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Hewlett-Packard Company 10-Q 2009 Documents found in this filing:QuickLinks -- Click here to rapidly navigate through this document
UNITED STATES
FORM 10-Q
For the transition period from to Commission file number 1-4423
HEWLETT-PACKARD COMPANY
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No ý The number of shares of HP common stock outstanding as of February 28, 2009 was 2,396,613,014 shares.
Forward-Looking Statements This Quarterly Report on Form 10-Q, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report, contains forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties ever materialize or the assumptions prove incorrect, the results of Hewlett-Packard Company and its consolidated subsidiaries ("HP") may differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to any projections of revenue, margins, expenses, tax provisions, earnings, cash flows, benefit obligations, share repurchases, acquisition synergies, currency exchange rates or other financial items; any statements of the plans, strategies and objectives of management for future operations, including the execution of cost reduction programs and restructuring and integration plans; any statements concerning expected development, performance or market share relating to products or services; any statements regarding future economic conditions or performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include macroeconomic and geopolitical trends and events; the execution and performance of contracts by HP and its customers, suppliers and partners; the challenge of managing asset levels, including inventory; the difficulty of aligning expense levels with revenue changes; assumptions related to pension and other post-retirement costs; expectations and assumptions relating to the execution and timing of cost reduction programs and restructuring and integration plans; the possibility that the expected benefits of business combination transactions may not materialize as expected; the resolution of pending investigations, claims and disputes; and other risks that are described herein, including but not limited to the items discussed in "Factors that Could Affect Future Results" set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 2 of Part I of this report, and that are otherwise described from time to time in HP's Securities and Exchange Commission reports, including HP's Annual Report on Form 10-K for the fiscal year ended October 31, 2008. HP assumes no obligation and does not intend to update these forward-looking statements. 2
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The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. 4
The accompanying notes are an integral part of these Consolidated Condensed Financial Statements. 5
Note 1: Basis of Presentation and Significant Accounting Policies In the opinion of management, the accompanying Consolidated Condensed Financial Statements of Hewlett-Packard Company and its consolidated subsidiaries ("HP") contain all adjustments, including normal recurring adjustments, necessary to present fairly HP's financial position as of January 31, 2009, and its results of operations and cash flows for the three months ended January 31, 2009 and 2008. The Consolidated Condensed Balance Sheet as of October 31, 2008 is derived from the October 31, 2008 audited financial statements. Certain reclassifications have been made to prior-year amounts in order to conform to the current year presentation. The results of operations for the three months ended January 31, 2009 are not necessarily indicative of the results to be expected for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with "Risk Factors," "Legal Proceedings," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Quantitative and Qualitative Disclosures About Market Risk" and the Consolidated Financial Statements and notes thereto included in Items 1A, 3, 7, 7A and 8, respectively, of the Hewlett-Packard Company Annual Report on Form 10-K for the fiscal year ended October 31, 2008. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in HP's Consolidated Condensed Financial Statements and accompanying notes. Actual results could differ materially from those estimates. HP has expanded its significant accounting policy disclosures beginning this quarter to include the following summary of its existing policy relating to loss contingencies. This summary previously has appeared, and continues to appear, as part of HP's disclosure regarding litigation and contingencies in Note 15. HP is involved in various lawsuits, claims, investigations and proceedings that arise in the ordinary course of business. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies," HP records a provision for a liability when it believes it is both probable that a liability has been incurred and the amount can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount. HP reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Litigation is inherently unpredictable and is subject to significant uncertainties, some of which are beyond HP's control. As previously reported in HP's 2008 Annual Report on Form 10-K, HP recognized the funded status of its benefit plans at October 31, 2007 in accordance with the recognition provisions of SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of Financial Accounting Standards Board ("FASB") Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). In addition to the recognition provisions, SFAS 158 also requires companies to measure the funded status of the plan as of the date of their fiscal year end, effective for fiscal years ending after December 15, 2008. HP will adopt the measurement provisions of SFAS 158 effective October 31, 2009 for the HP pension and post retirement plans. HP does not expect the adoption of the measurement provisions of SFAS 158 will have a material effect on its consolidated results of operations and financial condition. 6
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 1: Basis of Presentation and Significant Accounting Policies (Continued) In February 2008, the FASB issued FASB Staff Position ("FSP") SFAS 157-2, "Effective Date of FASB Statement No. 157" ("FSP SFAS 157-2"). FSP SFAS 157-2 delays the effective date of SFAS No. 157, "Fair Value Measurements" ("SFAS 157") to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). As a result of adoption of FSP SFAS 157-2, HP will adopt SFAS 157 for all nonfinancial assets and nonfinancial liabilities in the first quarter of fiscal 2010. Although HP will continue to evaluate the application of SFAS 157 to nonfinancial assets and nonfinancial liabilities, HP does not expect the adoption of SFAS 157 with respect to nonfinancial assets and nonfinancial liabilities will have a material impact on its consolidated results of operations and financial condition. In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"). SFAS 141(R) expands the definition of a business and a business combination; requires recognition of assets acquired, liabilities assumed, and contingent consideration at their fair value on the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination and expensed as incurred; requires in-process research and development to be capitalized at fair value as an intangible asset; and requires that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. SFAS 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008 and will be adopted by HP in the first quarter of fiscal 2010. HP is currently evaluating the potential impact of the adoption of SFAS 141(R) on its consolidated results of operations and financial condition, which will be largely dependent on the size and nature of the business combinations completed after the adoption of this statement. Among other potential impacts, HP currently believes that the adoption of SFAS 141(R) will result in the recognition of certain types of expenses in its results of operations that are currently capitalized pursuant to existing accounting standards. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51" ("SFAS 160"). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent's ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008 and will be adopted by HP in the first quarter of fiscal 2010. HP is currently evaluating the potential impact, if any, of the adoption of SFAS 160 on its consolidated results of operations and financial condition. In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 161 requires entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative 7
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 1: Basis of Presentation and Significant Accounting Policies (Continued) instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity's financial position, results of operations and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 and will be adopted by HP in the second quarter of fiscal 2009. HP will present the required disclosures in the prescribed format on a prospective basis upon adoption. HP does not expect the adoption of SFAS 161 will have a material effect on its consolidated results of operations and financial condition. In May 2008, the FASB issued FSP Accounting Principles Board ("APB") 14-1 "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer's non-convertible debt borrowing rate. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis and will be adopted by HP in the first quarter of fiscal 2010. HP currently does not have any outstanding convertible debt instruments that are subject to the provisions of FSP APB 14-1. However, HP's U.S. dollar zero-coupon convertible notes that were redeemed in full in March 2008 are subject to the provisions of FSP APB 14-1. As a result, upon adoption of FSP APB 14-1 in the first quarter of fiscal 2010, HP's fiscal 2008 consolidated results of operations and financial condition will be affected on a retroactive basis. HP does not expect the adoption of FSP APB 14-1 will have a material effect on its consolidated results of operations and financial condition. In June 2008, the FASB issued FSP Emerging Issues Task Force ("EITF") 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities" ("FSP EITF 03-6-1"). FSP EITF 03-6-1 clarifies that share-based payment awards that entitle their holders to receive nonforfeitable dividends or dividend equivalents before vesting should be considered participating securities. HP has granted and is expected to continue to grant restricted stock that contain non-forfeitable rights to dividends and will be considered participating securities upon adoption of FSP EITF 03-6-1. As participating securities, HP will be required to include these instruments in the calculation of HP's basic earnings per share ("EPS"), and it will need to calculate basic EPS using the "two-class method." Restricted stock is currently included in HP's dilutive EPS calculation using the treasury stock method. The two-class method of computing EPS is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 on a retrospective basis and will be adopted by HP in the first quarter of fiscal 2010. HP is currently evaluating the potential impact, if any, the adoption of FSP EITF 03-6-1 will have on its calculation of EPS. In November 2008, the FASB ratified EITF Issue No. 08-7, "Accounting for Defensive Intangible Assets" ("EITF 08-7"). EITF 08-7 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. As these assets are separately identifiable, EITF 08-7 requires an acquiring entity to account for defensive intangible assets as a separate unit of accounting. Defensive intangible assets must be recognized at fair value in accordance with SFAS 141(R) and SFAS 157. 8
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 1: Basis of Presentation and Significant Accounting Policies (Continued) EITF 08-7 is effective for defensive intangible assets acquired in fiscal years beginning on or after December 15, 2008 and will be adopted by HP in the first quarter of fiscal 2010. HP is currently evaluating the potential impact, if any, of the adoption of EITF 08-7 on its consolidated results of operations and financial condition. In December 2008, the FASB issued FSP SFAS 132(R)-1, "Employer's Disclosures about Postretirement Benefit Plan Assets" ("FSP SFAS 132(R)-1"). FSP SFAS 132(R)-1 requires additional disclosures about assets held in an employer's defined benefit pension or other postretirement plan. FSP SFAS 132(R)-1 is effective for fiscal years ending after December 15, 2009 and will be adopted by HP in the first quarter of fiscal 2010. HP will present the required disclosures in the prescribed format on a prospective basis upon adoption. HP does not expect the adoption of FSP SFAS 132(R)-1 will have a material effect on its consolidated results of operations and financial condition. During the first quarter of fiscal 2009, HP adopted the following accounting standards, none of which had a material effect on its consolidated results of operations during such period or financial condition at the end of such period:
See Note 8 for additional information pertaining to SFAS 157, FSP SFAS 157-1, FSP SFAS 157-2, FSP SFAS 157-3 and SFAS 159. Note 2: Stock-Based Compensation HP's stock-based compensation plans include incentive compensation plans and an employee stock purchase plan. Incentive compensation plans include principal option plans as well as various stock option plans assumed through acquisitions. Principal option plans include performance-based restricted units ("PRU"), stock options and restricted stock awards. HP accounts for its stock-based compensation plans under SFAS No. 123(R), "Share-Based Payment". 9
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 2: Stock-Based Compensation (Continued) Total stock-based compensation expense for the three months ended January 31, 2009 and 2008 was as follows:
In fiscal 2008, HP implemented a program that provides for the issuance of PRUs representing hypothetical shares of HP common stock that may be issued under the Hewlett-Packard Company 2004 Stock Incentive Plan. Under the PRU program, a target number of units are awarded at the beginning of each three-year performance period. The number of shares released at the end of the performance period will range from zero to two times the target number depending on performance during the period. The performance metrics of the PRU program are (a) annual targets based on cash flow from operations as a percentage of revenue, and (b) an overall "modifier" based on Total Shareholder Return ("TSR") relative to the S&P 500 over the three-year performance period. TSR is calculated using the quarterly average performance of the S&P 500 during the three-year performance period. As the cash flow goals are considered performance conditions, the expense for these awards, net of estimated forfeitures, will be recorded over the three-year performance period based on the number of shares that are expected to be earned based on the achievement of the cash flow goals during the performance period. 10
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 2: Stock-Based Compensation (Continued) HP estimates the fair value of a target PRU share using the Monte Carlo simulation model, as the TSR modifier contains a market condition. The following weighted-average assumptions were used to determine the fair values of the PRU awards:
Outstanding PRUs as of January 31, 2009 and October 31, 2008 and changes during the three months ended January 31, 2009 were as follows (shares in thousands):
At January 31, 2009, there was $320 million of unrecognized pre-tax stock-based compensation expense related to PRUs with an assigned fair value, which HP expects to recognize over the remaining weighted-average period of 2.2 years. 11
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 2: Stock-Based Compensation (Continued) HP estimated the fair value of stock options using the Black-Scholes option pricing model with the following weighted-average assumptions and weighted-average fair values:
Option activity as of January 31, 2009 and changes during the three months ended January 31, 2009 were as follows:
