FOOL CONFERENCE CALL SYNOPSIS*
By Deborah Tidwell (TMF Debit)

Hewlett-Packard Company
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3000 Hanover Street
Palo Alto, CA 94304
(415) 857-1501
http://www.hp.com

ALEXANDRIA, VA (August 18, 1997)/FOOLWIRE/ --- Hewlett-Packard Company reported their third quarter 1997 results this morning. Orders and revenue growth returned to the mid-to-high-teens as year-over-year comparisons normalized, but they were unable to translate this growth into the bottom-line performance expected. They are reporting much better growth than in recent periods, but their profitability was disappointing. They had hoped to turn strong growth into better margins and EPS. They had a substantial improvement in order and revenue growth and a good market response to many new products. It was also a good quarter for asset management. On the other hand, cost of sales was up significantly. Some of the increase stemmed from their own pricing actions in printers and PCs, some of it was due to shipment delays in their medical business, and there were mix impacts on cost of sales as well. The outcome on operating expenses fell short of their goals, 13% growth when revenue grew 15%. As a result, profits were decent, but down from the very strong first half.

SPECIFIC ITEMS IMPACTING EPS. The runup on HP's stock price last month increased expenses associated with stock appreciation rights (SARs). These are related to stock options, but HP gives SARs to employees to whom granting options is either not feasible or unwise for tax purposes, as in some countries outside the US. Unlike most options, SARs must be accounted for as compensation, which varies with stock price. This quarter, HP's stock price rose 33% and the associated SAR effect took about $0.02 out of EPS. In addition, medical revenues dropped sharply even though orders were very good because of shipment delays. Several of the shipment delay issues were resolved late in July and they are now shipping some of these products, others are still pending. Delays in medical lowered EPS by about $0.04. These two items are real and impacted EPS, but HP considers them to be irregular and unlikely to recur in coming months.

ORDER GROWTH. Order growth of 19% was their best since Q2 1996 and was $10.4 billion. Currency lowered this rate by about 5%, but this was pretty much offset by the relative easy comparison versus a weak third quarter last year. US orders were $4.9 billion, up 25% compared with a year ago. International orders totaled $5.5 billion and were up 15% despite unfavorable currency impacts. International orders were 53.1% of this quarter's total. 19% growth is a fine improvement over 6% in the first half of this year and 8% in Q3 last year. Growth rebounded in many businesses and the market responded very well to a number of new products. Order growth in the US of 25% outpaced international at 15% and was a very good improvement over last quarter when US orders declined 2% and international rose 7%. Last year, order growth was 4% in the US and 11% outside the US. Backlog increased during the quarter by $115 million which compares to a $433 million decrease in Q3 1996. A decrease in backlog from Q2 to Q3 is fairly typical, as order patterns are slower during the Summer months. PCs, most of the server business, printers, test and measurement, and support businesses all reported solid growth order numbers. Overall HP showed strong growth in the US and Latin America, moderate growth for Europe and Asia/Pacific. Currency affected them in Europe, where the dollar growth was up 13% compared to 22% in local currency and in Asia/Pacific where the dollar growth was up 13% compared to 26% in local currency. In Japan, the yen was up 2% while dollar growth was down 7%.

REVENUE GROWTH. Revenues for the quarter were $10.5 billion, an increase of 15% over Q3 last year and 1% sequentially. Adjusted for currency, the year-over-year increase would have been 4-5% higher. Revenue growth in Q3 1996 was 18% which was not an easy comparison. US and international revenue both grew 15%. With the exception of the medical business, the comments made regarding order growth also apply to revenues this quarter.

COMPUTER BUSINESS REVENUES. The computer business grew 17% versus Q3 1996 and 2% sequentially. PC revenue growth was excellent, pretty much across the board. Desktop revenues grew faster than the market. PC server growth was strong. Home PC revenues doubled over Q3 1996, helped by earlier product introductions this quarter compared to last year's Q3. Mobile PCs had excellent sales growth as they are picking up momentum in this business. UNIX systems revenues were up nicely compared to Q3 last year while workstation revenues were down as high-performance PCs continued to encroach on UNIX workstation turf.

