 31, 2000 and 1999.
18
Information regarding Compaq's defined benefit and OPEB Plans was as
follows:
YEAR ENDED DECEMBER 31, 2000 YEAR ENDED DECEMBER 31, 1999
---------------------------- ----------------------------
DEFINED BENEFIT OPEB DEFINED BENEFIT OPEB
PENSION PLANS PLANS PENSION PLANS PLANS
------------------ ------- ------------------ -------
(In millions, except assumptions) U.S. FOREIGN (1) U.S. FOREIGN (1)
------- -------- ------- ------- -------- -------
Change in benefit obligation
Benefit obligation at beginning of year ......................... $ 2,085 $ 1,728 $ 344 $ 2,203 $ 1,831 $ 335
Service cost .................................................... 40 66 6 41 65 10
Interest cost ................................................... 147 94 25 140 96 24
Actuarial (gain) loss............................................ (127) 144 (11) (99) (37) 5
Curtailment (gain) loss ......................................... -- (7) -- 13 (55) (7)
Benefits paid ................................................... (204) (70) (30) (213) (120) (27)
Currency loss ................................................... -- (172) (1) -- (101) (1)
Other ........................................................... -- (16) 5 -- 49 5
------- -------- ------- ------- -------- -------
Projected benefit obligation at end of year ................... 1,941 1,767 338 2,085 1,728 344
------- -------- ------- ------- -------- -------
Change in plan assets
Fair value of plan assets at beginning of year .................. 2,371 1,827 -- 2,198 1,813 --
Actual return on plan assets .................................... 174 233 -- 381 209 --
Benefits paid ................................................... (204) (70) (30) (213) (120) (26)
Currency loss ................................................... -- (161) -- -- (114) --
Other ........................................................... 3 5 30 5 39 26
------- -------- ------- ------- -------- -------
Fair value of plan assets at end of year ..................... 2,344 1,834 -- 2,371 1,827 --
------- -------- ------- ------- -------- -------
Funded status ..................................................... 403 67 (338) 286 99 (344)
Unrecognized net actuarial (gain) loss ............................ (179) 82 (22) (94) 124 (11)
Unrecognized prior service cost ................................... -- 50 3 -- 45 4
------- -------- ------- ------- -------- -------
Prepaid (accrued) benefit cost .................................. 224 199 (357) 192 268 (351)
Contributions after measurement date ............................ -- 8 -- -- 5 --
------- -------- ------- ------- -------- -------
Prepaid (accrued) benefit cost ............................... $ 224 $ 207 $ (357) $ 192 $ 273 $ (351)
======= ======== ======= ======= ======== =======
Amounts included in the Consolidated Balance Sheet are composed of:
Prepaid benefit cost ............................................ $ 230 $ 344 $ -- $ 199 $ 377 $ --
Accrued benefit liability ....................................... (6) (170) (357) (8) (182) (351)
Other assets .................................................... -- 22 -- -- 44 --
Accumulated other comprehensive income .......................... -- 11 -- 1 34 --
------- -------- ------- ------- -------- -------
Net amount recognized ......................................... $ 224 $ 207 $ (357) $ 192 $ 273 $ (351)
------- -------- ------- ------- -------- -------
Weighted average assumptions as of October 31
Discount rate ................................................... 8.00% 5.75% 8.00% 7.50% 5.75% 7.50%
Expected return on plan assets .................................. 9.00% 7.35% N/A 9.00% 7.50% N/A
Rate of compensation increase ................................... 4.50% 3.60% N/A 4.50% 3.30% N/A
Health care cost trend rate, current year ....................... N/A N/A 5.50% N/A N/A 5.50%
Health care cost trend rate, ultimate year ...................... N/A N/A 5.00% N/A N/A 5.00%
Trend rate decreases to the ultimate rate in the year ........... N/A N/A 2001 N/A N/A 2001
Components of net periodic benefit cost
Service cost .................................................... $ 40 $ 66 $ 6 $ 41 $ 65 $ 10
Interest cost ................................................... 147 94 25 140 96 24
Expected return on plan assets .................................. (199) (125) -- (191) (138) --
Settlement/curtailment gain ..................................... (17) (3) -- (9) (4) (7)
Other ........................................................... -- 9 1 -- 3 (1)
------- -------- ------- ------- -------- -------
Net periodic pension cost ..................................... $ (29) $ 41 $ 32 $ (19) $ 22 $ 26
======= ======== ======= ======= ======== =======
(1) The OPEB Plans are consolidated to include both U.S. and foreign results.