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that option holders would have received had all option holders exercised their options on January 31, 2009. The aggregate intrinsic value is the difference between HP's closing stock price on the last trading day of the first quarter of fiscal 2009 and the exercise price, multiplied by the number of in-the-money options. Total intrinsic value of options exercised for the three months ended January 31, 2009 was $65 million. At January 31, 2009, there was $364 million of unrecognized pre-tax stock-based compensation expense related to stock options, which HP expects to recognize over the remaining weighted-average period of 1.4 years. 12
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 2: Stock-Based Compensation (Continued) Non-vested restricted stock awards as of January 31, 2009 and changes during the three months ended January 31, 2009 were as follows:
At January 31, 2009, there was $226 million of unrecognized pre-tax stock-based compensation expense related to non-vested restricted stock awards, which HP expects to recognize over the remaining weighted-average period of 1.2 years. HP sponsors the Hewlett-Packard Company 2000 Employee Stock Purchase Plan, also known as the Share Ownership Plan (the "ESPP"), pursuant to which eligible employees may contribute up to 10% of base compensation, subject to certain income limits, to purchase shares of HP's common stock. Employees purchase stock pursuant to the ESPP semi-annually at a price equal to 85% of the fair market value on the purchase date. HP recognizes expense based on a 15% discount from fair market value. Effective May 1, 2009, HP will discontinue offering the 15% discount. Note 3: Net Earnings Per Share HP calculates basic earnings per share using net earnings and the weighted-average number of shares outstanding during the reporting period. Diluted EPS includes any dilutive effect of outstanding restricted stock, stock options, restricted stock units and convertible debt. 13
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 3: Net Earnings Per Share (Continued) The reconciliation of the numerators and denominators of the basic and diluted EPS calculations was as follows:
HP excludes options with exercise prices that are greater than the average market price from the calculation of diluted EPS because their effect would be anti-dilutive. In the first quarter of fiscal 2009 and 2008, HP excluded 107 million shares and 35 million shares, respectively, from its diluted EPS calculation. Also, in accordance with SFAS 123R, HP excluded from the calculation of diluted EPS options to purchase an additional 1 million shares and 30 million shares in the first quarter of fiscal 2009 and 2008, respectively, whose combined exercise price, unamortized fair value and excess tax benefits were greater in each of those periods than the average market price for HP's common stock because their effect would be anti-dilutive. As disclosed in Note 2, HP granted PRU awards representing at target approximately 14 million shares and 9 million shares, respectively. HP includes the shares underlying PRU awards in the calculation of diluted EPS when they become contingently issuable per SFAS No. 128, "Earnings per Share," and excludes such shares when they are not contingently issuable. Accordingly, HP has included 2 million shares underlying the PRU awards granted in fiscal 2008 when calculating diluted EPS as those shares became contingently issuable upon the satisfaction of the cash flow from operations condition with respect to the first year of the performance period applicable to those awards. HP has excluded all other shares underlying the fiscal 2008 awards and all shares underlying the fiscal 2009 awards as those shares are not contingently issuable. In October and November 1997, HP issued U.S. dollar zero-coupon subordinated convertible notes due 2017 (the "LYONs"), the outstanding principal amount of which was redeemed in March 2008. The 14
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 3: Net Earnings Per Share (Continued) LYONs were convertible at the option of the holders at any time prior to maturity, unless previously redeemed or otherwise purchased. For purposes of calculating diluted earnings per share above, the interest expense (net of tax) associated with the LYONs was added back to net earnings, and the shares issuable upon conversion of the LYONs were included in the weighted-average shares used to compute diluted earnings per share for periods that the LYONs were outstanding. Note 4: Balance Sheet Details Balance sheet details were as follows:
HP has revolving trade receivables-based facilities permitting it to sell certain trade receivables to third parties on a non-recourse basis. The aggregate maximum capacity under these programs was $569 million as of January 31, 2009. HP sold $549 million of trade receivables during the first quarter of fiscal 2009. As of January 31, 2009, HP had $167 million available under these programs.
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Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 4: Balance Sheet Details (Continued)
Note 5: Acquisitions In the first quarter of fiscal 2009, HP completed the acquisition of Lefthand Networks, Inc., a leading provider of storage virtualization and solutions for approximately $347 million including direct transaction costs and the assumption of certain liabilities in connection with the transaction. HP recorded $273 million to goodwill, $95 million to purchased intangibles and $6 million to in-process research and development charges ("IPR&D") related to this acquisition. Lefthand Networks is being integrated into HP's Enterprise Storage and Servers segment within the Technology Solutions Group. HP does not expect goodwill recorded with respect to this acquisition to be deductible for tax purposes. HP has not presented pro forma results of operations because this acquisition is not material to HP's consolidated results of operations. As previously disclosed in its Consolidated Financial Statements for the fiscal year ended October 31, 2008, on August 26, 2008, HP completed its acquisition of EDS. The purchase price for EDS was $13.0 billion, comprised of $12.7 billion cash paid for outstanding common stock, $328 million for the estimated fair value of stock options and restricted stock units assumed, and $36 million for direct transaction costs. Of the total purchase price, a preliminary estimate of $10.5 billion has been allocated to goodwill, $4.5 billion has been allocated to amortizable intangible assets acquired and $2.0 billion has been allocated to net tangible liabilities assumed in connection with the acquisition. HP also expensed $30 million for IPR&D charges. The purchase price allocation as of the date of the acquisition reflects various preliminary estimates and analyses, including preliminary work performed by third-party valuation specialists, and is subject to change during the purchase price allocation period (generally one year from the acquisition date) as valuations are finalized. HP has evaluated and continues to evaluate certain pre-acquisition contingencies related to EDS that existed as of the acquisition date. Additional information, which existed as of the acquisition date but was at that time unknown to HP, may become known to HP during the remainder of the purchase price allocation period, and may result in goodwill adjustments. If these pre-acquisition contingencies become probable in nature and estimable after the end of the purchase price allocation period, amounts would be recorded for such matters in HP's results of operations. 16
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 5: Acquisitions (Continued) The following table presents the unaudited results of HP (including EDS) for the three months ended January 31, 2009 and the unaudited pro forma results for the three months ended January 31, 2008. The unaudited pro forma financial information for the three months ended January 31, 2008 combines the results of operations of HP and EDS as though the companies had been combined as of the beginning of fiscal 2008. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition and related borrowings had taken place at the beginning of fiscal 2008. The unaudited pro forma results presented include amortization charges for acquired intangible assets, eliminations of intercompany transactions, restructuring charges, IPR&D charges, adjustments for incremental stock-based compensation expense related to the unearned portion of EDS stock options and restricted stock units assumed, adjustments for depreciation expense for property, plant and equipment, adjustments to interest expense and related tax effects.
Note 6: Goodwill and Purchased Intangible Assets Goodwill allocated to HP's business segments as of January 31, 2009 and changes in the carrying amount of goodwill for the three months ended January 31, 2009 are as follows:
During the three months ended January 31, 2009, HP recorded a reduction of approximately $300 million to goodwill as a result of currency translation related to EDS's foreign subsidiaries whose functional currency is not the U.S. dollar. The reduction to goodwill was partially offset by adjustments of approximately $130 million to the estimated fair values of EDS's intangible assets and net liabilities acquired. 17
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 6: Goodwill and Purchased Intangible Assets (Continued) HP's purchased intangible assets associated with completed acquisitions are composed of:
For the three months ended January 31, 2009, HP recorded a reduction of approximately $100 million to purchased intangibles as a result of currency translation related to EDS's foreign subsidiaries whose functional currency is not the U.S. dollar. In addition, HP also recorded an adjustment of approximately $90 million to the estimated fair value of EDS's intangible assets acquired. Estimated future amortization expense related to finite lived purchased intangible assets at January 31, 2009 is as follows:
Note 7: Restructuring Charges In connection with the acquisition of EDS on August 26, 2008, HP's management approved and initiated a restructuring plan to streamline the combined company's services business and to better align the structure and efficiency of that business with HP's operating model. The restructuring plan is expected to be implemented over the next four years and will include changes to the combined company's workforce as well as changes to corporate overhead functions, such as real estate, IT and procurement. 18
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 7: Restructuring Charges (Continued) In the fourth quarter of fiscal 2008, HP recorded a liability of approximately $1.8 billion related to this restructuring plan. Approximately $1.5 billion of the liability was associated with pre-acquisition EDS and was recorded to goodwill, and the remaining approximately $0.3 billion was associated with HP and was recorded as a restructuring charge. The liability consisted mainly of severance costs to eliminate approximately 25,000 positions, costs to vacate duplicate facilities and costs associated with early termination of certain contractual obligations. For the three months ended January 31, 2009, HP recorded a net charge of $150 million, due primarily to adjustments for severance and facilities costs. As of January 31, 2009, over 9,000 positions have been eliminated. HP expects the majority of the restructuring costs to be paid out by the end of fiscal 2009. In future quarters, HP expects to record an additional charge of approximately $115 million related to severance costs and the cost to vacate duplicative facilities. Restructuring plans initiated prior to 2008 are substantially complete and HP expects to record only minor revisions to these plans as necessary. The adjustments to the accrued restructuring expenses related to all of HP's restructuring plans described above for the three months ended January 31, 2009 were as follows:
At January 31, 2009 and October 31, 2008, HP included the long-term portion of the restructuring liability of $667 million and $670 million, respectively, in Other liabilities, and the short-term portion in Accrued restructuring in the accompanying Consolidated Condensed Balance Sheets. As part of HP's ongoing business operations, HP incurred workforce rebalancing charges for severance and related costs within certain business segments during the first three months of fiscal 2009. Workforce rebalancing activities are considered part of normal operations as HP continues to 19
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 7: Restructuring Charges (Continued) optimize its cost structure. Workforce rebalancing costs are included in HP's business segment results, and HP expects to incur additional workforce rebalancing costs in the future. Note 8: Fair Value Effective November 1, 2008, HP adopted the effective portions of SFAS 157 as highlighted in Note 1. The adoption did not have a material impact on our financial statements and did not result in any changes to the opening balance of retained earnings as of November 1, 2008. SFAS 157 establishes a new framework for measuring fair value and expands related disclosures. The SFAS 157 framework requires fair value to be determined based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The valuation techniques required by SFAS 157 are based upon observable and unobservable inputs. Observable or market inputs reflect market data obtained from independent sources, while unobservable inputs reflect HP's assumptions about market participant assumptions based on best information available. Observable inputs are the preferred source of values. In accordance with SFAS 157, these two types of inputs create the following fair value hierarchy: Level 1 - Quoted prices (unadjusted) for identical instruments in active markets. Level 2 - Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 - Prices or valuations that require management inputs that are both significant to the fair value measurement and unobservable. The following section describes the valuation methodologies HP uses to measure its financial assets and liabilities at fair value. Cash Equivalents: HP holds money market funds investing mainly in treasury bills, which are classified under level 1. HP also invests in time deposits, commercial paper and treasury bills, which are classified under level 2. Investments: HP holds time deposits, corporate and foreign government notes and bonds, asset-backed securities, and common stock and equivalents. In general, and where applicable, HP uses quoted prices in active markets for identical assets or liabilities to determine fair value. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then HP uses quoted prices for similar assets and liabilities or inputs that are observable either directly or indirectly. If quoted prices for identical or similar assets are not available, HP uses internally developed valuation models, whose inputs include bid prices, and third party valuations utilizing underlying assets assumptions. Derivative Instruments: HP mainly holds non-speculative forwards, swaps and options to hedge certain foreign currency and interest rate exposures. HP uses quoted prices in an active market for identical derivative assets and liabilities that are traded on exchanges and, when active market quotes 20
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 8: Fair Value (Continued) are not available, HP uses industry standard valuation models, such as the Black-Scholes model. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, credit risk, foreign exchange rates, and forward and spot prices for currencies. In certain cases, market-based observable inputs are not available and, in those cases, HP uses management judgment to develop assumptions which are used to determine fair value. Other Liabilities: HP has a liability to company executives as part of the executive deferred compensation plan. The liability is linked to a group of mutual funds and indexes and is classified under level 1. The following table presents HP's assets and liabilities that are measured at fair value on a recurring basis at January 31, 2009:
The following table presents the changes in level 3 instruments measured on a recurring basis for the three months ended January 31, 2009. The majority of the level 3 balances consist of investment 21
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 8: Fair Value (Continued) securities classified as available-for-sale with changes in fair value recorded in other comprehensive income.