COMPUTER PRODUCTS ORDER GROWTH. Orders in computer products, services, and support rose 20% over Q3 1996. Hardcopy products were in double digits again for year-over-year comparisons. Unit volume growth rates are significantly higher because they have continued their offering of new products as well as offering competitive price/performance. The Laserjet business achieved a strong pickup in US orders, partly influenced by a few of their resellers building up some Q3 inventory to increase their stocking position. Most of the geographies showed growth. Canada was up solidly and Europe showed signs of coming back even with the struggles of lower pricing and currency problems. Latin America and Asia/Pacific posted very strong growth. Quarter over quarter order growth was moderately strong for business Laserjets and very strong for personal Laserjets. Color Laserjets also had strong year-over-year growth as the color market takes off and also because of the aggressive price reductions announced in the Spring. Supplies are back in the double-digit growth area after last quarter's slower growth. Scanners order dollar growth was slight, but unit growth was stellar. They have seen no significant market share movement in their business Laserjets in recent months. But, their personal Laserjets have shown a moderate increase. Laserjet revenues increased modestly in dollars. However, the pricing action they took in May contributed to strong unit shipment growth this quarter. Laserjet profitability was excellent as was return on assets.

INKJET ORDER GROWTH. Inkjet order growth was driven by a number of new product introductions -- most notably, new Officejet all-in-one devices and a Deskjet printer. They also introduced new inkjet color copiers and moved to full US distribution for the Photosmart PC photography system. Inkjet supplies also posted excellent growth. Even with the traditional seasonal slowdown for resellers before the Fall buying season, they saw very strong US growth quarter-over-quarter with Canada's numbers even higher. Latin America slowed to single-digit growth while Europe moved up somewhat. Asia/Pacific had good growth without Japan which continued its decline. Of course, these results are in comparison to a weak Q3 1996 in the US. They lost some market share but they believe this is mainly because competitors introduced new products while HP was still selling the previous generation. This has typically caused their market share to fluctuate.

ORDER GROWTH IN CLIENTS. Overall growth in clients (which includes home PCs, desktop systems, mobile, and hand-held products) was strongest in North Ameria, followed closely by Asia/Pacific without Japan. In Europe, despite the fact that the computer business, particularly PCs has been in a slump, they had very strong growth. On a calendar year basis, they gained nearly two marketshare points in Europe. Home PCs drove this product line with a 3x growth rate, achieved despite the traditionally slow retail season. This growth probably reflects the continued consolidation of leading brands in stores by major US retailers and by the early success of their newly redesigned Pavilion home PC family introduced last month which experienced exceptional sell-through. Desktop PC orders showed remarkable order growth. They are comparing to a weak Q3 1996 when they had to clear backlog. Even taking that into account, growth is very solid. UNIX workstations declined due to competitive pricing pressures, slow migration to the 10.2 operating system, and NT workstation demand. Next month they will announce and begin shipping the next generation of Visualized Graphics with HP-UX. PC workstations will also offer a version of the HP Visualized Graphics subsystem with three times the performance of the fastest competitive systems. Notebook PCs had outstanding growth as they filled out this product line. Growth in hand-helds was exceptional and according to Microsoft, HP's 320LX is the best-selling Windows CE-based product. Their small-business PCs had very solid year-over-year growth. This line is still an emerging market for them and they have a number of Q4 introductions.

ORDER GROWTH IN SERVERS. The UNIX server business showed healthy growth in the low-double-digit range. Overall market strength continues due to strong demand for mission critical applications and the year 2000 which is prompting additional replacement of legacy mainframe systems. UNIX servers displayed renewed strength at the high end with both the T600 and V-class systems showing encouraging early acceptance. A rejuvenated high end is producing the expected ripple effect through the product line, boosting sales of their K and D-class servers and leading to record overall sales in July. Strong order performance in telecom, manufacturing, and financial services translate into the solid order growth in the enterprise server group. This covered most geographies. They are pleased with the focus they have achieved by having a separate enterprise server group and by the fact that HP is the number one UNIX server provider. PC server growth was excellent with especially strong growth in the low-end and the midrange NetServer LH. All geographies except Japan experienced significant growth.