Foreign results are immaterial for separate disclosure.
19
Assumed healthcare cost trend rates could have an effect on the amounts
reported for the healthcare plans. A one-percentage point increase in rates
would result in an increase of $3 million in the total service and interest
costs components and a $34 million increase in the postretirement benefit
obligation. Conversely, a one-percentage point decrease in rates would result in
a decrease of $3 million in total service and interest costs and a $29 million
decrease in the postretirement benefit obligation.
Compaq has defined contribution plans under which Compaq makes matching
contributions based on employee contributions. These plans are intended to
qualify as deferred compensation plans under Section 401(k) of the Internal
Revenue Code of 1986. Contributions are invested at the direction of the
employee in one or more funds, including a fund that consists of common stock of
Compaq. Amounts charged to expense were $138 million, $121 million and $98
million in 2000, 1999 and 1998, respectively.
Compaq has an incentive compensation plan for the majority of its
employees. Payments under the plan are based on a uniform percentage of
employees' base pay as determined by a matrix using financial performance as
defined by the plan and customer satisfaction results. Payments are made
semiannually. Amounts charged to expense were $106 million, $26 million and $68
million in 2000, 1999 and 1998, respectively.
NOTE 11. RESTRUCTURING AND RELATED ACTIVITIES
During 2000, Compaq substantially completed all of the actions
contemplated under the 1998 and 1999 restructuring plans. In December 2000,
Compaq reversed excess reserves of $86 million for employee separations,
facility closure costs and other costs related to the 1999 plan. Accrued costs
under both plans at December 31, 2000 include amounts for actions that have
already been taken, but for which expenditures have not yet been made.
In September 1999, Compaq's management approved a restructuring plan to
realign Compaq's organization, reduce infrastructure and overhead, and eliminate
excess and duplicative facilities. Restructuring and related charges of $868
million ($600 million, net of tax) were expensed. These charges were composed of
$787 million of accrued restructuring costs, $58 million of related asset
impairment charges and a $23 million pension curtailment loss to recognize a
change in Compaq's projected pension benefit obligation in connection with
employee separations. Costs for employee separations related to approximately
7,000 employees worldwide affecting the majority of business functions, job
classes and regions, predominantly occurring in North America and Europe.
Employee separation benefits include severance, medical and other benefits.
In June 1998, Compaq recorded a restructuring charge of approximately $1.7
billion to integrate the operations of Compaq and Digital, consolidate
duplicative facilities, improve service delivery and reduce overhead.
Approximately $1.5 billion was related to the acquisition of Digital and
recorded as a component of purchase accounting and $286 million related to
Compaq and was charged to operations. During 1998, Compaq also recorded a $107
million charge related to asset impairments.