HP measures certain assets including cost and equity method investments, at fair value on a nonrecurring basis. These assets are recognized at fair value when they are deemed to be other-than-temporarily impaired. As of January 31, 2009, assets with a total fair value of $29 million were included in the level 3 hierarchy. HP recorded an impairment charge of $5 million during the first quarter of fiscal 2009. HP reviews the carrying values of the investments when events and circumstances warrant and considers all available evidence in evaluating when declines in fair value are other-than-temporary. The fair values of the investments are determined based on valuation techniques using the best information available, which may include quoted market prices, market comparables, and discounted cash flow projections. An impairment charge is recorded when the cost of the investment exceeds its fair value and is determined to be other-than-temporary. Effective November 1, 2008, HP also adopted SFAS 159, which allows an entity to choose to measure certain financial instruments and liabilities at fair value on a contract-by-contract basis. Subsequent fair value measurement for the financial instruments and liabilities an entity chooses to measure at fair value will be recognized in earnings. As of January 31, 2009, HP did not elect such option for any eligible financial instruments and liabilities. Note 9: Financing Receivables and Operating Leases Financing receivables represent sales-type and direct-financing leases resulting from the marketing of HP's and third-party products. These receivables typically have terms from two to five years and are usually collateralized by a security interest in the underlying assets. Financing receivables also include 22
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 9: Financing Receivables and Operating Leases (Continued) billed receivables from operating leases. The components of net financing receivables, which are included in financing receivables and long-term financing receivables and other assets, were as follows:
Equipment leased to customers under operating leases was $2.4 billion at January 31, 2009 and $2.3 billion at October 31, 2008 and is included in machinery and equipment. Accumulated depreciation on these operating leases was $0.6 billion at January 31, 2009 and $0.5 billion at October 31, 2008. Note 10: Guarantees In the ordinary course of business, HP may provide certain clients, principally governmental entities, with subsidiary performance guarantees and/or financial performance guarantees, which may be backed by standby letters of credit or surety bonds. In general, HP would be liable for the amounts of these guarantees in the event HP or HP's subsidiaries' nonperformance permits termination of the related contract by the client, the likelihood of which HP believes is remote. HP believes that the company is in compliance with the performance obligations under all material service contracts for which there is a performance guarantee. As a result of the acquisition of EDS, HP acquired certain service contracts supported by client financing or securitization arrangements. Under specific circumstances involving non performance resulting in service contract termination or failure to comply with terms under the financing arrangement, HP would be required to acquire certain assets. HP considers the possibility of its failure to comply to be remote and the asset amounts involved to be immaterial. In the ordinary course of business, HP enters into contractual arrangements under which HP may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of HP or for losses arising from certain events as defined within the particular contract, which may include, for example, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial. 23
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 10: Guarantees (Continued) HP provides for the estimated cost of product warranties at the time it recognizes revenue. HP engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its component suppliers; however, product warranty terms offered to customers, ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product class failures outside of HP's baseline experience, affect the estimated warranty obligation. If actual product failure rates, repair rates or any other post sales support costs differ from these estimates, revisions to the estimated warranty liability would be required. The changes in HP's aggregate product warranty liabilities for the three months ended January 31, 2009 were as follows:
Note 11: Borrowings Notes payable and short-term borrowings, including the current portion of long-term debt, were as follows:
Notes payable to banks, lines of credit and other includes deposits associated with HP's banking-related activities of approximately $247 million and $262 million at January 31, 2009 and October 31, 2008, respectively. 24
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 11: Borrowings (Continued) Long-term debt was as follows:
25
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 11: Borrowings (Continued) HP may redeem some or all of the Global Notes as set forth in the above table at any time at the redemption prices described in the prospectus supplements relating thereto. The Global Notes are senior unsecured debt. HP registered the sale of up to $3.0 billion of debt or global securities, common stock, preferred stock, depositary shares and warrants under a shelf registration statement in March 2002 (the "2002 Shelf Registration Statement"). The 2002 Shelf Registration Statement expired on December 1, 2008, and, accordingly, HP is no longer able to issue any additional securities under this Registration Statement. In May 2006, HP filed a shelf registration statement (the "2006 Shelf Registration Statement") with the Securities and Exchange Commission ("SEC") to enable HP to offer and sell, from time to time, in one or more offerings, an unlimited amount of debt securities, common stock, preferred stock, depositary shares and warrants. As of January 31, 2009, HP had $9.0 billion of global notes issued under the 2006 Shelf Registration Statement. On December 5, 2008, HP issued $2.0 billion of global notes under the 2006 Shelf Registration Statement. The global notes issued in December 2008 are due in March 2014, bear interest at a fixed interest rate of 6.125% per annum and were issued at a discount to par of 99.561%. HP used the net proceeds from these offerings for general corporate purposes and the repayment of short-term commercial paper, some of which was issued in connection with its acquisition of EDS. On February 26, 2009, HP issued an additional $2.8 billion of global notes under the 2006 Shelf Registration Statement. The global notes include $275 million of floating rate notes due February 2011 issued at par, $1.0 billion of notes due February 2012 with a fixed rate of 4.25% per annum issued at a discount to par of 99.956% and $1.5 billion of notes due June 2014 with a fixed rate of 4.75% per annum issued at a discount to par of 99.993%. HP used the net proceeds from these offerings for general corporate purposes and the repayment of short-term commercial paper, some of which was issued in connection with its acquisition of EDS. In May 2008, the Board of Directors approved increasing the capacity of HP's U.S. commercial paper program by $10.0 billion to $16.0 billion. HP's subsidiaries are authorized to issue up to an additional $1.0 billion of commercial paper, of which $500 million of capacity is currently available to be used by Hewlett-Packard International Bank PLC, a wholly-owned subsidiary of HP, for its Euro Commercial Paper/Certificate of Deposit Programme. In October 2008, HP registered for the Commercial Paper Funding Facility ("CPFF") provided by the Federal Reserve Bank of New York. The facility enables HP to issue three-month unsecured commercial paper through a special purpose vehicle of the Federal Reserve at a rate established by the CPFF program, which is currently equal to a spread over the three-month overnight index swap rate. The maximum amount of commercial paper that HP may issue at any time through this program is $10.4 billion less the total principal amount of all other outstanding commercial paper that HP has issued. As of January 31, 2009, HP had not issued any commercial paper under the CPFF program. In February 2009, the Federal Reserve extended the CPFF program through October 30, 2009. HP has a $2.9 billion five-year credit facility expiring in May 2012. In February and July 2008, HP entered into additional 364-day credit facilities of $3.0 billion and $8.0 billion, respectively. The February 2008 credit facility expired in February 2009, at which time HP entered into a new $3.5 billion 364-day credit facility. Commitment fees, interest rates and other terms of borrowing under the credit facilities vary based on HP's external credit ratings. The credit facilities are senior unsecured committed 26
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 11: Borrowings (Continued) borrowing arrangements primarily to support the issuance of U.S. commercial paper. Under the terms of the July 2008 $8.0 billion 364-day credit facility, the amount of credit available declines in an amount equal to the proceeds of any future issuance of long-term debt by HP. In December 2008 and February 2009, HP issued $2.0 billion and $2.8 billion, respectively, in global notes, which resulted in a reduction in the amount of credit available under the July 2008 credit facility to $3.2 billion. HP also maintains uncommitted lines of credit from a number of financial institutions that are available through various foreign subsidiaries. The amount available for use as of January 31, 2009 was approximately $1.4 billion. Included in Other, including capital lease obligations, are borrowings that are collateralized by certain financing receivable assets. As of January 31, 2009, the carrying value of the assets approximated the carrying value of the borrowings of $6.8 million. At January 31, 2009, HP had up to approximately $10.7 billion of available borrowing resources, including $9.3 billion under credit facilities that support primarily its commercial paper programs and approximately $1.4 billion under other programs. HP also may issue an unlimited amount of additional debt securities, common stock, preferred stock, depositary shares and warrants under the 2006 Shelf Registration Statement. Note 12: Income Taxes HP's effective tax rate was 18.0% and 20.6% for the three months ended January 31, 2009 and January 31, 2008, respectively. HP's effective tax rate generally differs from the U.S. federal statutory rate of 35% due to the tax rate benefits of certain earnings from HP's operations in lower-tax jurisdictions throughout the world. HP has not provided U.S. taxes for such earnings because HP plans to reinvest those earnings indefinitely outside the United States. There were no material discrete items affecting the tax rate for the three months ended January 31, 2009 and January 31, 2008, respectively. During the first three months of fiscal 2009, the amount of gross unrecognized tax benefits determined in accordance with Financial Interpretation No. 48, "Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109" ("FIN 48") increased by $171 million to $2.5 billion, of which up to $758 million would affect HP's effective tax rate if realized. HP recognizes interest expense and penalties on unrecognized tax benefits within income tax expense. During the first three months of fiscal 2009, there was no material change in the amount of accrued net interest and penalties. HP is subject to income tax in the United States and over sixty foreign countries and is subject to routine corporate income tax audits in many of these jurisdictions. In addition, HP is subject to numerous ongoing audits by state and foreign tax authorities. HP has received from the Internal Revenue Service ("IRS") Notices of Deficiency for its fiscal 1999, 2000 and 2003 tax years and Revenue Agent's Reports ("RAR's") for its fiscal 2001 and 2002 tax years. The IRS began an audit of HP's 2004 and 2005 income tax returns in 2007. With respect to major foreign and state tax jurisdictions, HP is no longer subject to tax authority examinations for years prior to 1999. HP believes that adequate reserves have been provided for all open tax years. 27
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 12: Income Taxes (Continued) HP engages in continuous discussion and negotiation with taxing authorities regarding tax matters in the various jurisdictions. HP does not expect complete resolution of any IRS audit cycle within the next 12 months. However, it is reasonably possible that certain foreign and state tax issues may be concluded in the next 12 months, including issues involving transfer pricing and other matters. Accordingly, HP believes it is reasonably possible that its existing unrecognized tax benefits may be reduced by an amount up to $320 million within the next twelve months. The breakdown between current and long-term deferred tax assets and deferred tax liabilities was as follows:
Note 13: Stockholders' Equity HP's share repurchase program authorizes both open market and private repurchase transactions. In the first quarter of fiscal 2009, HP completed share repurchases of approximately 22 million shares. Repurchases of approximately 34 million shares were settled for $1.2 billion, which included approximately 14 million shares repurchased in transactions that were executed in fiscal 2008 but settled in the first quarter of fiscal 2009. HP had approximately 2 million shares purchased in the first quarter of fiscal 2009 but that will be settled in the second quarter of fiscal 2009. HP paid $3.3 billion in connection with share repurchases of 72 million shares during the three months ended January 31, 2008. As of January 31, 2009, HP had remaining authorization of approximately $7.9 billion for future share repurchases under the $8.0 billion repurchase authorization approved by HP's Board of Directors on September 19, 2008. The changes in the components of other comprehensive income, net of taxes, were as follows:
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Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 13: Stockholders' Equity (Continued) The components of accumulated other comprehensive loss, net of taxes, were as follows:
Note 14: Retirement and Post-Retirement Benefit Plans On August 26, 2008, EDS became a wholly owned subsidiary of HP. EDS sponsors qualified and non-qualified defined benefit pension plans covering substantially all of its employees. The majority of the EDS defined benefit pension plans are noncontributory. In most plans, employees become fully vested upon attaining two to five years of service, and benefits are based on many factors, which differ by country, but the most significant are years of service and earnings. The projected unit credit cost method is used for actuarial purposes. Following the acquisition of EDS, HP announced that it was modifying the EDS U.S. qualified and non-qualified plans for employees accruing benefits under the programs. Effective January 1, 2009, EDS employees in the U.S. ceased accruing pension benefits. The final pension benefit amount will be based on pay and service through December 31, 2008. Modifications to Defined Contribution Plans HP offers various defined contribution plans for U.S. and non-U.S. employees. As disclosed in our Consolidated Financial Statements for the fiscal year ended October 31, 2008, HP matches employee contributions to the HP 401(k) Plan with cash contributions up to a maximum of 6% of eligible compensation for U.S. employees hired prior to August 1, 2008 and up to a maximum of 4% of eligible compensation for U.S. employees hired on or after August 1, 2008. Further, effective January 1, 2009, U.S. employees participating in the EDS 401(k) Plan became eligible for a 4% HP matching contribution on eligible compensation. Effective April 1, 2009, HP matching contributions under both the HP 401(k) Plan and the EDS 401(k) Plan will be changed to a quarterly, discretionary, performance-based match of up to a maximum of 4% of eligible compensation for all U.S. employees, which will be determined each fiscal quarter based on business results. HP matching contributions will vary from 0% to 100% of the maximum 4% match, based on factors such as quarterly earnings, market share growth, and performance relative to market and economic conditions. The first quarterly match under this new formula will be determined as of July 31, 2009 covering an extended period of April 1, 2009 through July 31, 2009. 29
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 14: Retirement and Post-Retirement Benefit Plans (Continued) HP's net pension and post-retirement benefit costs were as follows:
HP previously disclosed in its Consolidated Financial Statements for the fiscal year ended October 31, 2008 that it expected to contribute approximately $360 million to its non-U.S. pension plans and approximately $35 million to cover benefit payments to U.S. non-qualified plan participants in fiscal 2009. In addition, HP expected to pay approximately $70 million to cover benefit claims for HP's post-retirement benefit plans. HP's funding policy is to contribute cash to its pension plans so that it meets at least the minimum contribution requirements, as established by local government and funding and taxing authorities. As of January 31, 2009, HP has made $157 million of contributions to non-U.S. pension plans, paid $15 million to cover benefit payments to U.S. non-qualified plan participants, and paid $12 million to cover benefit claims under post-retirement benefit plans. HP presently anticipates making additional contributions of approximately $235 million to its non-U.S. pension plans and approximately $20 million to its U.S. non-qualified plan participants and expects to pay up to $55 million to cover benefit claims under post-retirement benefit plans during the remainder of fiscal 2009. HP's pension and other post-retirement benefit costs and obligations are dependent on various assumptions. Differences between expected and actual returns on investments will be reflected as unrecognized gains or losses, and such gains or losses will be amortized and recorded in future periods. Poor financial performance of asset markets in any year could lead to increased contributions in certain countries and increased future pension plan expense. Asset gains or losses are determined at the measurement date and amortized over the remaining service life or life expectancy of plan participants. HP's next expected measurement date is October 31, 2009. 30
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies HP is involved in lawsuits, claims, investigations and proceedings, including those identified below, consisting of intellectual property, commercial, securities, employment, employee benefits and environmental matters that arise in the ordinary course of business. In accordance with SFAS No. 5, "Accounting for Contingencies", HP records a provision for a liability when management believes that it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. HP believes it has adequate provisions for any such matters. HP reviews these provisions at least quarterly and adjusts these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. Based on its experience, HP believes that any damage amounts claimed in the specific matters discussed below are not a meaningful indicator of HP's potential liability. Litigation is inherently unpredictable. However, HP believes that it has valid defenses with respect to legal matters pending against it. Nevertheless, it is possible that cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies or because of the diversion of management's attention and the creation of significant expenses. Pending Litigation, Proceedings and Investigations Copyright levies. As described below, proceedings are ongoing against HP in certain European Union ("EU") member countries, including litigation in Germany, seeking to impose levies upon equipment (such as multifunction devices ("MFDs"), personal computers ("PCs") and printers) and alleging that these devices enable producing private copies of copyrighted materials. The total levies due, if imposed, would be based upon the number of products sold and the per-product amounts of the levies, which vary. Some EU member countries that do not yet have levies on digital devices are expected to implement similar legislation to enable them to extend existing levy schemes, while some other EU member countries are expected to limit the scope of levy schemes and applicability in the digital hardware environment. HP, other companies and various industry associations are opposing the extension of levies to the digital environment and advocating compensation to rights holders through digital rights management systems. VerwertungsGesellschaft Wort ("VG Wort"), a collection agency representing certain copyright holders, instituted non-binding arbitration proceedings against HP in June 2001 in Germany before the arbitration board of the Patent and Trademark Office. The proceedings relate to whether and to what extent copyright levies for photocopiers should be imposed in accordance with copyright laws implemented in Germany on MFDs that allegedly enable the production of copies by private persons. Following unsuccessful arbitration, VG Wort filed a lawsuit against HP in May 2004 in the Stuttgart Civil Court in Stuttgart, Germany seeking levies on certain MFDs sold from 1997 to 2001. On December 22, 2004, the court held that HP is liable for payments regarding MFDs sold in Germany, and ordered HP to pay VG Wort an amount equal to 5% of the outstanding levies claimed, plus interest, on MFDs sold in Germany up to December 2001. VG Wort appealed this decision. On July 6, 2005, the Stuttgart Court of Appeals ordered HP to pay VG Wort levies based on the published tariffs for photocopiers in Germany (which range from EUR 38.35 to EUR 613.56 per unit), plus interest, on MFDs sold in Germany up to December 2001. HP appealed the Stuttgart Court of Appeals' decision to the Bundesgerichtshof (the German Federal Supreme Court). On January 30, 2008, the German Federal Supreme Court held that the MFDs covered by this lawsuit were photocopiers within the meaning of the German copyright law that was in effect until December 31, 2007, and, therefore, are subject to the levies on photocopiers established by that law. HP has filed a claim with the German Federal Constitutional Court challenging that ruling. 31
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued) On September 26, 2005, VG Wort filed an additional lawsuit against HP in the Stuttgart Civil Court in Stuttgart, Germany seeking levies on MFDs sold in Germany between 1997 and 2001, as well as for MFDs sold from 2002 onwards. On July 26, 2007, the court issued a decision following the ruling of the Stuttgart Court of Appeals with respect to the initial VG Wort lawsuit as described above. HP has appealed the decision. HP has submitted comments on the German Federal Supreme Court judgment in the initial VG Wort lawsuit seeking levies on MFDs described above as required by the court. In July 2004, VG Wort filed a separate lawsuit against HP in the Stuttgart Civil Court seeking levies on printers. On December 22, 2004, the court held that HP is liable for payments regarding all printers using ASCII code sold in Germany but did not determine the amount payable per unit. HP appealed this decision in January 2005 to the Higher Regional Court of Baden Wuerttemberg. On May 11, 2005, the Higher Regional Court issued a decision confirming that levies are due. On June 6, 2005, HP filed an appeal to the German Federal Supreme Court in Karlsruhe. On December 6, 2007, the German Federal Supreme Court issued a judgment that printers are not subject to levies under the existing law. The court issued a written decision on January 25, 2008, and VG Wort subsequently filed an application with the German Federal Supreme Court under Section 321a of the German Code of Civil Procedure contending that the court did not consider their arguments. On May 9, 2008, the German Federal Supreme Court denied VG Wort's application. In addition, VG Wort has filed a claim with the German Federal Constitutional Court challenging the ruling that printers are not subject to levies. HP has submitted unsolicited arguments to the latter court, and VG Wort has been directed to provide comments with respect to those arguments. In September 2003, VG Wort filed a lawsuit against Fujitsu Siemens Computer GmbH ("FSC") in Munich State Court seeking levies on PCs. This is an industry test case in Germany, and HP has agreed not to object to the delay if VG Wort sues HP for such levies on PCs following a final decision against FSC. On December 23, 2004, the Munich State Court held that PCs are subject to a levy and that FSC must pay 12 euros plus compound interest for each PC sold in Germany since March 2001. FSC appealed this decision in January 2005 to the Higher Regional Court of Bavaria. On December 15, 2005, the Higher Regional Court affirmed the Munich State Court decision. FSC filed an appeal with the German Federal Supreme Court in February 2006. On October 2, 2008, the German Federal Supreme Court issued a judgment that PCs were not photocopiers within the meaning of the German copyright law that was in effect until December 31, 2007 and, therefore, not subject to the levies on photocopiers established by that law. VG Wort has filed a claim with the German Federal Constitutional Court challenging that ruling. On December 29, 2005, ZPU, a joint association of various German collection societies, instituted non-binding arbitration proceedings against HP before the arbitration board of the Patent and Trademark Office demanding reporting of every PC sold by HP in Germany from January 2002 through December 2005 and seeking a levy of 18.42 euros plus tax for each PC sold during that period. HP filed a notice of defense in connection with these proceedings in February 2006, and an arbitration hearing was held in December 2006. On August 3, 2007, the arbitration board issued a ruling proposing a levy of 15 euros plus tax for each PC sold during that period. HP has rejected the ruling of the arbitration board, and the arbitration proceedings have concluded. ZPU has filed a claim with the appeals court in Munich to which HP has responded. A hearing date has been set by the court for February 18, 2010. 32
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued) Based on industry opposition to the extension of levies to digital products, HP's assessments of the merits of various proceedings and HP's estimates of the units impacted and levies, HP has accrued amounts that it believes are adequate to address the matters described above. However, the ultimate resolution of these matters and the associated financial impact on HP, including the number of units impacted, the amount of levies imposed and the ability of HP to recover such amounts through increased prices, remains uncertain. Sky Subscribers Services Limited and British Sky Broadcasting Limited v. EDS and EDS Limited (UK) is a lawsuit filed on August 17, 2004 by Sky Subscribers Services Limited and British Sky Broadcasting Limited against Electronic Data Systems Corporation ("EDS"), a company that HP acquired in August 2008, and EDS Limited (UK) ("EDS UK"), one of EDS's subsidiaries, alleging deceit, negligent misrepresentation, negligent misstatement and breach of contract. The claims arose out of a customer relationship management project that was awarded to EDS in 2000, the principal objective of which was to develop a customer call center in Scotland. EDS's main role in the project was as systems integrator. On November 12, 2004, EDS and EDS UK filed their defense and counterclaim denying the claims and seeking damages for monies owed under the contract. The trial of this action commenced on October 15, 2007, and final arguments concluded on July 30, 2008. At trial, the plaintiffs claimed damages in excess of £700 million, and EDS and EDS UK counterclaimed for damages of approximately £5 million. A decision from the court is expected in early 2009. Skold, et al. v. Intel Corporation and Hewlett-Packard Company is a lawsuit in which HP was joined on June 14, 2004 that is pending in state court in Santa Clara County, California. The lawsuit alleges that HP (along with Intel) misled the public by suppressing and concealing the alleged material fact that systems that use the Intel Pentium 4 processor are less powerful and slower than systems using the Intel Pentium III processor and processors made by a competitor of Intel. The plaintiffs seek unspecified damages, restitution, attorneys' fees and costs, and certification of a nationwide class. On February 27, 2009, the court denied without prejudice plaintiffs' motion for nationwide class certification for a third time. Inkjet Printer Litigation. As described below, HP is involved in several lawsuits claiming breach of express and implied warranty, unjust enrichment, deceptive advertising and unfair business practices where the plaintiffs have alleged, among other things, that HP employed a "smart chip" in certain inkjet printing products in order to register ink depletion prematurely and to render the cartridge unusable through a built-in expiration date that is hidden, not documented in marketing materials to consumers, or both. The plaintiffs have also contended that consumers received false ink depletion warnings and that the smart chip limits the ability of consumers to use the cartridge to its full capacity or to choose competitive products.
