2/09/01 - Management`s Discussions: 10-K, COMPAQ COMPUTER
CORP 5 of 7
Compaq's 2000 effective tax rate was primarily affected by the recovery of tax
basis in the stock of Microcom, Inc., a former operating subsidiary which was
acquired in 1997. In addition, Compaq decreased the level of activity of its
Singaporean manufacturing subsidiary which, when considered with other foreign
effects, reduced the beneficial foreign tax effect as had occurred in previous
years.
The Singapore tax holiday for manufacturing operations will continue through
August 2001 and could be extended through August 2004 if cumulative
investment levels and other conditions are maintained. Compaq ceased utilization
of a portion of its Singaporean manufacturing subsidiary's production capacity
during 2000. Consequently, the profitability of this facility has decreased
significantly resulting in a corresponding decrease in the impact of the tax
holiday on Compaq's effective tax rate during 2000.
Compaq's 1999 effective tax rate was primarily affected by benefits from its
Singaporean manufacturing subsidiary's tax holiday and by incremental taxes
resulting from the disposition of AltaVista. In connection with the 1998
acquisition of Digital, Compaq recorded non-recurring, non-tax-deductible
charges for purchased in-process technology of approximately $3.2 billion.
Compaq has determined that the undistributed earnings of certain foreign
subsidiaries will be permanently reinvested. As a result of these determinations,
no incremental tax is reflected for the earnings of Compaq's Singaporean
manufacturing subsidiary or for the earnings of certain other foreign subsidiaries.
These earnings would become subject to incremental foreign withholding, federal
and state income tax if they were actually or deemed to be remitted to the U.S.
Compaq estimates an additional tax provision of approximately $2.1 billion would
be required if the full amount of approximately $6.2 billion in accumulated
earnings were actually or deemed distributed to the U.S.
Compaq recorded a gross deferred tax asset of approximately $2.8 billion in
conjunction with the acquisition of Digital in 1998. This gross deferred tax asset
was reduced by a valuation allowance of $562 million, resulting in a net increase
in the deferred tax asset of approximately $2.2 billion in 1998. The valuation
allowance consisted principally of pre-acquisition tax loss carryforwards and
credit carryforwards incurred by Digital which management has determined are
more likely than not to expire unused. The valuation allowance was reduced by
$95 million during 2000 and $152 million during 1999 as a result of tax loss and
credit carryforward expirations.
During 1998, Compaq recorded $65 million of other tax loss and credit
carryforwards for which a full valuation allowance was provided due to
uncertainty surrounding their realizability. In addition, the valuation allowance
was reduced by $77 million to reflect Tandem Computers Incorporated
("Tandem") credit carryforwards which, as a result of the liquidation of the U.S.
Tandem parent company at the close of 1998, are now believed more likely than
not to be realized. This reduction in the valuation allowance resulted in a tax
benefit in the 1998 deferred income tax provision.
Deferred tax assets (liabilities) were as follows:
December 31 (In millions) 2000
1999
--------
--------
Loss carryforwards .................................... $ 379
$ 1,230
Credit carryforwards .................................. 1,109
960
Accrued liabilities ................................... 748
655
Tax versus financial reporting year-end ............... 446
--
Capitalized research and development costs ............ 349
449
Receivable allowances and related reserves ............ 278
380
Inventory adjustments ................................. 347
341
Other ................................................. 514
273
--------
--------
Gross deferred tax assets ......................... 4,170
4,288
--------
--------
Equity investments .................................... (46)
(1,604)
Intangible assets ..................................... (333)
(382)
Other ................................................. (87)
(27)
--------
--------
Gross deferred tax liabilities .................... (466)
(2,013)
--------
--------
Deferred tax asset valuation allowance ................ (434)
(529)
--------
--------
$ 3,270
$ 1,746
========
======== Tax loss carryforwards will generally expire between 2001 and 2020.
Credit carryforwards will generally expire between 2001 and 2014. U.S. tax laws
limit the annual utilization of tax loss and credit
carryforwards of acquired entities. These limitations should not materially impact
the utilization of the tax carryforwards.
NOTE 8. EMPLOYEE STOCK PLANS
Compaq maintains various stock plans for its employees. Options to employees
are generally granted at the fair market value of the common stock at the date
of grant and generally vest over two to five years. Options granted to employees
under Compaq's stock option plans must be exercised no later than ten years
from the date of grant. The vesting period and option life for grants to
employees are at the discretion of the Board of Directors (the "Board").