20
An analysis of accrued costs and amounts charged against the provision
follows:
BEGINNING DECEMBER 31, EXPENDITURES DECEMBER 31,
(In millions) ACCRUAL EXPENDITURES 1999 AND ADJUSTMENTS 2000
--------- ------------ ------------ --------------- ------------
1999 PLAN
Employee separations .................................... $ 491 $ (68) $ 423 $ (321) $ 102
Facility closure costs .................................. 96 -- 96 (50) 46
Contract cancellation and other exit costs .............. 200 (167) 33 (28) 5
--------- ------------ ------------ --------------- ------------
$ 787 $ (235) $ 552 $ (399) $ 153
--------- ------------ ------------ --------------- ------------
1998 PLAN
Employee separations .................................... $ 1,131 $ (962) $ 169 $ (106) $ 63
Facility closure costs .................................. 414 (184) 230 (124) 106
Relocation .............................................. 99 (65) 34 (18) 16
Other exit costs ........................................ 100 (83) 17 (12) 5
--------- ------------ ------------ --------------- ------------
$ 1,744 $ (1,294) $ 450 $ (260) $ 190
--------- ------------ ------------ --------------- ------------
$ 2,531 $ (1,529) $ 1,002 $ (659) $ 343
========= ============ ============ =============== ============
Employee separations related to the 1998 and 1999 restructuring plans were
1,100 and 4,900, respectively, during 2000. Total employee separations related
to the 1998 and 1999 restructuring plans were 23,400 as of December 31, 2000.
NOTE 12. SEGMENT DATA
During 2000, Compaq realigned the operations of its Enterprise Solutions
and Services segment, which resulted in the formation of two reportable
segments: Enterprise Computing and Compaq Global Services. Compaq's other two
reportable segments, Commercial Personal Computing and Consumer, were unaffected
by the realignment. Enterprise Computing designs, develops, manufactures and
markets advanced computing and telecommunication products, including
business-critical servers, industry-standard servers and storage products.
Compaq Global Services delivers worldwide infrastructure and solution design
implementation, management and support services through Professional and
Customer Services. Commercial Personal Computing delivers standards-based
computing emphasizing Internet access through workstations, desktops, portables,
monitors, Internet access devices and life-cycle management products. The
Consumer segment targets home users with Internet-ready desktops and portables,
printers and related products, as well as Internet access and e-services.
Business activities that do not qualify for separate segment reporting are
aggregated in Other. Financial data for prior periods has been restated to
conform to the current presentation.
The accounting policies of the segments are the same as those used in the
preparation of Compaq's consolidated financial statements. Compaq evaluates the
performance of its operating segments based on segment operating income, which
includes sales and marketing expenses, research and development costs and other
overhead charges directly attributable to the operating segment. Certain
expenses which are managed outside of the operating segments are excluded. These
consist primarily of corporate and unallocated shared expenses, other income and
expense items, and other non-recurring charges such as purchased in-process
technology and restructuring and related activities. Corporate and unallocated
shared expenses consist primarily of indirect information management expenses,
certain costs related to business integration and other general and
administrative expenses that are separately managed. Gains and losses associated
with sale of businesses and investments are excluded from segment operating
income. Compaq does not include inter-segment transfers for management reporting
purposes. Asset information by operating segment is not reported since Compaq
does not identify assets by segment.
21
Summary financial data by operating segment was as follows:
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
ENTERPRISE COMPUTING
Revenue ....................... $ 14,316 $ 12,974 $ 10,498
Operating income .............. 2,140 1,201 948
COMPAQ GLOBAL SERVICES
Revenue ....................... 6,993 7,162 3,990
Operating income .............. 944 1,148 776
COMMERCIAL PERSONAL COMPUTING
Revenue ....................... 13,136 12,185 11,846
Operating income (loss) ....... 289 (448) (46)
CONSUMER
Revenue ....................... 7,586 5,994 4,932
Operating income .............. 170 262 183
OTHER
Revenue ....................... 352 210 (97)
Operating income (loss) ....... 27 (281) (115)
CONSOLIDATED SEGMENT TOTALS
Revenue ....................... $ 42,383 $ 38,525 $ 31,169
Operating income .............. $ 3,570 $ 1,882 $ 1,746
A reconciliation of Compaq's consolidated segment operating income to
consolidated income (loss) before income taxes follows:
Year ended December 31 (In millions) 2000 1999 1998
-------- -------- --------
Consolidated segment operating income ......... $ 3,570 $ 1,882 $ 1,746
