Compaq's Capellas launches VLM

To: Compaq Global Team
I don't think any of us will soon forget the year 2001. It has been a time of momentous change in our world, our industry and our company. We have been challenged by a difficult economic and IT spending environment. And we have begun to articulate a new vision for Compaq's future with the proposed merger of Compaq and HP.

This is a lot of change to absorb in one year, and we all have days where the future doesn't seem so clear or so certain. But through it all, you have stayed focused on the most important tasks at hand: to strengthen our business, execute our strategy and build on our commitment to customer success.

Despite the difficult business and economic environment in 2001, we had a strong record of achievement. For example:

* We extended our enterprise product and service portfolio, further demonstrating our commitment to innovation and industry leadership.

* We made important operational improvements that will give us significant earnings leverage as the market improves.

* We built world-class e-commerce capabilities that are now being recognized.

* And we made substantial progress in the vital areas of quality and customer satisfaction.

As a result, we are a stronger company today than we were when the year began, and we're ending 2001 with solid momentum. The best evidence of that momentum is the growing number of large, multi-year contracts we're winning worldwide. Since the beginning of September, we have announced more than $4.5 billion in customer wins, and these are only the ones we can talk about publicly. These wins represent a clear vote of confidence from our customers, and that sends a powerful message to the market and our competitors.

Enterprise products and services
One of the key elements of our strategy - and of the Compaq-HP merger - is to expand our enterprise capabilities. A good example is the recent announcement by the Industry Standard Server Group of its Adaptive Infrastructure strategy. By combining innovative hardware and software, we will help customers expand their existing infrastructures and make it easier for them to adapt to rapidly changing IT demands. This kind of approach - taking standard platforms and adding significant value above the core components - is the foundation of our worldwide market share leadership in industry standard servers. And it's what helped us regain market leadership in the U.S. and North America in Q3.

Considering the tough industry conditions, 2001 has been a good year for the Enterprise Storage business. According to IDC, we regained the No. 1 market position in overall storage, including revenue, units and capacity shipped, and we solidified our position as No. 1 in deployment of storage area networks. We continue to execute well on our Enterprise Network Storage Architecture vision and to expand our portfolio of leadership technology.

In Business Critical Solutions, we're demonstrating to more and more customers how they can become real-time enterprises with our Zero Latency Enterprise (ZLE) solutions. ZLE has opened the door to more high-end opportunities, including our big win with Sabre, the leader in technology and marketing services for the travel industry. Our strengths in clustering and high-performance systems have solidified our position as the market leader in high performance technical computing.

The Business Critical Solutions team also worked very closely and successfully with customers on our plans to standardize high performance servers on the Intel Itanium Processor Family.

Compaq Global Services launched several compelling new offerings as part of our new Computing on Demand initiatives, which enable customers to deploy the IT resources they need, when and where they need them, at a variable cost. Computing on Demand is an important part of our increased focus on managed services, the fastest growing segment of the services market. In fact, we recently passed the $1 billion mark in new managed services bookings for 2001 - a 25% increase over last year.

These bookings have generated an additional $1 billion in hardware and other services.

Access
In the Access Business Group, we made progress on two important fronts: new products and business model improvements.

We completely redesigned our product portfolio and sharpened our focus on three sub-brands: Evo* for commercial products, Presario* for consumer and iPAQ* for innovative personal access devices. We're winning scores of awards - including a Best of Show award at Comdex - for innovation and design, and we're leading the way on integrated wireless and mobility solutions.

Overall, 2001 was the toughest year ever for the PC market. IDC says total PC revenue worldwide was down 15%. Price competition has been fierce. Together those two factors have had a significant impact on our profitability.

Although we still have a lot of work to do, we made good progress on improving our business model. We reduced operating expenses and inventory levels. We increased asset velocity, more than doubling inventory turns to 49 in Q3. We implemented auto-replenishment with our distribution partners in the U.S. And we ramped direct fulfillment in the U.S., including 65% of commercial PC sales in Q3. We will launch expanded direct programs in Europe next year.

All of these steps - plus others we will take in the coming months - will help us return the Access business to profitability. And an unwavering commitment to innovation and creative market approaches will help us grow. Let there be no doubt - this is a good business, and we continue to see significant opportunities for growth in the Access business.

Operational improvements
The operational improvements in the PC business are just one part of our company-wide effort to increase asset velocity, reduce structural costs and enhance an already strong balance sheet.

Overall, we:

* Reduced inventory across the supply chain by $2 billion from Q4 of last year. This had a negative impact on our revenue, but it greatly increased velocity in our supply chain - and that is going to pay significant benefits in the quarters to come. We have reduced supply chains costs per unit by 25% so far this year.