INFORMATION STORAGE PRODUCTS. Information storage revenues were up compared to Q3 1996 and down sequentially. Orders in information storage are beginning a slight move up over Q3 1996 now that the disk mechanism closure is behind them. Although high-end tapes have been relatively flat, there has been good growth in CD products and in storage solutions. The Americas drove the growth. Asia/Pacific showed slight growth and Europe declined.

SERVICES GROUP. Worldwide Service and Service Support, now called their Software and Services Group, posted very strong year-over-year order growth. All major geographies experienced double-digit growth over Q3 1996. There was especially strong growth in Asia/Pacific and the Americas.

TEST & MEASUREMENT PRODUCTS. Test and measurement revenues were up 20% over Q3 1996 and up 3% sequentially. They did a great job of turning last quarter's strong order performance into shipments this quarter. With continued strong order momentum, they were able to build backlog modestly despite strong shipments. They reported very strong profits. Their test and measurement business achieved yet another billion-dollar quarter, its third in a row, with 14% worldwide growth. Much of the order growth came from the rebounding semiconductor test business with orders from their largest customers up sharply. The US achieved very good growth year-over-year and sequentially. They also achieved good growth in their communications segment, aided by the buildup of wireless infrastructures, especially mobile stations and base-station test in Korea and Europe.

COMPONENTS. Components revenue was up 13% compared to both last year and last quarter. Orders continued to rebound in their component businesses with a 66% increase in orders over Q3 1996. They are seeing excellent growth in communications, both wireless and fiberoptic systems, year-over-year. While they are not growing as fast, they are seeing solid growth in the LED market as well.

CHEMICAL ANALYSIS. Chemical analysis revenue increased 5% over last year and increased 4% sequentially. This business showed a 2% increase in orders over Q3 1996, with continuing strong performance in the mass spectrometry product line.

MEDICAL. Orders in this business grew 8% over last year and 3% sequentially. Imaging systems did extremely well in year-over-year growth across all geographies. Overall, the medical products business reported double-digit growth in Asia/Pacific and solid growth in the Americas and Europe. Their Far East market also turned in strong results. Revenue from the medical products division decreased 27% compared to Q3 1996 and was down 28% sequentially. Medical performance really hurt HP this quarter. Production problems and product transition issues caused a significant shipment backup which affected the entire medical products group for three to four weeks. The revenue shortfall was around $9 million which resulted in gross profits coming in at $50-60 million below normal.

COST OF SALES GROWTH. The recent trend of slower growth in cost of sales did not continue in Q3. At 67.4%, cost of sales was up a lot -- 1.4% from last year and 2.2% higher than in Q2 this year. Pricing was an important factor in the cost of sales increase. They knew their own price cuts in printers and PCs would affect cost of sales. The businesses made these cuts for sound competitive and financial reasons and will continue to move decisively on pricing across HP. In addition, their very strong growth in PCs as well as the shipment decline in medical produced an unfavorable mix effect on cost of sales. This result was a real change from the first half. The increase in cost of sales was expected, but the magnitude of it was more than expected. They said many times that they expected upward pressure on cost of sales to be the basic trend. When they reported those great cost of sales quarters earlier this year they said that it couldn't go on indefinitely. Cost of sales as a percentage of revenue was 67.4% for the quarter compared to 66% in Q3 1996. Sequentially the cost of sales ratio was up 2.2% from 65.2%. Laserjet gross margins actually improved because of currency and DRAM effects. Price protection and inventory write-offs did not play a significant role in this quarter's margin decline. Supply chain efforts are still paying off. The first and most obvious contributor to the fall-off was the revenue shortfall in the medical business. They don't expect medical, which is one of their higher gross margin businesses, to be a drag on cost of sales in the future. The second issue is a bit more systemic in nature -- competitive pressures in PC and inkjet businesses. On the PC side, last quarter was not exactly robust. This quarter they cut prices. The last two quarters really illustrate how price-sensitive the PC business is. Cost of sales also crept up a bit on the inkjet side this quarter which is typical third quarter seasonality for this business. Even though year-over-year inkjet growth was strong, sequentially revenue was down which was expected in Q3. This is a high fixed cost business, so gross margins are very sensitive to volume. However, they are on plan and are well positioned going into Q4. The other cost of sales issue is mix. The PC and inkjet business models call for lower gross margins and lower expense structures than their other businesses. They also happen to be their fastest-growing businesses as well. By definition, their mix effect will bring average gross margins down for the company. In spite of this, with strong asset and supply chain management, they have still been able to meet their profit and ROA plans for these businesses.