Corporate and unallocated shared expenses ..... (1,117) (1,156) (888)
Restructuring and related activities .......... 86 (868) (393)
Purchased in-process technology ............... -- -- (3,196)
Other income (expense), net ................... (1,664) 1,076 69
-------- -------- --------
Income (loss) before income taxes ............. $ 875 $ 934 $ (2,662)
======== ======== ========
Geographic revenue and long-lived assets related to operations as of
and for the years ended December 31, were as follows:
(In millions) 2000 1999 1998
-------- -------- --------
Revenue:
United States .............................. $ 18,966 $ 17,351 $ 13,981
Europe, Middle East and Africa ............. 14,178 14,420 11,929
Other ...................................... 9,239 6,754 5,259
-------- -------- --------
$ 42,383 $ 38,525 $ 31,169
======== ======== ========
Long-lived assets:
United States .............................. $ 2,229 $ 2,332 $ 2,166
Other ...................................... 1,202 917 736
-------- -------- --------
$ 3,431 $ 3,249 $ 2,902
======== ======== ========
22
NOTE 13. COMMITMENTS, CONTINGENCIES, FINANCIAL INSTRUMENTS AND FACTORS THAT MAY
AFFECT FUTURE OPERATIONS
DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS
Compaq primarily utilizes forward contracts and purchased foreign currency
options to reduce its exposure to potentially adverse changes in foreign
currency exchange rates and simple interest rate swaps to reduce exposure to
interest rate volatility. Compaq does not hold or issue financial instruments
for trading purposes nor does it hold or issue leveraged derivative financial
instruments.
Compaq's program to reduce currency exposure associated with the net
monetary assets of Compaq's international subsidiaries includes agreements to
exchange various foreign currencies for U.S. dollars. At December 31, 2000 and
1999, such forward contracts to sell foreign currencies, net of forward
contracts to purchase foreign currencies aggregated $4.2 billion and $2.6
billion, respectively. Generally, gains and losses associated with currency rate
changes on these forward contracts are recorded currently to income and are
reflected in accounts receivable or other current liabilities in Compaq's
consolidated balance sheet, while the interest element is recognized over the
life of each contract. The amount recorded in the consolidated balance sheet
approximates the fair value of such contracts at December 31, 2000 and 1999. The
maturity dates of the forward contracts which were outstanding at December 31,
2000 ranged from three days to nine months, except for CFS which had forward
contracts with maturity dates up to three years.
Compaq frequently utilizes forward contracts to protect Compaq from the
effects of currency fluctuations on anticipated but not firmly committed sales
which are expected to occur within a three-month period. These forward contracts
generally do not extend beyond the end of any quarter or year. Any gains or
losses and the interest element on these forward contracts are recognized as a
component of sales during each quarter. In prior years, Compaq hedged a portion
of its anticipated but not firmly committed sales of its international marketing
subsidiaries using purchased foreign currency options. Realized and unrealized
gains and the net premiums on these options are deferred and recognized as a
component of revenue in the same period that the related sales occur. Option
contracts aggregating $660 million were outstanding at December 31, 1999,
related to hedges of sales for the first half of the year. The unrealized gains
deferred on these contracts were not material.
Compaq does periodically enter into interest rate swap transactions for
the purpose of hedging interest rate exposure on existing or anticipated
liabilities. All interest rate swaps entered into by Compaq are for the sole
purpose of hedging existing or anticipated interest rate sensitive positions,
and not for speculation. At December 31, 1999, Compaq had entered into interest
rate swaps with a notional value of $250 million with maturity dates of up to
nine months. Amounts to be paid or received under interest rate swap agreements
are accrued as interest rates change and are recognized over the life of the
swap transactions as an adjustment to interest expense.
In the event of a failure to honor one of these forward or swap contracts
by one of the banks with which Compaq has contracted, management believes any
loss, which could be material, would be limited to the exchange rate
differential from the time the contract was made until the time it was
compensated. In the case of a default by a counterparty to an interest rate swap
transaction, management believes any loss would be limited to the interest rate
differential between market rates and the rates contractually set in the swap
contract. To the extent Compaq has option contracts outstanding, the amount of
any loss resulting from a breach of contract would be limited to the amount of
premiums paid for the options and the unrealized gain, if any, related to such
contracts.