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Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued)
restitution, damages (including enhanced damages), injunctive relief, interest, costs, and attorneys' fees. Baggett v. HP is a consumer class action filed against HP on June 6, 2007 in the United States District Court for the Central District of California alleging that HP employs a technology in its LaserJet color printers whereby the printing process shuts down prematurely, thus preventing customers from using the toner that is allegedly left in the cartridge. The plaintiffs also allege that HP fails to disclose to consumers that they will be unable to utilize the toner remaining in the cartridge after the printer shuts down. The complaint seeks certification of a nationwide class of purchasers of all HP LaserJet color printers and seeks unspecified damages, restitution, disgorgement, injunctive relief, attorneys' fees and costs. Rich v. HP is a consumer class action filed against HP on May 22, 2006 in the United States District Court for the Northern District of California. The suit alleges that HP designed its color inkjet printers to unnecessarily use color ink in addition to black ink when printing black and white images and text. The plaintiffs seek injunctive and monetary relief on behalf of a nationwide class. On December 27, 2001, Cornell University and the Cornell Research Foundation, Inc. filed a complaint, amended on September 6, 2002, against HP in United States District Court for the Northern District of New York alleging that HP's PA-RISC 8000 family of microprocessors, and servers and workstations incorporating those processors, infringe a patent assigned to Cornell Research Foundation, Inc. that describes a way of executing microprocessor instructions. The complaint sought declaratory and injunctive relief and unspecified damages. The patent at issue in this litigation, United States Patent No. 4,807,115, expired on February 21, 2006. Therefore, the plaintiffs are no longer entitled to seek injunctive relief against HP. This matter was tried between May 19 and May 30, 2008, and, on May 30, 2008, a jury returned a verdict in favor of the plaintiffs in the amount of $184 million. The court has not yet entered a final judgment, and it will not do so until after it rules on HP's equitable defenses and HP's post-trial motions to vacate the judgment and/or to reduce the amount of damages awarded by the jury. Depending on the outcome of HP's defenses and post-trial motions, HP may file an appeal with the Federal Circuit Court of Appeals. CSIRO Patent Litigation. Microsoft Corporation, Hewlett-Packard Company, et al. v. Commonwealth Scientific and Industrial Research Organisation of Australia is an action filed by HP and two other plaintiffs on May 9, 2005, in the District Court for the Northern District of California seeking a declaratory judgment against Commonwealth Scientific and Industrial Research Organisation of Australia ("CSIRO") that HP's products employing the IEEE 802.11a and 802.11g wireless protocol standards do not infringe CSIRO's United States Patent No. 5,487,069 relating to wireless transmission of data at frequencies in excess of 10GHz. On September 22, 2005, CSIRO filed an answer and counterclaims alleging that all HP products which employ those wireless protocol standards infringe the CSIRO patent and seeking damages, including enhanced damages and attorneys' fees and costs, and an injunction against sales of infringing products. On December 12, 2006, CSIRO successfully moved to have the case transferred to the District Court of the Eastern District of Texas. In March 2009, the 34
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued) parties reached an understanding to settle the matter and dismiss the pending lawsuit. The proposed settlement provides for HP to pay CSIRO an amount of money that is immaterial to HP in exchange for protection from claims of infringement of the patent at issue, including all United States and worldwide continuations and counterparts of that patent, in the form of a combination of licenses and covenants not to sue. The parties are in the process of preparing a definitive settlement agreement. The United States of America, ex rel. Norman Rille and Neal Roberts v. Hewlett-Packard Company, et al. In 2004, two private individuals filed a civil "qui tam" complaint under the False Claims Act in the United States District Court for the Eastern District of Arkansas containing generalized allegations that HP and several other companies participated in an industry-wide practice of using partnership and alliance programs to make improper payments and cause the submission of false claims in connection with contracts to provide products and services to the federal government. On April 12, 2007, the U.S. Department of Justice intervened in the qui tam action and filed a complaint against HP (and several other companies in separate actions) on behalf of the United States containing allegations that HP violated the False Claims Act and the Anti-Kickback Act of 1986 by providing millions of dollars in kickbacks to its alliance partners, including "influencer fees" and "new business opportunity rebates." The U.S. complaint further alleges that HP violated the False Claims Act and the Anti-Kickback Act, breached its federal government contracts, induced the federal government to make payments to HP that HP was not entitled to receive under those contracts, and was unjustly enriched by expressly or impliedly making false statements, records or certifications to the federal government that it complied with and would continue to comply with the Anti-Kickback Act and by submitting claims to the government that allegedly were inflated because they included the amounts of the influencer fees and new business opportunity rebates. The U.S. complaint seeks treble damages plus civil penalties in connection with the alleged violations of the False Claims Act, double damages plus civil penalties in connection with the alleged violations of the Anti-Kickback Act and disgorgement of profits earned in connection with the breach of contract and unjust enrichment claims. Leak Investigation Proceedings. As described below, HP is or has been the subject of various governmental inquiries concerning the processes employed in an investigation into leaks of HP confidential information to members of the media that concluded in May 2006:
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Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued)
In addition, four stockholder derivative lawsuits have been filed in California purportedly on behalf of HP stockholders seeking to recover damages for alleged breach of fiduciary duty and to require HP to improve its corporate governance and internal control procedures as a result of the activities of the leak investigation: Staehr v. Dunn, et al. was filed in Santa Clara County Superior Court on September 18, 2006; Worsham v. Dunn, et al. was filed in Santa Clara County Superior Court on September 14, 2006; Tansey v. Dunn, et al. was filed in Santa Clara County Superior Court on September 20, 2006; and Hall v. Dunn, et al. was filed in Santa Clara County Superior Court on September 25, 2006. On October 19, 2006, the Santa Clara County Superior Court consolidated the four California cases under the caption In re Hewlett-Packard Company Derivative Litigation. The consolidated complaint filed on November 19, 2006, also seeks to recover damages in connection with sales of HP stock alleged to have been made by certain current and former HP officers and directors while in possession of material non-public information. Two additional stockholder derivative lawsuits, Pifko v. Babbio, et al., filed on September 19, 2006, and Gross v. Babbio, et al., filed on November 21, 2006, were filed in Chancery Court, County of New Castle, Delaware; both seek to recover damages for alleged breaches of fiduciary duty and to obtain an order instructing the defendants to refrain from further breaches of fiduciary duty and to implement corrective measures that will prevent future occurrences of the alleged breaches of fiduciary duty. On January 24, 2007, the Delaware court consolidated the two cases under the caption In re Hewlett-Packard Company Derivative Litigation and subsequently stayed the proceedings, as the parties had reached a tentative settlement. The HP Board of Directors appointed a Special Litigation Committee consisting of 36
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued) independent Board members authorized to investigate, review and evaluate the facts and circumstances asserted in these derivative matters and to determine how HP should proceed in these matters. On December 14, 2007, HP and the plaintiffs in the California and Delaware derivative actions entered into an agreement to settle those lawsuits. Under the terms of the settlement, HP agreed to continue certain corporate governance changes until December 31, 2012 and to pay the plaintiffs' attorneys' fees. The California court granted final approval to the settlement on March 11, 2008 and subsequently granted plaintiffs' counsel's fee application and dismissed the action. On June 12, 2008, the Delaware court granted final approval to the settlement and the plaintiffs' application for attorneys' fees and also dismissed the action. Because neither the dismissal of the California nor the Delaware derivative action was thereafter appealed, both cases are now concluded. Schorsch v. HP was a consumer class action filed against HP on October 28, 2003 in Illinois state court alleging that HP had included an electrically erasable programmable read only memory (EEPROM) chip in certain of its LaserJet printers that prematurely advises the user that the drum kit needs replacing in violation of Illinois state law. The plaintiffs subsequently filed an amended complaint seeking to expand the class from purchasers of drum kits to purchasers of all HP printer consumables that contain EEPROM chips. The plaintiffs sought certification of an Illinois-only class and seeks unspecified damages, attorneys' fees and costs. The action was dismissed by the court with prejudice on December 20, 2008. HP is subject to various federal, state, local and foreign laws and regulations concerning environmental protection, including laws addressing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, the content of its products and the recycling, treatment and disposal of its products including batteries. In particular, HP faces increasing complexity in its product design and procurement operations as it adjusts to new and future requirements relating to the chemical and materials composition of its products, their safe use, the energy consumption associated with those products and product take-back legislation. HP could incur substantial costs, its products could be restricted from entering certain jurisdictions, and it could face other sanctions, if it were to violate or become liable under environmental laws or if its products become non-compliant with environmental laws. HP's potential exposure includes fines and civil or criminal sanctions, third-party property damage or personal injury claims and clean up costs. The amount and timing of costs under environmental laws are difficult to predict. HP is party to, or otherwise involved in, proceedings brought by U.S. or state environmental agencies under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), known as "Superfund," or state laws similar to CERCLA. HP is also conducting environmental investigations or remediations at several current or former operating sites pursuant to administrative orders or consent agreements with state environmental agencies. HP is also subject to legislation in an increasing number of jurisdictions that makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products (sometimes referred to as "product take-back legislation"). For example, the European Union ("EU") adopted the Waste 37
