2/09/01 - Management`s Discussions: 10-K, COMPAQ COMPUTER
CORP 4 of 7
LONG-LIVED ASSETS. Property, plant and equipment are stated at cost less
accumulated depreciation. Major renewals and improvements are capitalized;
minor replacements, maintenance and repairs are charged to current operations.
Depreciation is computed by applying the straight-line method over the
estimated useful lives of the buildings (ten to thirty years) and by applying the
straight-line or accelerated methods over the estimated useful lives of machinery
and equipment (two to ten years). Leasehold improvements are amortized over
the shorter of the useful life of the improvement or the life of the related lease.
Compaq performs reviews for the impairment of long-lived assets whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable.
LONG-TERM INVESTMENTS. Compaq holds minority equity investments in
companies having operations or technology in areas within Compaq's strategic
focus. Certain of the investments carry restrictions on immediate disposition.
Investments in public companies with restrictions of less than one year are
classified as available-for-sale and are adjusted to their fair market value with
unrealized gains and losses recorded as a component of accumulated other
comprehensive income. Upon disposition of these investments, the specific
identification method is used to determine the cost basis in computing realized
gains or losses. Declines in value that are judged to be other than temporary are
reported in other income and expense.
INTANGIBLE ASSETS. Intangible assets primarily relate to the value of the
installed customer base, proven research and development, and trademarks of
companies acquired, as well as capitalized software and goodwill. The cost of
the installed customer base, proven research and development, trademarks,
capitalized software and goodwill is amortized on a straight-line basis over the
estimated lives of fifteen years, five years, five years, up to three years and up
to ten years, respectively. Intangible assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable.
REVENUE RECOGNITION. Compaq recognizes revenue when persuasive evidence
of an arrangement exists, delivery has occurred, the sales price is fixed or
determinable and collectibility is probable. Generally, these criteria are met at the
time product is shipped. Provision is made at the time the related revenue is
recognized for estimated product returns, price protection and other offerings
which may occur under programs Compaq has with its customers. Compaq
provides for the estimated cost of product warranties upon shipment. When
other significant obligations remain after products are delivered, revenue is
recognized only after such obligations are fulfilled. Revenue from fixed price,
long-term contracts is generally recognized over the contract term using the
percentage of completion method, based on the achievement of external
milestones. Losses on fixed price contracts are recognized during the period in
which the loss first becomes apparent. Revenue in excess of billings on service
contracts is recorded as unbilled receivables and is included in trade accounts
receivable. Billings in excess of revenue recognized on service contracts are
recorded as deferred income until revenue recognition criteria are met. Revenue
earned from services is recognized ratably over the contractual period or as the
services are performed. Shipping and handling costs are included in cost of goods
sold.
FINANCING TRANSACTIONS. Compaq offers customer financing to assist
customers in their acquisition of Compaq's products through its leasing
subsidiary, Compaq Financial Services Corporation ("CFS"). At the time a
financing transaction is consummated, which qualifies as either a sales-type or
direct financing lease, Compaq records the total lease receivable net of unearned
income and the estimated residual value of the equipment. The non-current
portion of lease receivables and the residual value, net of unearned income, are
included in long-term other assets. Unearned income is recognized as finance
income using the interest method over the term of the lease. Leases not
qualifying as either sales-type or direct financing leases are accounted for as
operating leases. The underlying equipment is depreciated on a straight-line
basis over the initial term of the operating lease to its estimated residual value.
ADVERTISING COSTS. Advertising costs are charged to operations when
incurred. Advertising expenses for 2000, 1999 and 1998 were $370 million, $385
million and $336 million, respectively.
FOREIGN CURRENCY. Compaq's foreign subsidiaries predominately have the U.S.
dollar designated as their functional currency. Financial statements of these
foreign subsidiaries are remeasured to U.S. dollars for consolidation purposes
using current rates of exchange for monetary assets and liabilities and historical
rates of exchange for nonmonetary assets and related elements of expense.
Revenue and other expense elements are remeasured at rates that approximate
the rates in effect on the transaction dates. Remeasurement gains and losses
are included in other income and expense. Certain foreign subsidiaries designate
the local currency as their functional currency and related cumulative translation
adjustments are included as a component of accumulated other comprehensive
income.
INCOME TAXES. Compaq accounts for income taxes under Statement of Financial
Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES. The asset and
liability approach is used to recognize deferred tax assets and liabilities for the
expected future tax consequences of temporary differences between the
carrying amounts and the tax bases of assets and liabilities. Compaq records a
valuation allowance to reduce the deferred tax assets to the amount that is
more likely than not to be realized.