Compaq enters into various other types of financial instruments in the
normal course of business. Fair values for certain financial instruments are
based on quoted market prices. For other financial instruments, fair values are
based on the appropriate pricing models using current market information. The
amounts ultimately realized upon settlement of these financial instruments will
depend on actual market conditions during the remaining life of the instruments.
Carrying values of cash and cash
23
equivalents, short-term investments, accounts receivable, accounts payable and
other current liabilities reflected in the December 31, 2000 and 1999
consolidated balance sheet approximate fair value at these dates.
CONCENTRATION OF CREDIT RISK
Compaq's cash, cash equivalents, short-term investments and accounts
receivable are subject to potential credit risk. Compaq's cash management and
investment policies restrict investments to low risk, highly liquid securities
and Compaq performs ongoing evaluations of the relative credit standing of the
financial institutions with which it deals.
Compaq distributes products primarily through third-party resellers and as
a result, maintains individually significant accounts receivable balances from
various major resellers. If the financial condition and operations of these
resellers deteriorate, Compaq's operating results could be adversely affected.
One such reseller, Ingram Micro, Inc., accounted for approximately 14 percent of
consolidated revenue in 2000 and 11 percent of accounts receivable as of
December 31, 2000, predominately in the Commercial Personal Computing segment.
In 1999, Ingram Micro accounted for approximately 11 percent of consolidated
revenue and 8 percent of accounts receivable at December 31, 1999. During these
periods, no other customer of Compaq accounted for 10 percent or more of
consolidated revenue. In 2000, Compaq's two largest resellers represented
approximately 21 percent of consolidated revenue and 15 percent of accounts
receivable at December 31, 2000. In 1999, Compaq's four largest resellers
represented approximately 22 percent of consolidated revenue and 12 percent of
accounts receivable at December 31, 1999. Compaq generally has experienced
longer accounts receivable cycles in its emerging markets, in particular
Asia-Pacific and Latin America, when compared to its U.S. and European markets.
In the event that accounts receivable cycles in these developing markets
lengthen further or one or more of Compaq's larger resellers in these regions
fails, Compaq's operating results could be adversely affected.
CONTINGENCIES
Certain of Compaq's resellers finance a portion of their inventories
through third-party finance companies. Under the terms of the financing
arrangements, Compaq may be required, in limited circumstances, to repurchase
certain products from the finance companies. Additionally, Compaq has on
occasion guaranteed a portion of certain resellers' outstanding balances with
third-party finance companies and financial institutions. Guarantees under these
and other arrangements were not significant at December 31, 2000 or 1999.
In January 2001, Compaq exercised an option to sell an investment in a
limited liability corporation accounted for under the equity method. Once the
sale of the investment closes and proceeds are received, Compaq expects to
record a gain.
FACTORS THAT MAY AFFECT FUTURE OPERATIONS
Compaq participates in a highly volatile industry that is characterized by
intense industry-wide competition for market share. Industry participants
confront aggressive pricing practices, continually changing customer demand
patterns and rapid technological developments. Compaq's operating results could
be adversely affected should Compaq be unable to successfully anticipate
customer demand accurately, manage its product transitions, inventory levels and
manufacturing processes efficiently, distribute its products quickly in response
to customer demand, differentiate its products from those of its competitors or
compete successfully in the markets for its new products.
Significant numbers of components are purchased from single sources due to
technology, availability, price, quality or other considerations. Key components
and processes currently obtained from single sources include certain of Compaq's
displays, microprocessors, application specific integrated circuits and other
custom chips, and certain processes relating to construction of the plastic
24
housing for Compaq's computers. In addition, new products introduced by Compaq
often initially utilize custom components obtained from only one source until
Compaq has evaluated whether there is a need for additional suppliers. In the
event that a supply of a key single-sourced material process or component were
delayed or curtailed, Compaq's ability to ship the related product in desired
quantities and in a timely manner could be adversely affected. Compaq attempts
to mitigate these risks by working closely with key suppliers on product plans,
strategic inventories and coordinated product introductions.