Compaq also maintains plans under which it offers stock options to non-employee
directors. Pursuant to the terms of the plans under which directors are eligible to
receive options, each non-employee director is entitled to receive options to
purchase common stock upon initial appointment to the Board (initial grants) and
upon subsequent reelection to the Board (annual grants). Initial grants are
exercisable during the period beginning one year after initial appointment to the
Board and ending ten years after the date of grant. Annual grants vest over two
years and are exercisable thereafter until the tenth anniversary of the date of
grant. Both initial grants and annual grants have an exercise price equal to the
fair market value of Compaq's common stock on the date of grant. Additionally,
directors may elect to receive stock options in lieu of all or a portion of the
annual retainer to be earned. Such options are granted at 50 percent of the
price of Compaq's common stock at the date of grant and are exercisable during
the period beginning one year after the grant date and ending ten years after
the grant date. The expense resulting from options granted at 50 percent of the
price of Compaq's common stock at the grant date is charged to operations over
the vesting period.
Compaq had approximately 2 million shares of restricted stock outstanding at
December 31, 2000. Compaq records unearned compensation equal to the market
value of the restricted shares on the date of grant and charges the unearned
compensation to expense over the vesting period.
At December 31, 2000, there were 336 million shares of common stock reserved
for issuance under all of Compaq's stock option plans. For all plans, options of
107 million, 101 million and 88 million shares were exercisable at December 31,
2000, 1999 and 1998 with a weighted average exercise price of $20.16, $16.13
and $11.76, respectively. There were 31 million, 123 million and 217 million shares
available for grant under the plans at December 31, 2000, 1999 and 1998,
respectively.
The following table summarizes stock option activity for each of the three years
ended December 31:
SHARES
WEIGHTED AVERAGE
IN MILLIONS
PRICE PER SHARE PRICE PER SHARE
-----------
-------------------- ----------------
OPTIONS OUTSTANDING, DECEMBER 31, 1997............. 171
$ 13.63
Options granted in the acquisition of Digital.. 25
$ 5.94 - $ 39.23 22.23
Options granted................................ 13
$ 14.44 - $ 42.00 33.35
Options lapsed or canceled..................... (16)
21.84
Options exercised.............................. (36)
$ 1.30 - $ 39.23 11.39
-----------
----------------
OPTIONS OUTSTANDING, DECEMBER 31, 1998............. 157
16.37
Options granted................................ 118
$ 3.36 - $ 47.63 31.42
Options lapsed or canceled..................... (24)
28.18
Options exercised.............................. (17)
$ 1.30 - $ 39.23 9.66
-----------
----------------
OPTIONS OUTSTANDING, DECEMBER 31, 1999............. 234
23.37
Options granted................................ 119
$ 15.04 - $ 34.08 22.74
Options lapsed or canceled..................... (30)
29.99
Options exercised.............................. (23)
$ 1.58 - $ 31.25 10.40
-----------
----------------
OPTIONS OUTSTANDING, DECEMBER 31, 2000............. 300
$ 23.45
===========
----------------
39
The following table summarizes significant ranges of outstanding
and
exercisable options at December 31, 2000:
OPTIONS OUTSTANDING
OPTIONS EXERCISABLE
---------------------------------------
-----------------------
WEIGHTED WEIGHTED
WEIGHTED
AVERAGE AVERAGE
AVERAGE
RANGES OF SHARES REMAINING EXERCISE
SHARES EXERCISE
EXERCISE PRICES IN MILLIONS LIFE IN YEARS PRICE IN
MILLIONS PRICE
---------------- ----------- ------------- ---------
----------- --------
under $5.00 15 1.8 $ 3.20
15 $ 3.20
5.01 to 10.00 20 3.7 8.82
20 8.82
10.01 to 15.00 8 4.3 12.40
8 12.36
15.01 to 20.00 77 9.0 17.67
13 16.22
20.01 to 25.00 20 7.5 23.25
10 23.27
25.01 to 30.00 122 8.7 26.54
22 26.61
over $30.00 38 7.1 43.34
19 42.34
----------- ------------- ---------
----------- --------
300 7.7 $ 23.45
107 $ 20.16
=========== ============= =========
=========== ========
In April 1999, Compaq's stockholders approved the Compaq Computer
Corporation Employee Stock Purchase Plan (the "ESPP") which became
effective in
April 2000. Most employees are eligible to participate. Employees who
choose to
participate are granted an option to purchase common stock at 85
percent of
market value on the first or last day of the six month purchase period,
whichever is lower. The ESPP authorizes the issuance, and the purchase
by
employees, of up to 25 million shares of common stock through payroll
deductions. No employee is allowed to buy more than $25,000 of common
stock in
any year, based on the market value of the common stock at the
beginning of the
purchase period. During 2000, employees purchased approximately 2
million shares
for approximately $61 million under the ESPP. At December 31, 2000,
there were
approximately 23 million shares available for future purchases under
the ESPP.