EARNINGS PER COMMON SHARE. Basic earnings (loss) per common share is
computed using the weighted average number of common shares outstanding
during the period. Diluted earnings per common share is computed using the
combination of dilutive common share equivalents and the weighted average
number of common shares outstanding during the period. Incremental shares of
40 million and 42 million in 2000 and 1999, respectively, were used in the
calculation of diluted earnings per common share. Diluted loss per common share
for 1998 is based only on the weighted average number of common shares
outstanding during the period, as the inclusion of 60 million common share
equivalents would have been antidilutive. Stock options to purchase 107 million,
66 million and 13 million shares of common stock in 2000, 1999 and 1998,
respectively, were outstanding but not included in the computation of diluted
earnings (loss) per common share because the option exercise price was greater
than the average market price of the common shares. For the year ended
December 31, 1999, net income used in the calculation of earnings per common
share was adjusted to include a $22 million gain on redemption of Digital
preferred stock.
STOCK-BASED COMPENSATION. Compaq measures compensation expense for its
stock-based employee compensation plans using the intrinsic value method, and
has provided in Note 8 the pro forma disclosure of the effect on net income
(loss) and earnings (loss) per common share as if the fair value based method
had been applied in measuring compensation expense.
COMPREHENSIVE INCOME (LOSS). Other comprehensive income (loss) refers to
revenues, expenses, gains and losses that under accounting principles generally
accepted in the United States are included in comprehensive income (loss) but
are excluded from net income (loss) as these amounts are recorded directly as
an adjustment to stockholders' equity, net of tax. Compaq's other comprehensive
income (loss) is composed of unrealized gains and losses on available-for-sale
securities, foreign currency translation adjustments and adjustments made to
recognize additional minimum liabilities associated with Compaq's defined benefit
pension plans. Amounts relating to realized investment gains and losses and
investment impairment charges are reclassified from other comprehensive income
as they are included in net income.
SEGMENT DATA. Compaq reports segment data based on the management
approach which designates the internal reporting that is used by management for
making operating decisions and assessing performance as the source of Compaq's
reportable operating segments. Compaq also discloses information about
products and services, geographical areas and major customers.
RECENT PRONOUNCEMENTS. Effective January 1, 2001, Compaq adopted
Statement of Financial Accounting Standards No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, as amended ("FAS 133").
This statement establishes a new model for accounting for derivatives and
hedging activities. Under FAS 133, all derivatives must be recognized as assets
and liabilities and measured at fair value. The impact of the adoption will be
based on factors such as specific derivative and hedging activities, market
conditions and contractual arrangements at the date of adoption. The effect of
the adoption will not have a significant impact on Compaq's financial position or
results of operations in 2001.
RECLASSIFICATIONS. Certain prior year amounts have been reclassified to
conform to the current year presentation.
NOTE 2. ACCOUNTING CHANGE
Effective January 1, 2000, Compaq adopted Staff Accounting Bulletin No. 101,
REVENUE RECOGNITION IN FINANCIAL STATEMENTS, as amended ("SAB 101"),
issued by the Securities and Exchange Commission in December 1999. Compaq's
adoption of SAB 101 resulted in a change in method of accounting for certain
revenue product shipments. The cumulative effect of this accounting change
was $38 million ($26 million, net of tax). The accounting change did not have a
material effect on revenue
and quarterly earnings during 2000. Compaq has restated its results for the first
three quarters of the year ended December 31, 2000, as reflected in the
Selected Quarterly Financial Data on page 50. Pro forma results for prior years
are not disclosed due to immateriality.
NOTE 3. ACQUISITIONS AND DIVESTITURES
In February 2000, Compaq acquired certain configuration and distribution assets
of Inacom, a provider of information technology services and products, for
approximately $370 million in cash and the assumption of certain related
liabilities. This acquisition was accounted for as a purchase. The estimated
purchase price was allocated to the assets acquired and liabilities assumed,
including goodwill of $230 million which is being amortized on a straight-line basis
over a period of ten years. Pro forma statements of operations reflecting this
acquisition are not shown as such disclosure is not material.
In August 1999, Compaq sold an 81.5 percent equity interest in AltaVista for
approximately 38 million CMGI common shares, CMGI preferred shares convertible
into 3.6 million CMGI common shares and a $220 million three-year note
receivable. In October 1999, CMGI converted the CMGI preferred shares held by
Compaq into 3.6 million CMGI common shares. The CMGI common shares acquired
by Compaq in this transaction carry certain restrictions whereby Compaq may
not sell more than 50 percent (20.8 million) of such shares prior to August 2001.