LITIGATION
Compaq is subject to legal proceedings and claims that arise in the
ordinary course of business. Compaq does not believe that the outcome of any of
those matters will have a material adverse effect on Compaq's consolidated
financial position, operating results or cash flows.
Compaq and certain of its current and former officers and directors are
named in two consolidated class action lawsuits pending in the United States
District Court for the Southern District of Texas, Houston Division. One lawsuit
was filed in 1998 and the other in 1999. The 1998 litigation consolidates five
class action lawsuits, brought by persons who purchased Compaq common stock from
July 10, 1997 through March 6, 1998. It asserts claims under Section 10(b) of
the Exchange Act and Rule 10b-5 promulgated thereunder and Section 20(a) of the
Exchange Act. Allegations in the 1998 lawsuit include the claim that the
defendants withheld information and made misleading statements about channel
inventory and factoring of receivables in order to inflate the market price of
Compaq's common stock and further alleges that certain of the individual
defendants sold Compaq common stock at the inflated prices. The 1999 litigation
also consolidates a number of class action lawsuits. The litigation is brought
on behalf of purchasers of Compaq common stock between January 27, 1999 and
April 9, 1999. It asserts claims for alleged violations of Section 10(b) of the
Exchange Act and Rule 10b-5 promulgated thereunder; Section 20(a) of the
Exchange Act; and Sections 11 and 15 of the Securities Act. Allegations in the
1999 litigation include the claim that certain defendants and Compaq issued a
series of materially false and misleading statements concerning Compaq's
prospects in 1999 in order to inflate the market price of Compaq's common stock
and further alleges that certain of the individual defendants sold Compaq common
stock at the inflated prices. Lead counsels for the plaintiffs have been
appointed in both the 1998 and 1999 litigation. The plaintiffs seek monetary
damages, interest, costs and expenses in both the 1998 and 1999 litigation. In
the 1998 litigation, the court entered an order granting class certification on
July 18, 2000. Compaq has appealed class certification and is awaiting a
decision. Discovery has been stayed by order of the appellate court pending
their decision on the class certification appeal. On December 12, 2000, the
judge in the 1999 litigation dismissed the consolidated amended complaint after
finding that it failed to comply with pleading requirements under the law. The
plaintiffs filed a second amended complaint on January 31, 2001, which Compaq
will move to dismiss. Compaq is vigorously defending both lawsuits.
Several purported class action lawsuits were filed against Digital during
1994 alleging violations of the Federal Securities laws arising from alleged
misrepresentations and omissions in connection with Digital's issuance and sale
of Series A 8 7/8 percent Cumulative Preferred Stock and Digital's financial
results for the quarter ended April 2, 1994. During 1995, the lawsuits were
consolidated into three cases, which were pending before the United States
District Court for the District of Massachusetts. On August 8, 1995, the
Massachusetts federal court granted the defendants' motion to dismiss all three
cases in their entirety. On May 7, 1996, the United States Court of Appeals for
the First Circuit affirmed in part and reversed in part the dismissal of two of
the cases, and remanded for further proceedings. The parties are proceeding with
discovery.
Compaq is vigorously defending consumer class action lawsuits alleging
various defects in computers sold by Compaq. These lawsuits are pending in
Texas, North Carolina, Illinois, California, Colorado and Washington. A class
has been certified in the North Carolina case. All of these cases are
25
in the discovery stage. Three of these class actions (Thurmond v. Compaq, LaPray
v. Compaq, and Sprung v. Compaq) are part of a series of similar lawsuits filed
against other major computer manufacturers, involving claims that the computer
industry sold computers with allegedly defective floppy disk controllers.