The weighted average fair value per share of options granted during 2000, 1999
and 1998 was $11.80, $13.22 and $12.95, respectively. The weighted average
fair value per share of options granted under the ESPP during 2000 was $8.62.
The fair value for these options was estimated using the Black-Scholes model
with the following weighted average assumptions:
STOCK OPTIONS
ESPP
-------------------------------- --------
Year ended December 31 2000 1999
1998 2000
-------- --------
-------- --------
Expected option life (in years) ........ 6 5
5 .5
Risk-free interest rate ................ 5.0% 5.5%
4.6% 6.3%
Volatility ............................. 49.7% 39.8%
33.5% 55.9%
Dividend yield ......................... 0.4% 0.3%
0.2% 0.4%
The table that follows summarizes the pro forma effect on net
income
(loss) in the year presented if the fair values of stock-based
compensation had
been recognized as compensation expense on a straight-line basis over
the
vesting period of the grant. The following pro forma effect on net
income (loss)
for the years presented is not representative of the pro forma effect
on net
income (loss) in future years because it does not take into
consideration pro
forma compensation expense related to grants made prior to 1995.
Year ended December 31 (In millions, except per share amounts)
2000 1999 1998
-------- -------- --------
Income (loss) before income taxes:
As reported ......................................................
$ 875 $ 934 $ (2,662)
Pro forma ........................................................
293 623 (2,832)
Net income (loss):
As reported ......................................................
569 569 (2,743)
Pro forma ........................................................
191 367 (2,854)
Diluted earnings (loss) per share:
As reported ......................................................
0.33 0.34 (1.71)
Pro forma ........................................................
0.11 0.23 (1.77)
NOTE 9. STOCKHOLDERS' EQUITY
On December 29, 2000, the Board approved a cash dividend of $0.025 per share
of common stock, or approximately $43 million, to stockholders of record as of
December 31, 2000 to be paid in 2001. Total dividends declared in 2000, 1999
and 1998 were $170 million ($0.10 per share), $144 million ($0.085 per share)
and $107 million ($0.065 per share), respectively.
During 1998, a systematic common stock repurchase program was authorized by
the Board and implemented by Compaq. Compaq repurchased approximately 10
million shares during 2000, for a cost of approximately $303 million under this
program. The program was implemented to reduce the dilutive impact of common
shares issued under Compaq's equity incentive plans. On December 1, 2000, the
Board authorized a new program for the repurchase of up to $1 billion of Compaq
common shares. The systematic repurchase program initiated in 1998 has been
suspended while this new program is in effect. During 2000, total shares
repurchased to date under the new plan were 22 million, for a cost of
approximately $370 million. Compaq accounts for treasury stock using the cost
method.
In April 1999, Compaq redeemed the four million outstanding shares of the Digital
Series A 8-7/8 percent Cumulative Preferred Stock, par value $1.00 per share.
The redemption price was $400 million, plus accrued and unpaid dividends of $9
million. Compaq realized a gain of $22 million on the redemption that was
recorded directly to retained earnings.
NOTE 10. PENSION AND OTHER BENEFIT PROGRAMS
Compaq sponsors a number of defined benefit and other postretirement employee
benefit plans ("OPEB Plans") that were acquired in the Digital acquisition. Benefits
under the defined benefit pension plans are generally based on pay and service.
In the U.S., the defined benefit plan is a cash balance plan, under which the
benefit is usually paid as a lump sum.
Compaq recorded an additional minimum liability as of December 31, 2000 and
1999 totaling $33 million and $78 million, respectively, for plans where the
accumulated benefit obligation exceeded the fair market value of assets.
The projected benefit obligation, accumulated benefit obligation and fair value of
plan assets for which the accumulated benefit obligations exceed plan assets
approximated $401 million, $324 million and $154 million, respectively, for the
year ended December 31, 2000, and $353 million, $332 million and $161 million for
the year ended December 31, 1999. The measurement dates of the plans were
October 31, 2000 and 1999.
Information regarding Compaq's defined benefit and OPEB Plans was as follows:
YEAR ENDED DECEMBER 31, 2000 YEAR ENDED DECEMBER 31, 1999
---------------------------- ----------------------------
DEFINED BENEFIT OPEB DEFINED BENEFIT OPEB
PENSION PLANS PLANS PENSION PLANS PLANS
------------------ ------- ------------------ -------
(In millions, except assumptions)
U.S. FOREIGN (1) U.S. FOREIGN (1)
------- -------- ------- ------- -------- -------
Change in benefit obligation
Benefit obligation at beginning of year ......................... $
2,085 $ 1,728 $ 344 $ 2,203 $ 1,831 $ 335
Service cost ....................................................