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 15: Litigation and Contingencies (Continued) Electrical and Electronic Equipment Directive in January 2003. That directive makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The EU member states were obliged to make producers participating in the market financially responsible for implementing these responsibilities. Note 16: Segment Information HP is a leading global provider of products, technologies, software, solutions and services to individual consumers, small and medium sized businesses ("SMBs"), and large enterprises including the public and education sectors. HP's offerings span personal computing and other access devices; imaging and printing-related products and services; enterprise information technology ("IT") infrastructure, including enterprise storage and server technology; software that optimizes business technology investments; financial services including leasing; and multi-vendor customer services, including technology support and maintenance, consulting and integration, information technology and business process outsourcing services and application services. HP and its operations are organized into seven business segments for financial reporting purposes: Services, Enterprise Storage and Servers ("ESS"), HP Software, the Personal Systems Group ("PSG"), the Imaging and Printing Group ("IPG"), HP Financial Services ("HPFS"), and Corporate Investments. HP's organizational structure is based on a number of factors that management uses to evaluate, view and run its business operations, which include, but are not limited to, customer base, homogeneity of products and technology. The business segments disclosed in the accompanying Consolidated Condensed Financial Statements are based on this organizational structure and information reviewed by HP's management to evaluate the business segment results. Services, ESS and HP Software are reported collectively as a broader Technology Solutions Group ("TSG"). In order to provide a supplementary view of HP's business, aggregated financial data for TSG is presented herein. HP has reclassified segment operating results for fiscal 2008 and fiscal 2007 to conform to certain fiscal 2009 organizational realignments. None of the changes impacts HP's previously reported consolidated net revenue, earnings from operations, net earnings or net earnings per share. Future changes to this organizational structure may result in changes to the business segments disclosed. A description of the types of products and services provided by each business segment follows. 38
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued) Each of the business segments within TSG is described in detail below.
39
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued)
HP's other business segments are described below.
40
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued)
such as Exstream Software and Web Jetadmin, managed print services products and solutions, and Halo telepresence. Graphics solutions include large format printing (Designjet, Scitex, ColorSpan and NUR), large format supplies, WebPress supplies, Indigo printing, specialty printing systems, inkjet high-speed production solutions and light production solutions. Printer supplies include LaserJet toner and inkjet printer cartridges and other printing-related media such as HP-branded Vivera and ColorSphere ink and HP Premium and Premium Plus photo papers. Segment Data HP derives the results of the business segments directly from its internal management reporting system. The accounting policies HP uses to derive business segment results are substantially the same as those the consolidated company uses. Management measures the performance of each business segment based on several metrics, including earnings from operations. Management uses these results, in part, to evaluate the performance of, and to assign resources to, each of the business segments. HP does not allocate to its business segments certain operating expenses, which it manages separately at the corporate level. These unallocated costs include primarily amortization of purchased intangible assets, stock-based compensation expense related to HP-granted employee stock options, PRUs and the employee stock purchase plan, certain acquisition-related charges and charges for purchased IPR&D, as well as certain corporate governance costs. HP does not allocate to its business segments restructuring charges and any associated adjustments related to restructuring actions. 41
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued) Selected operating results information for each business segment was as follows:
42
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued) The reconciliation of segment operating results information to HP consolidated totals was as follows:
HP allocates its assets to its business segments based on the primary segments benefiting from the assets. The total assets of PSG decreased 11% to $14.7 billion as of January 31, 2009 from $16.5 billion as of October 31, 2008 due primarily to a decline in accounts and other receivables resulting from the current economic slowdown. There have been no material changes in the total assets of HP's other segments. 43
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued) Net revenue by segment and business unit
44
Notes to Consolidated Condensed Financial Statements (Continued) (Unaudited) Note 16: Segment Information (Continued) Systems Group segments. There was no impact on the previously reported financial results for the Enterprise Storage and Servers, HP Financial Services and Corporate Investments segments.
45
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. HEWLETT-PACKARD COMPANY AND SUBSIDIARIES The following discussion should be read in conjunction with the Consolidated Condensed Financial Statements and the related notes that appear elsewhere in this document. OVERVIEW We are a leading global provider of products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses ("SMBs"), and large enterprises, including customers in the public and education sectors. Our offerings span:
We have seven business segments for financial reporting purposes: Services, Enterprise Storage and Servers ("ESS"), HP Software, the Personal Systems Group ("PSG"), the Imaging and Printing Group ("IPG"), HP Financial Services ("HPFS"), and Corporate Investments. Services, ESS and HP Software are reported collectively as a broader Technology Solutions Group ("TSG"). While TSG is not an operating segment, we sometimes provide financial data aggregating the segments within TSG in order to provide a supplementary view of our business. The operating framework within which we manage our businesses and which guides our strategies is based on the disciplined management of three business levers: targeted growth, operational efficiency and strategic deployment of capital. Although we have made progress towards our goals in recent periods, there are still many areas in which we believe that we can improve. To implement this operating framework, we are focused on the following initiatives:
46
In September 2008, we announced a restructuring plan to gain efficiencies following the EDS acquisition. The restructuring plan will be implemented over four years and includes a targeted reduction in headcount of approximately 25,000 employees over that period, with the majority of the reductions occurring by the end of fiscal 2009. Our plan includes replacing roughly half of these positions in order to optimize our global footprint. As part of this plan, we recorded $1.8 billion in restructuring costs in the fourth quarter of fiscal 2008, $1.5 billion of which was booked to goodwill and $0.3 billion of which was recorded as a restructuring charge. In February 2009, we announced additional changes to our compensation and benefit programs in response to the current challenges of the global economy and the resulting effect on our revenues. As part of these changes, we will reduce the base pay of most of our U.S. employees effective in the second quarter of fiscal 2009 and the base pay of many of our non-U.S. employees in future periods in compliance with local laws. Beginning in the second quarter of fiscal 2009, we will also cap matching contributions under the HP 401(k) Plan for all U.S. employees at 4% of eligible compensation and will fund those matching contributions quarterly on a discretionary basis based on our financial performance. In addition, effective in the third quarter of fiscal 2009, we will modify our employee stock purchase plan to eliminate the 15% discount currently applicable to purchases made under the plan. We are continuing to evaluate our businesses and current market conditions and may consider additional restructuring actions in future periods. In terms of how our execution has translated into financial performance, the following provides an overview of our key financial metrics in the first quarter of fiscal 2009:
Cash and cash equivalents at January 31, 2009 totaled $11.2 billion, an increase of $1.0 billion from October 31, 2008. The increase for the first three months of fiscal 2009 was due primarily to $2.0 billion proceeds from the issuance of debt, and $1.1 billion cash provided from operations, partially offset by $1.2 billion of cash used to repurchase common stock and $0.7 billion net investment in property, plant and equipment. We intend the discussion of our financial condition and results of operations that follows to provide information that will assist in understanding our Consolidated Condensed Financial Statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our Consolidated Condensed Financial Statements. 47 The discussion of results of operations at the consolidated level is followed by a more detailed discussion of results of operations by segment. For a further discussion of factors that could impact operating results, see the section entitled "Factors That Could Affect Future Results" below. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Condensed Financial Statements, which we have prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development, selection and disclosure of significant estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably likely to occur could materially impact the financial statements. Management believes that there have been no significant changes during the three months ended January 31, 2009 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended October 31, 2008. However, we have expanded our critical accounting policy disclosures beginning this quarter to include the following summary of our existing policy relating to loss contingencies. This summary previously has appeared, and continues to appear, as part of our disclosures regarding litigation and contingencies in Note 15 to the Consolidated Condensed Financial Statements in Item 1. Loss Contingencies We are involved in various lawsuits, claims, investigations and proceedings that arise in the ordinary course of business. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies", we record a provision for a liability when we believe that it is both probable that a liability has been incurred and the amount can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information. Litigation is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and cash flows. ACCOUNTING PRONOUNCEMENTS As previously reported in our 2008 Annual Report on Form 10-K, we recognized the funded status of our benefit plans at October 31, 2007 in accordance with the recognition provisions of SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of Financial Accounting Standards Board ("FASB") Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). In addition to the recognition provisions, SFAS 158 also requires companies to 48 measure the funded status of the plan as of the date of their fiscal year end, effective for fiscal years ending after December 15, 2008. We will adopt the measurement provisions of SFAS 158 effective October 31, 2009 for the HP pension and post retirements plans. We do not expect the adoption of the measurement provisions of SFAS 158 will have a material effect on our consolidated results of operations and financial condition. In February 2008, the FASB issued FASB Staff Position ("FSP") SFAS 157-2, "Effective Date of FASB Statement No. 157" ("FSP SFAS 157-2"). FSP SFAS 157-2 delays the effective date of SFAS No. 157, "Fair Value Measurements" ("SFAS 157") to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). As a result of adoption of FSP SFAS 157-2, we will adopt SFAS 157 for nonfinancial assets and nonfinancial liabilities in the first quarter of fiscal 2010. Although we will continue to evaluate the application of SFAS 157 to nonfinancial assets and nonfinancial liabilities, we do not expect the adoption of SFAS 157 with respect to nonfinancial assets and nonfinancial liabilities will have a material impact on our consolidated results of operations and financial condition. In December 2007, the FASB issued SFAS 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"). SFAS 141(R) expands the definition of a business and a business combination; requires recognition of assets acquired, liabilities assumed, and contingent consideration at their fair value on the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination and expensed as incurred; requires in-process research and development to be capitalized at fair value as an intangible asset; and requires that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for taxes. SFAS 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008 and will be adopted by us in the first quarter of fiscal 2010. We are currently evaluating the potential impact of the adoption of SFAS 141(R) on our consolidated results of operations and financial condition, which will be largely dependent on the size and nature of the business combinations completed after the adoption of this statement. Among other potential impacts, we currently believe that the adoption of SFAS 141(R) will result in the recognition of certain types of expenses in our results of operations that are currently capitalized pursuant to existing accounting standards. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51" ("SFAS 160"). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent's ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008 and will be adopted by us in the first quarter of fiscal 2010. We are currently evaluating the potential impact, if any, of the adoption of SFAS 160 on our consolidated results of operations and financial condition. In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 applies to all derivative instruments and related hedged items accounted for under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 161 requires entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity's financial position, results of 49 operations and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 and will be adopted by us in the second quarter of fiscal 2009. We will present the required disclosures in the prescribed format on a prospective basis upon adoption. We do not expect the adoption of SFAS 161 will have a material effect on our consolidated results of operations and financial condition. In May 2008, the FASB issued FSP Accounting Principles Board ("APB") 14-1 "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)" ("FSP APB 14-1"). FSP APB 14-1 requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer's non-convertible debt borrowing rate. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008 on a retroactive basis and will be adopted by us in the first quarter of fiscal 2010. We currently do not have any outstanding convertible debt instruments that are subject to the provisions of FSP APB 14-1. However, our U.S. dollar zero-coupon convertible notes that were redeemed in full in March 2008 are subject to the provisions of FSP APB 14-1. As a result, upon adoption of FSP APB 14-1 in the first quarter of fiscal 2010, our fiscal 2008 consolidated results of operations and financial condition will be affected on a retroactive basis. We do not expect the adoption of FSP APB 14-1 will have a material effect on our consolidated results of operations and financial condition. In June 2008, the FASB issued FSP Emerging Issues Task Force ("EITF") 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities" ("FSP EITF 03-6-1"). FSP EITF 03-6-1 clarifies that share-based payment awards that entitle their holders to receive nonforfeitable dividends or dividend equivalents before vesting should be considered participating securities. We have granted and expect to continue to grant restricted stock that contain non-forfeitable rights to dividends and will be considered participating securities upon adoption of FSP EITF 03-6-1. As participating securities, we will be required to include these instruments in the calculation of our basic earnings per share ("EPS"), and we will need to calculate basic EPS using the "two-class method." Restricted stock is currently included in our dilutive EPS calculation using the treasury stock method. The two-class method of computing EPS is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 on a retrospective basis and will be adopted by us in the first quarter of fiscal 2010. We are currently evaluating the potential impact, if any, the adoption of FSP EITF 03-6-1 will have on our calculation of EPS. In November 2008, the FASB ratified EITF Issue No. 08-7, "Accounting for Defensive Intangible Assets" ("EITF 08-7"). EITF 08-7 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. As these assets are separately identifiable, EITF 08-7 requires an acquiring entity to account for defensive intangible assets as a separate unit of accounting. Defensive intangible assets must be recognized at fair value in accordance with SFAS 141(R) and SFAS 157. EITF 08-7 is effective for defensive intangible assets acquired in fiscal years beginning on or after December 15, 2008 and will be adopted by us in the first quarter of fiscal 2010. We are currently evaluating the potential impact, if any, of the adoption of EITF 08-7 on our consolidated results of operations and financial condition. In December 2008, the FASB issued FSP SFAS 132(R)-1, "Employer's Disclosures about Postretirement Benefit Plan Assets," ("FSP SFAS 132(R)-1"). FSP SFAS 132(R)-1 requires additional disclosures about assets held in an employer's defined benefit pension or other postretirement plan. FSP SFAS 132(R)-1 is effective for fiscal years ending after December 15 2009 and will be adopted by us in the first quarter of fiscal 2010. We will present the required disclosures in the prescribed format 50 on a prospective basis upon adoption. We do not expect the adoption of FSP FAS 132(R)-1 will have a material effect on our consolidated results of operations and financial condition. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS During the first quarter of fiscal 2009, we adopted the following accounting standards, none of which had a material effect on our consolidated results of operations during such period or financial condition at the end of such period:
See Note 8 to the Consolidated Condensed Financial Statements in Item 1, which is incorporated herein by reference, for the effect of applying SFAS 157, FSP SFAS 157-1, FSP SFAS 157-2, FSP SFAS 157-3 and SFAS 159. RESULTS OF OPERATIONS Results of operations in dollars and as a percentage of net revenue were as follows:
51 The components of weighted net revenue growth as compared to the prior-year period were as follows:
For the three months ended January 31, 2009, the global slowdown of IT and consumer spending impacted each of our segments as net revenue increased only 1.2% from the prior-year comparable period (4.2% on a constant currency basis). The Services segment was the largest contributor to total HP net revenue growth as a result of the acquisition of EDS. U.S. net revenue increased 15% to $10.1 billion for the first quarter of fiscal 2009, while international net revenue decreased 5% to $18.7 billion. The net revenue increase in Services was due primarily to revenue increases in infrastructure technology outsourcing, application services and business process outsourcing primarily as a result of our acquisition of EDS in the fourth quarter of fiscal 2008. Net revenue in technology services was flat due primarily to unfavorable currency impacts, offset by growth in extended warranty and IT solution support services revenue. Net revenue in Corporate Investments and Other declined as a result of the slowing IT spend environment. Net revenue in HP Software declined in both the Business Technology Optimization ("BTO") and other software business units due primarily to revenue declines in license and services partially offset by increases in support revenue. The net revenue decline in ESS was driven by declines in industry standard servers, business critical systems and storage. The slowing global economy drove the declines in each of the business units. Industry standard servers experienced both volume and average unit price declines and was the largest business unit contributor to the decline in ESS revenue. IPG experienced net revenue declines across each of the commercial and consumer hardware business units along with the supplies business unit. Volume declines across each of the business units were a result of the softness in both the business and consumer economic environments. The PSG net revenue decline was the result of the overall slowdown in the global economy, including a reversing trend in the growth in emerging markets. PSG volumes declined by 4% while average selling prices ("ASPs") declined in both consumer clients and in commercial clients. The HPFS net revenue decrease was due to unfavorable currency movement. 52 Gross Margin The weighted components of the change in gross margin as a percentage of net revenue as compared to the prior-year period were as follows:
The Services contribution to the overall decline in HP gross margin and the decline in Services gross margin on a year-over-year basis was a result of a mix impact from the acquisition of the EDS business, which has lower gross margins. Each of the Services business units experienced an increase in gross margin in the first quarter of fiscal 2009 compared to the prior-year period. The decrease in ESS gross margin was due primarily to competitive pricing, business mix shifts, and unfavorable currency impacts in all of the business units, as well as a product mix shift to entry level products in business critical systems. Gross margin in Corporate Investments and Other declined as a result of a volume decline. PSG gross margin declined in the first quarter of fiscal 2009, despite its positive contribution to the overall change in HP gross margin. The gross margin decline in PSG was the result primarily of ASPs declining at a faster pace than component costs, and a mix shift toward lower-end models. The increase in IPG gross margin was driven primarily by favorable impacts from an increased supplies mix and supplies price increases. The improvement in HP Software gross margin resulted primarily from a favorable revenue mix with more higher-margin support revenue and less lower-margin services revenue. The HPFS gross margin decline was due primarily to higher bad debt expenses and lower margins in used equipment sales. Operating Expenses Research and Development Total research and development ("R&D") expense decreased in the first quarter of fiscal 2009 as compared to the prior-year period due primarily to favorable currency impacts related to the movement of the dollar against the euro as well as effective cost controls. As a percentage of net revenue, except for HP Software, each of our major segments experienced a year-over-year decrease in R&D expense for the three months ended January 31, 2009. Selling, General and Administrative Selling, general and administrative ("SG&A") expense decreased in the first quarter of fiscal 2009 from the corresponding prior-year period, due primarily to favorable currency impacts related to the movement of the dollar against the euro as well as effective cost management, partially offset by 53 additional expenses related to the EDS acquisition. As a percentage of net revenue, each of our major segments experienced a year-over-year decrease in SG&A expense for the three months ended January 31, 2009. Amortization of Purchased Intangible Assets The increase in amortization expense for the three months ended January 31, 2009 as compared to the same period in the prior year was due primarily to amortization expenses related to the EDS acquisition as well as other acquisitions made subsequent to the first quarter of fiscal 2008. In-Process Research and Development Charges We recorded $6 million of in-process research and development ("IPR&D") charges for the first quarter of fiscal 2009. IPR&D charges are incurred in connection with our acquisitions. Restructuring Restructuring charges for the three months ended January 31, 2009 were $146 million, which included $150 million for severance and facility costs related to the fiscal 2008 restructuring plan and a reduction of $4 million related to adjustments to prior fiscal year plans. Restructuring charges for the three months ended January 31, 2008 were $10 million. These charges were due primarily to adjustments for severance and facility costs associated with restructuring programs implemented in fiscal years 2005, 2003, 2002 and 2001. Workforce Rebalancing As part of our ongoing business operations, we incurred workforce rebalancing charges for severance and related costs within certain business segments during the first three months of fiscal 2009. Workforce rebalancing activities are considered part of normal operations as we continue to optimize our cost structure. Workforce rebalancing costs are included in our business segment results, and we expect to incur additional workforce rebalancing costs in the future. Acquisition-related Charges In the first quarter of fiscal 2009, we recorded acquisition-related charges of $48 million for consultant integration costs and retention bonuses associated with our acquisition of EDS. Interest and Other, Net Interest and other, net decreased by $304 million for the three months ended January 31, 2009 as compared to the corresponding period in fiscal 2008. The decrease resulted primarily from currency losses on balance sheet remeasurement items, lower interest income as a result of lower interest rates, as well as higher interest expenses due to higher average debt balances. Provision for Taxes Our effective tax rate was 18.0% and 20.6% for the three months ended January 31, 2009 and January 31, 2008, respectively. Our effective tax rate generally differs from the U.S. federal statutory rate of 35% due to the tax rate benefits of certain earnings from our operations in lower-tax jurisdictions throughout the world. We have not provided U.S. taxes for such earnings because we plan to reinvest those earnings indefinitely outside the United States. There were no material discrete items affecting the tax rate for the three months ended January 31, 2009 and January 31, 2008, respectively. 54 A description of the products and services for each segment can be found in Note 16 to the Consolidated Condensed Financial Statements. Future changes to this organizational structure may result in changes to the business segments disclosed. Technology Solutions Group Services, ESS and HP Software are structured beneath TSG. The results of the business segments of TSG are described in more detail below. Services As a result of the acquisition of EDS, we renamed our services segment and reorganized the business units within that segment to better align to our enhanced services portfolio. The business reorganization resulted in three new business units: application services, infrastructure technology outsourcing and business process outsourcing. As part of this reorganization, the businesses included in the former consulting and integration business unit were divided among the application services and technology services business units and the HP Software segment. In addition, the businesses included in the former outsourcing services business unit were divided among the infrastructure technology outsourcing and business process outsourcing business units. Further, the managed print services offering under technology services was moved to IPG. The combined segment results below refer to the results of our services business for the three months ended January 31, 2008 combined with the EDS results for the three months ended December 31, 2007. The combined segment results are presented for informational purposes only and are not indicative of the results of operations that would have been achieved had the businesses been operated together during that period.