Thurmond is pending in federal district court in Beaumont, Texas; LaPray in
Texas state court in Beaumont; Sprung in Colorado federal district court. No
class has been certified in any of these cases although a hearing on class
certification has been scheduled in the Thurmond case for March 19, 2001. Compaq
is also providing information to the federal government and state attorneys
general in California and Illinois in response to inquiries regarding floppy
disk controllers in computers sold to government entities.
Non-current other assets as of December 31, 2000 included approximately
$97 million ($22 million, net of reserve) owed to Compaq in connection with the
sale of products. Compaq believes such amounts were misdirected by its customers
to Inacom, which was acting as an agent for Compaq in connection with such
sales. Compaq believes that such funds were improperly applied to reduce
Inacom's indebtedness to its lenders. Inacom filed for bankruptcy on June 16,
2000 in the District of Delaware Bankruptcy Court. Compaq is seeking to realize
the full value of these receivables in an adversary proceeding filed October 20,
2000 against Inacom, Deutsche Bank, A.G. and other Inacom lenders. In the same
proceeding, Inacom has sued Compaq for approximately $41 million that Compaq is
holding as a setoff against the $97 million. Compaq has recorded a reserve of
$75 million related to this asset.
LEASE COMMITMENTS
Compaq leases certain manufacturing and office facilities and equipment
under noncancelable operating leases with terms from one to thirty years. Rent
expense for 2000, 1999 and 1998 was $347 million, $283 million and $205 million,
respectively.
Compaq's minimum rental commitments under noncancelable operating leases
at December 31, 2000 were approximately $235 million in 2001, $184 million in
2002, $136 million in 2003, $98 million in 2004, $69 million in 2005 and $376
million thereafter.
26
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
The table below sets forth selected unaudited financial data for each
quarter of the last two years.
(In millions, except per share amounts) 1ST 2ND 3RD 4TH
QUARTER(1) QUARTER(1) QUARTER(1) QUARTER
---------- ---------- ---------- --------
2000
Revenue ............................................................. $ 9,505 $ 10,135 $ 11,217 $ 11,526
Gross margin ........................................................ 2,184 2,388 2,683 2,711
Income (loss) before cumulative effect of accounting change(2) ...... 322 388 557 (672)
Basic earnings (loss) per common share(3) .................... $ 0.19 $ 0.23 $ 0.32 $ (0.39)
Diluted earnings (loss) per common share(3) .................. $ 0.19 $ 0.22 $ 0.31 $ (0.39)
Net income (loss) ................................................... 296 388 557 (672)
Basic earnings (loss) per common share(3) .................... $ 0.17 $ 0.23 $ 0.32 $ (0.39)
Diluted earnings (loss) per common share(3) .................. $ 0.17 $ 0.22 $ 0.31 $ (0.39)
1999
Revenue ............................................................. $ 9,419 $ 9,420 $ 9,208 $ 10,478
Gross margin ........................................................ 2,327 1,936 2,136 2,328
Net income (loss)(4) ................................................ 281 (184) 140 332
Earnings (loss) per common share(3)
Basic ............................................................ $ 0.17 $ (0.10) $ 0.08 $ 0.20
Diluted .......................................................... $ 0.16 $ (0.10) $ 0.08 $ 0.19
- ------------
(1) Effective January 1, 2000, Compaq adopted Staff Accounting Bulletin No.
101, REVENUE RECOGNITION IN FINANCIAL STATEMENTS, as amended. Compaq has
restated its results for the first three quarters of the year ended
December 31, 2000.
(2) Includes a $1.7 billion charge for impairment of investments in the fourth
quarter of 2000.
(3) Earnings (loss) per common share are computed independently for each of
the quarters presented and therefore may not sum to the total for the
year.
(4) Includes a $1.2 billion gain on the sale of a business and an $868 million
charge for restructuring and related charges to realign Compaq's
organization, reduce infrastructure and overhead, and eliminate excess and
duplicative facilities occurring in the third quarter of 1999.
27