40 66 6 41 65 10
Interest cost ...................................................
147 94 25 140 96 24
(127) 144 (11) (99) (37) 5
Curtailment (gain) loss .........................................
-- (7) -- 13 (55) (7)
Benefits paid ...................................................
(204) (70) (30) (213) (120) (27)
Currency loss ...................................................
-- (172) (1) -- (101) (1)
Other ...........................................................
-- (16) 5 -- 49 5
------- -------- ------- ------- -------- -------
Projected benefit obligation at end of year ...................
1,941 1,767 338 2,085 1,728 344
------- -------- ------- ------- -------- -------
Change in plan assets
Fair value of plan assets at beginning of year ..................
2,371 1,827 -- 2,198 1,813 --
Actual return on plan assets ....................................
174 233 -- 381 209 --
Benefits paid ...................................................
(204) (70) (30) (213) (120) (26)
Currency loss ...................................................
-- (161) -- -- (114) --
Other ...........................................................
3 5 30 5 39 26
------- -------- ------- ------- -------- -------
Fair value of plan assets at end of year .....................
2,344 1,834 -- 2,371 1,827 --
------- -------- ------- ------- -------- -------
Funded status .....................................................
403 67 (338) 286 99 (344)
Unrecognized net actuarial (gain) loss ............................
(179) 82 (22) (94) 124 (11)
Unrecognized prior service cost ...................................
-- 50 3 -- 45 4
------- -------- ------- ------- -------- -------
Prepaid (accrued) benefit cost ..................................
224 199 (357) 192 268 (351)
Contributions after measurement date ............................
-- 8 -- -- 5 --
------- -------- ------- ------- -------- -------
Prepaid (accrued) benefit cost ............................... $
224 $ 207 $ (357) $ 192 $ 273 $ (351)
======= ======== ======= ======= ======== =======
Amounts included in the Consolidated Balance Sheet are composed of:
Prepaid benefit cost ............................................ $
230 $ 344 $ -- $ 199 $ 377 $--
Accrued benefit liability .......................................
(6) (170) (357) (8) (182) (351)
Other assets ....................................................
-- 22 -- -- 44 --
Accumulated other comprehensive income ..........................
-- 11 -- 1 34 --
------- -------- ------- ------- -------- -------
Net amount recognized ......................................... $
224 $ 207 $ (357) $ 192 $ 273 $ (351)
------- -------- ------- ------- -------- -------
Weighted average assumptions as of October 31
Discount rate ...................................................
8.00% 5.75% 8.00% 7.50% 5.75% 7.50%
Expected return on plan assets ..................................
9.00% 7.35% N/A 9.00% 7.50% N/A
Rate of compensation increase ...................................
4.50% 3.60% N/A 4.50% 3.30% N/A
Health care cost trend rate, current year .......................
N/A N/A 5.50% N/A N/A 5.50%
Health care cost trend rate, ultimate year ......................
N/A N/A 5.00% N/A N/A 5.00%
Trend rate decreases to the ultimate rate in the
year ...........................................................
N/A N/A 2001 N/A N/A 2001
Components of net periodic benefit cost
Service cost .................................................... $
40 $ 66 $ 6 $ 41 $ 65 $ 10
Interest cost ...................................................
147 94 25 140 96 24
Expected return on plan assets ..................................
(199) (125) -- (191) (138) --
Settlement/curtailment gain .....................................
(17) (3) -- (9) (4) (7)
Other ...........................................................
-- 9 1 -- 3 (1)
------- -------- ------- ------- -------- -------
Net periodic pension cost ..................................... $
(29) $ 41 $ 32 $ (19) $ 22 $ 26
======= ======== ======= ======= ======== =======
(1) The OPEB Plans are consolidated to include both U.S. and foreign results.
Foreign results are immaterial for separate disclosure.
Assumed healthcare cost trend rates could have an effect on the amounts
reported for the healthcare plans. A one-percentage point increase in rates
would result in an increase of $3 million in the total service and interest costs
components and a $34 million increase in the postretirement benefit obligation.
Conversely, a one-percentage point decrease in rates would result in a decrease
of $3 million in total service and interest costs and a $29 million decrease in the
postretirement benefit obligation.
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STOCK SYMBOLS: [(cpq |