Total consideration received from CMGI was valued at $1.8 billion. After adjusting
for the net assets sold and for the expenses associated with the divestiture,
Compaq realized a gain of approximately $1.2 billion ($670 million, net of tax).
Compaq accounts for its minority investments in CMGI and AltaVista under the
cost method. All CMGI share information reflects CMGI's two-for-one stock split,
effective January 2000.
In April 1999, Compaq acquired Zip2 for an aggregate purchase price of $341
million consisting of $307 million in cash, the issuance of employee stock options
to purchase AltaVista stock with a fair value of $28 million and other acquisition
costs. In February 1999, Compaq acquired SDC for an aggregate purchase price
of $257 million consisting of $219 million in cash, the issuance of employee stock
options to purchase Compaq stock with a fair value of $32 million and other
acquisition costs. These transactions were accounted for as purchases.
In June 1998, Compaq consummated its acquisition of Digital for an aggregate
purchase price of $9.1 billion. The purchase price consisted of approximately
$4.5 billion in cash, the issuance of approximately 141 million shares of Compaq
common stock valued at approximately $4.3 billion and the issuance of
approximately 25 million options to purchase Compaq common stock valued at
approximately $249 million. This acquisition was accounted for as a purchase.
The unaudited consolidated pro forma information for 1998 as if Compaq and
Digital had been combined as of the beginning of 1998 included revenue and net
income of $36.4 billion and $275 million, respectively, and basic and diluted
earnings per common share of $0.16 each.
NOTE 4. CERTAIN BALANCE SHEET COMPONENTS
Compaq's trade accounts receivable are reported net of allowance for doubtful
accounts of $211 million and $222 million at December 31, 2000 and 1999,
respectively. Other current assets include deferred tax assets of $1.7 billion and
$1.5 billion at December 31, 2000 and 1999, respectively. The net investment in
lease receivables consisted of the following:
December 31 (In millions) 2000
1999
-------
-------
Minimum lease payment receivable ............... $ 1,868
$ 1,160
Unguaranteed residual values ................... 122
59
Initial direct costs ........................... 21
12
Allowance ...................................... (27)
(12)
Unearned income ................................ (217)
(118)
-------
-------
$ 1,767
$ 1,101
=======
======= Contractual maturities of Compaq's lease receivables at December 31,
2000 were $866 million in 2001, $601 million in 2002, $328 million in 2003, $66
million in 2004 and $7 million in 2005. Compaq also leases its products to
customers under operating leases. Minimum future rentals under operating leases
at December 31, 2000 were $426 million in 2001, $244 million in 2002 and $48
million in 2003.
Inventories consisted of the following:
December 31 (In millions) 2000
1999
------
------
Raw material ............................. $ 540
$ 448
Work-in-progress ......................... 298
394
Finished goods ........................... 1,323
1,166
------
------
$2,161
$2,008
======
====== Property, plant and equipment consisted of the following:
December 31 (In millions) 2000
1999
--------
--------
Land ................................................. $ 342
$ 342
Buildings and leasehold improvements ................. 1,493
1,572
Machinery and equipment .............................. 3,786
3,095
Equipment leased to third parties .................... 1,166
741
Construction-in-process .............................. 261
301
--------
--------
7,048
6,051
Less: Accumulated depreciation ....................... (3,617)
(2,802)
--------
--------
$ 3,431
$ 3,249
========
======== Depreciation expense totaled $1.1 billion, $839 million and $606 million
in 2000, 1999 and 1998, respectively. Accumulated depreciation related to
equipment leased to third parties was $422 million and $224 million at December
31, 2000 and 1999, respectively.
Other non-current assets consisted of the following:
December 31 (In millions) 2000
1999
--------
--------
Investments .................................. $ 864 $
6,617
Intangible assets ............................ 2,637
2,351
Deferred income taxes ........................ 1,604
342
Other assets ................................. 2,032
1,442
--------
--------
7,137
10,752
Less: Accumulated amortization ............... (823)
(573)
--------
--------
$ 6,314 $
10,179
========
======== Amortization expense related to intangible assets totaled $313 million,
$563 million and $287 million in 2000, 1999 and 1998, respectively. The cost
basis and fair value of Compaq's available-for-sale securities at December 31,
2000 was $350 million and $461 million, respectively. Gross unrealized gains and
gross unrealized losses related to these investments at December 31, 2000 were
$132 million ($86 million, net of tax) and $21 million ($14 million, net of tax),
respectively. At December 31, 1999, the cost basis and fair value of
available-for-sale securities was $857 million and $5.4 billion, respectively, and
the cumulative unrealized gain was $4.6 billion ($3.0 billion, net of tax). Compaq
made
cash purchases of investments of approximately $480 million and $89 million
during 2000 and 1999, respectively.