EXPENSE GROWTH. Unfortunately they did not offset this cost of sales pressure with a good outcome on expenses. The 13% growth in expenses this year compares to 7% growth last quarter. Last year in Q3 operating expenses were up 15%. There were a few factors at work beyond the SARs that affected expenses. Two acquisitions and several new marketing and channel programs to strengthen their market position all added to expenses. Employment was up in the quarter by 5,900 people. About 3300 of these are VeriFone. Even without VeriFone this is a big increase. It wasn't a surprise because Summer is when most college hires arrive and it takes several months to see the impact of hiring controls. Controls are in effect and there are hiring freezes in several businesses. They had operating profit of 7.9% and net of 5.9%. These are lower than their goals and lower than what they have achieved recently. Q3 is typically their weakest profit quarter. Laserjet, test and measurement, and service and support made healthy contributions to HP's profits.

BALANCE SHEET. They are pleased with their asset ratios and generally satisfied with asset performance this quarter. Increases in inventory and accounts receivable were the result of accelerating revenue growth and the need to build some stock for the back-to-school and holiday seasons. Net cash declined by a few hundred million dollars. They are still in good shape with cash which is well above where they were a year ago. Return on assets was 10.4%, a nice increase over both last quarter and the year-ago quarter. Return on equity was 21%. Net cash decreased by $524 million during the quarter, ending at $1.2 billion. They define net cash as cash, marketable securities, and long-term cash included in the other assets category, less total debt. The amount of cash in Puerto Rico which is reported as other assets, was $1.2 billion, unchanged from last quarter. The major sources of cash during the quarter were net earnings of $617 million, depreciation and amortization of $410 million, and stock issuance of $107 million. The major uses of cash were increases in A/R and inventory of $209 million and $109 million respectively, a net increase in property, plant, and equipment of $504 million, stock repurchases of $158 million, $142 million for dividends, and an increase in other balance sheet items of $536 million. They repurchased 2 million shares of common stock and continue to repurchase based on an algorithm which considers a number of factors including share price. Their objective is to buy opportunistically with the goal of achieving zero dilution over time. Capital expenditures were $559 million. After 9 months they are behind on their original capital spending plan of about $2.6 billion for the year. They estimate that they will finish the year between $2.2 and $2.3 billion.

OPERATING EXPENSES. Operating expenses as a percentage of revenue were down 26% compared to Q3 last year but were up 0.6% sequentially. Overall, operating expenses grew 13% over Q3 1996 and increased 4% from Q2. R&D spending was up 10% year-over-year and 4% sequentially, while SG&A expense grew 14% over Q3 last year and 4% sequentially. Currency, profit sharing, bad debt, and a one-time gain on the sale of real property had a positive effect on expense growth this time while an unusually high accrual of Stock Appreciation Rights expense had a negative effect. SARs added $20 million to expenses and acquisitions such as VeriFone added $15 million. Most of the other expense increases were investments in strategic areas to support growth.

EARNINGS, MARGINS, ROA, ROE. Net earnings were up 11% over Q3 1996 and were down 14% compared to last quarter. Net margin was 5.9^ compared to an adjusted 6.1% last year and 7.6% last quarter. Return on assets was 10.4% this quarter versus 9.6% last year and 9.9% last quarter. This is a 4-quarter rolling average calculation. Return on equity was 21% this quarter compared to 21.1% in Q3 1996 and 20.3% last quarter. Earnings per share was $0.58, up 9% from last year's adjusted $0.53 per share.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.