* Increased inventory turns across the board. The 49 turns in access was our biggest achievement, but we also increased turns by nearly 40% in enterprise products and by almost 20% in services.

* Reduced structural costs by an annualized run rate of $1.6 billion. This was not an easy process because it meant eliminating jobs. But it was necessary in a market with lower demand and extreme price competition.

* Increased our cash balance to $3.9 billion, with six consecutive quarters of positive cash flow from operations.

These improvements are already having a positive impact on our operating results, and they will help accelerate earnings as the IT market begins to improve - which it will.

E-commerce leadership
The untold story for much of 2001 was probably our progress on the e-commerce front. But that progress is now being recognized. Interactive Week magazine recently printed its annual Interactive 500 list, which ranks companies by total e-commerce revenue, including sales over the Internet, extranets, electronic data interchange and other online systems. Compaq jumped from No. 19 last year to No. 6 this year - ahead of No. 7 Dell. We currently generate nearly 50% of our revenues through the various forms of e-commerce.

According to IDC, Compaq is now No. 2 in Internet direct sales, and we're growing faster than any of our competitors. We had more than 10% market share in unit sales over the Internet in Q3 - behind Dell but ahead of IBM and Gateway. Our year-over-year growth rate of 67% was well ahead of our top competitors. In Latin America we're No. 1 in Internet direct sales, with market share of more than 30%.

Several factors have led to our success in e-commerce, including the redesign of compaq.com, which streamlined navigation for users and improved the customer buying experience. We also made significant strides in deploying our business-to-business e-commerce program. We increased worldwide business-to-business revenue by 109% by substantially expanding our customer deployment sites to customers such as Microsoft, American Express and Disney. Our partners, who play an important role in our e-commerce success, increased online orders by 80% year-over-year.

Quality and customer satisfaction
It's safe to say that nothing is more important to our future success than continuous improvement in quality and customer satisfaction. Based on customer feedback and satisfaction research, we set some aggressive improvement goals in eight targeted areas at the beginning of the year.

We made improvements in all eight, and significant improvement in four:

* On-time delivery
* Product quality, with an emphasis on portables
* Portables reputation and repair process
* Spares fulfillment

It appears that we will be on or very near our stretch goal of 40% improvement in order cycle time in both direct and indirect. The changes led by a network of quality leadership teams around the world helped us achieve our inventory goals and contributed to a 7 point improvement in our satisfaction scores for direct delivery in North America.

We achieved product quality improvement nearly across the board, with excellent results from the engineering and supply chain teams in Storage (+19 points) and Desktop (+9 points on an already solid base). We saw a 16-point improvement in portables quality. Mid-year satisfaction surveys also showed a 15-point improvement in customer satisfaction with our new Evo portable line and Q4 results show another 7-point improvement. In addition, we cut portables repair time around the world by nearly 30%, and we have seen portable service satisfaction go up a significant 12 points in Q4.

Spares availability improved from a critical customer issue this time last year to excellent levels of fulfillment throughout most of 2001.

Getting this right had a direct impact on both "fix in time" and "first time fix" metrics - also key drivers of customer satisfaction.

Merger/year ahead
Of all the decisions we made in 2001, the one that has been most closely scrutinized is the decision to merge with HP. It has not been an easy road in terms of public opinion. But the right road is not always the smoothest road. And you can expect it to be bumpy right up to the completion of the merger.

Compaq and HP are working hard on two important fronts - first, to win regulatory and shareholder approval for the merger, and, two, to do the detailed integration planning necessary to make the merger a success.

Earlier today, Jeff Clarke sent out an update on the merger and integration process.

As I said in my e-mail a couple of weeks ago, this merger is not about a new strategy. It is about accelerating the strategies both companies are pursuing today - by at least two years. It is about:

* Expanding our enterprise capabilities across products, services and solutions

* Achieving critical mass in services, and,

* Improving the economics of our PC business while also driving innovation around new access categories and devices

I'm confident in Compaq's future. But I'm particularly confident that this merger is in the best interests of employees, customers, partners and shareholders. No matter what happens, we will have to embrace change because our industry is changing and our customers' needs are changing. We can either lead change or be led by it.

Personally, I think it's a lot more fun and a lot more rewarding to lead change, and that's the opportunity in front of us. We will need your continued support to makes these changes - and to make them as seamless as possible for our customers.

I think all of us look back on 2001 with a wide range of emotions. But if there's one emotion I feel more than any other as the year draws to a close, it is pride - pride in the strength and tenacity of Compaq people around the world . . . pride in our ability to succeed in the toughest of environments . . . pride in our spirit of community and support for our colleagues and neighbors . . . and pride in our commitment to our customers.

Thank you for everything you've done to make Compaq successful. I look forward to an even more promising and rewarding New Year.

Michael