Other current liabilities consisted of the following:
December 31 (In millions) 2000
1999
--------
--------
Salaries, wages and related items ...................... $ 922
$ 644
Accrued restructuring costs ............................ 343
1,002
Income taxes payable ................................... 769
992
Accrued warranties ..................................... 938
937
Other accrued liabilities .............................. 2,544
2,458
--------
--------
$ 5,516
$ 6,033
========
======== NOTE 5. BORROWINGS
Compaq has a $2.2 billion revolving credit facility that expires in September 2001
and a $3.0 billion revolving credit facility that expires in October 2002. The
facilities bear interest at LIBOR plus 0.625 percent and LIBOR plus 0.325 percent,
respectively. Fees associated with these facilities are immaterial. Both of these
facilities were unused at December 31, 2000 and 1999. Compaq also operates
two short-term commercial paper programs: a $1.5 billion program in the name of
Compaq Computer Corporation and a $1.0 billion program in the name of CFS.
Both programs are supported by the $3.0 billion credit facility. Outstanding
commercial paper reduces available borrowings under this credit facility. At
December 31, 2000, Compaq had $418 million and $218 million in commercial
paper outstanding under the Compaq and CFS programs, respectively, with a
weighted average interest rate of 7.5 percent. The carrying amounts of the
borrowings under the commercial paper program approximate their fair value.
Additionally, Compaq maintains various uncommitted lines of credit, which totaled
approximately $275 million at December 31, 2000. There were no outstanding
borrowings against these lines at December 31, 2000 and 1999.
Compaq filed a $2.0 billion shelf registration statement for debt securities with
the Securities and Exchange Commission during the second quarter of 2000. In
August 2000, Compaq placed under the registration statement $300 million of
unsecured 7.65 percent notes that mature on August 1, 2005, and $275 million
of unsecured 7.45 percent notes that mature on August 1, 2002 (collectively,
the "Notes"), unless previously redeemed. Interest will be paid on the Notes on
February 1 and August 1 of each year, beginning on February 1, 2001. The fair
value of the Notes approximates carrying value. The financing is for general
corporate purposes (including investments in CFS and other subsidiaries), capital
expenditures and repayment of outstanding indebtedness (including commercial
paper issued for working capital purposes). Compaq has the capacity to issue an
additional $1.4 billion of debt securities under the shelf registration statement.
NOTE 6. OTHER INCOME AND EXPENSE
Other (income) expense consisted of the following:
Year ended December 31 (In millions) 2000 1999
1998
-------- --------
--------
Investment (income) loss, net .............. $ 1,568 $ (67)
$ (9)
Gain on sale of businesses ................. -- (1,182)
--
Interest and dividend income ............... (276) (196)
(287)
Interest expense ........................... 273 211
166
Currency losses, net ....................... 75 136
16
Other, net ................................. 24 22
45
-------- --------
--------
$ 1,664 $ (1,076)
$ (69)
======== ========
======== Net investment loss in 2000 included a $1.8 billion ($1.1 billion, net of
tax) impairment charge for certain equity investments judged to have
experienced an other than temporary decline in value, a $252 million ($164
million, net of tax) realized gain on the sale of available-for-sale securities and a
$77
million loss from investments accounted for under the equity method. Net
investment income in 1999 included a $126 million ($82 million, net of tax)
realized gain on the sale of available-for-sale securities and a $52 million loss
from investments accounted for under the equity method. Proceeds associated
with the sale of available-for-sale securities were $264 million and $149 million in
2000 and 1999, respectively.
NOTE 7. PROVISION FOR INCOME TAXES
The components of income (loss) before provision for income taxes were as
follows:
Year ended December 31 (In millions) 2000 1999
1998
-------- --------
--------
Domestic ........................... $ 200 $ 94
$ (4,782)
Foreign ............................ 675 840
2,120
-------- --------
--------
$ 875 $ 934
$ (2,662)
======== ========
======== The provisions for income taxes charged to operations were as
follows:
Year ended December 31 (In millions) 2000 1999
1998
-------- --------
--------
Current tax expense (benefit)
U.S. federal ............................. $ (91) $ 1
$ (92)
State and local .......................... 5 11
(9)
Foreign .................................. 353 460
312
-------- --------
--------
Total current ......................... 267 472
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