Historical Results Services net revenue increased 115.8% (121.4% when adjusted for currency) for the three months ended January 31, 2009, as compared to the same periods in fiscal 2008 due primarily to the EDS acquisition. Services net revenue for the three months ended January 31, 2009 includes revenue from infrastructure technology outsourcing, technology services, application services and business process outsourcing, which accounted for approximately 46%, 28%, 18% and 8% of revenues, respectively. 55 The components of weighted net revenue growth as compared to the prior-year periods by business unit were as follows:
Net revenue in infrastructure technology outsourcing increased due primarily to the EDS acquisition, partially offset by unfavorable currency impacts and contractual pricing adjustments. Net revenue in application services increased due primarily to the EDS acquisition, partially offset by unfavorable currency impacts and slowing demand in the current economic environment. Net revenue in business process outsourcing increased due primarily to the EDS acquisition. Net revenue in technology services was flat due primarily to unfavorable currency impacts, offset by growth in extended warranty and IT solution support services revenue. Services earnings from operations as a percentage of net revenue increased by 0.5 percentage points for the three months ended January 31, 2009. The operating margin increase was due primarily to the decrease in operating expenses as a percentage of revenue, partially offset by a decrease in gross margin. The operating expense decline was a result of continued focus on cost structure improvements from overall cost controls. The decline in gross margin was due primarily to the mix effect from the acquisition of EDS. Combined Segment Results Services net revenue decreased 11.5% (3.9% when adjusted for currency) for the three months ended January 31, 2009, as compared to the prior period combined segment results presented in the table above. Net revenue for the prior period combined segment results includes revenue from infrastructure technology outsourcing, technology services, application services and business process outsourcing, which accounted for approximately 46%, 25%, 20% and 9% of revenues, respectively. Further, Services net revenue for the three months ended January 31, 2009 as compared to the prior period combined segment results reflects a weighted net revenue decline in the infrastructure technology outsourcing, application services and business process outsourcing business units of 5.9%, 3.6% and 2.0%, respectively, while net revenue for technology services was relatively flat. The net revenue decline was due primarily to an unfavorable currency impact and lower add-on business due to the slowing economic environment. Services earnings from operations as a percentage of net segment revenue increased by 3.4 percentage points for the three months ended January 31, 2009 as compared to the prior period combined segment results. The operating margin increase was the result of an increase in gross margin and a decrease in operating expenses as a percentage of net revenue. The gross margin increase was due primarily to the continued focus on cost structure improvements generated by delivery efficiencies and cost controls. The continued improvements in our operating expense structure contributed to the decline in operating expenses as a percentage of net revenue compared to the prior year. 56 Enterprise Storage and Servers
The components of weighted net revenue growth as compared to the prior-year period by business unit were as follows:
ESS net revenue decreased 18.1% (14.4% when adjusted for currency) in the first quarter of fiscal 2009 as compared to the same period of fiscal 2008 due to the economic slowdown and overall declines in business IT spending. Industry standard servers ("ISS") net revenue declined 22%, with declines in both volume and average unit prices in the first quarter of fiscal 2009 as compared to the same period of fiscal 2008. The ISS blades business, however, continued to outperform overall ISS performance. Total ESS blades revenue increased by 4% for the first quarter of fiscal 2009 when compared to the prior-year period. Business critical systems net revenue decreased 17% for the first quarter of fiscal 2009 compared to the prior-year period, impacted by the planned phase-out of the PA-RISC and Alpha Server product lines and a decline in integrity server revenue resulting from a decrease in customer capital purchases. Storage net revenue decreased 7% in the first quarter of fiscal 2009 compared to the prior-year period due to declines in tape, media, commercial automation and EVA revenue, the effect of which was partially offset by the revenue resulting from the acquisition of Lefthand Networks. In the first quarter of fiscal 2009, ESS earnings from operations as a percentage of net revenue decreased by 3.7 percentage points compared to the same period in fiscal 2008, due to a decrease in gross margin that was partially offset by a decrease in operating expenses as a percentage of net revenue. Gross margin decreased due primarily to competitive pricing, business mix shifts, and unfavorable currency impacts in all the business units, as well as product mix shift to entry level products in business critical systems. The decrease in operating expense as a percentage of net revenue was due to continued cost structure improvements including lower compensation expense. HP Software
57 The components of weighted net revenue growth as compared to the prior-year period by business unit were as follows:
HP Software net revenue decreased 7.3% (4.3% when adjusted for currency) for the three months ended January 31, 2009 as compared to the same period in fiscal 2008 due to softening enterprise spending. Declines in revenue from licenses and services were partially offset by increased support revenue as a result of renewal rate increases. Net revenue for other software decreased 14% for the first quarter of fiscal 2009 from the corresponding prior-year period, due primarily to declines in revenues for communication and media solutions and business intelligence solutions, the effect of which was partially offset by revenue growth in information management driven by our acquisition of Tower Software in May 2008. Net revenue from BTO decreased 4% for the first quarter of fiscal 2009 from the corresponding prior-year period, due primarily to declines in license and service revenues, the effect of which was partially offset by growth in support revenues. The operating margin improvement of 10.7 percentage points for HP Software for the three months ended January 31, 2009 as compared to the same period in fiscal 2008 was due primarily to an increase in gross margin coupled with a decrease in operating expenses as a percentage of net revenue. The improvement in gross margin in the first quarter of fiscal 2009 resulted primarily from a favorable revenue mix with more higher-margin support revenue and less lower-margin services revenue. The decrease in operating expenses as a percentage of net revenue in the first quarter of fiscal 2009 was due primarily to effective cost controls in sales, marketing and integration administrative expenses related to acquisitions. Personal Systems Group
The components of weighted net revenue growth as compared to the prior-year period by business unit were as follows:
PSG net revenue decreased 18.6% (15.5% when adjusted for currency) for the first quarter of fiscal 2009 as compared to the same period in fiscal 2008. The revenue decline is the result of the 58 overall slowdown in the global economy, including a reversing trend in the growth of emerging markets. PSG net revenue decreased across all geographies and all businesses. Unit volumes decreased by 4% for the first quarter of fiscal 2009 as compared to the same period in fiscal 2008. An increase in notebook PC volumes was more than offset by declines in desktop PCs, workstations, and handheld devices. The unit volume increase in notebook PCs was due in part to growth of the HP and Compaq MiniNote PCs. Net revenue for notebook PCs decreased 13%, while net revenue for desktop PCs decreased 25% from the prior-year period. Handheld revenue declined 35% from the prior-year period. Net revenue for consumer clients decreased 18%, while net revenue for commercial clients decreased 19% from the prior-year period. The net revenue increase in Other PSG was related primarily to increased sales of extended warranties and third-party branded options. The PSG unit volume decrease was intensified by ASP declines of 17% in consumer clients and 16% in commercial clients. ASPs declined from the prior-year period as a result of a competitive pricing environment, component cost reductions and the impact of currency combined with a mix shift toward lower-end models and a decline in the monitor attach rate. PSG earnings from operations as a percentage of net revenue decreased by 0.8 percentage points for the first quarter of fiscal 2009 compared to the same period in fiscal 2008. The decrease was due primarily to a decrease in gross margin, which was partially offset by a decline in operating expenses as a percentage of net revenue. The decline in gross margin was the result primarily of ASPs declining at a faster pace than component costs and a mix shift toward lower-end models, the effect of which was partially offset by lower warranty and supply chain costs and an increase in higher-margin option attach rates. The decline in operating expenses as a percentage of net revenue was the result of continued cost controls, including lower compensation expense. Imaging and Printing Group
The components of weighted net revenue growth as compared to the prior-year period by business unit were as follows:
IPG net revenue decreased 18.7% (17.5% when adjusted for currency) for the three months ended January 31, 2009 as compared to the prior-year comparable period due to a decline in economic conditions in the marketplace with customers delaying printer purchases. In the first quarter of fiscal 2009, net revenue for commercial hardware, consumer hardware and supplies declined 34%, 37% and 7%, respectively. The net revenue decline in commercial hardware was across all regions and was driven by a unit volume decline of 39% due to market weaknesses impacting both our laser and our graphics businesses. The net revenue decline in consumer hardware was across all regions as well and was driven by a unit volume decline of 31% reflecting the impact of the current global economic 59 slowdown. The decline in supplies net revenue was across all platforms as customers sought to reduce expenses and was partially moderated by supplies price increases. Despite the revenue decline, IPG earnings from operations as a percentage of net revenue increased 3.0 percentage points for the three months ended January 31, 2009 as compared to the same period in fiscal 2008. Operating margin improvement in the first quarter of fiscal 2009 was a combination of increased gross margin and decreased operating expenses as a percentage of net revenue. The improvement in gross margin in the first quarter of fiscal 2009 resulted primarily from an increase in the supplies mix and supplies price increases, the effect of which was partially offset by hardware margin declines. The decrease in operating expenses as a percentage of net revenue in the first quarter of fiscal 2009 was due primarily to effective cost controls, including lower compensation expense. HP Financial Services
For the three months ended January 31, 2009, HPFS net revenue decreased by 0.9% as compared to the prior-year comparable period. The net revenue decrease was due primarily to unfavorable currency movements. On a constant currency basis, net revenue increased due primarily to portfolio growth, increased operating lease mix, higher buyouts and used equipment sales, the effect of which was offset by lower end of lease activity. Earnings from operations as a percentage of net revenue decreased 0.3 percentage points for the three months ended January 31, 2009. The decrease is due primarily to higher bad debt and lower used equipment sales margin due to compression in proceeds, the effect of which was offset by lower expenses due to cost controls. Financing Originations
New financing originations, which represent the amounts of financing provided to customers for equipment and related software and services and includes intercompany activity, increased 2.1% in the first quarter of fiscal 2009 compared to the same period in fiscal 2008. The increase was driven by higher financing associated with HP product sales resulting from improved integration and engagement with HP's sales efforts offset by an unfavorable currency impact. Portfolio Assets and Ratios HPFS maintains a strategy to generate a competitive return on equity by effectively leveraging its portfolio against the risks associated with interest rates and credit. The HPFS business model is asset-intensive and uses certain internal metrics to measure its performance against other financial services companies, including a segment balance sheet that is derived from our internal management reporting system. The accounting policies used to derive these amounts are substantially the same as those used by the consolidated company. However, certain intercompany loans and accounts that are reflected in the segment balances are eliminated in our Consolidated Condensed Financial Statements. 60 The portfolio assets and ratios derived from the segment balance sheet for HPFS were as follows:
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