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HR Committee Meeting

HR Committee Meeting. October 25, 2000. Agenda. Current Climate Compensation 2000 Management Incentives Discussion Long Term Incentive Proposal Proposed Changes to Executive Severance Agreements Venture Capital Investment Fund Program Status One off Senior Management Salary changes

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HR Committee Meeting

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  1. HR Committee Meeting October 25, 2000

  2. Agenda • Current Climate • Compensation • 2000 Management Incentives Discussion • Long Term Incentive Proposal • Proposed Changes to Executive Severance Agreements • Venture Capital Investment Fund Program Status • One off Senior Management Salary changes • Work/Life Initiatives

  3. Climate • Renewed energy and enthusiasm • Increased overall employee satisfaction • Emphasis on employee – supervisor relationship making a difference • Employees see clear link between their work and Compaq’s objectives • Continue to experience organizational burn and fatigue (quarter by quarter focus) • Dot.com mania slowing down

  4. 2000 YTD Actual and FY2000 Forecast According to FY2000 projections we will achieve turnover goals for VPs, Engineers and Marketing. However, Director turnover will exceed target by 16.1%.

  5. VOW SurveyMost Favorable Items • 80%+ of people feel • they will be working for Compaq 12 months from now • they can make an impact • their managers are conscious of diversity • their work groups cooperate • they can give honest feedback to their manager • their managers act with a high degree of integrity • their managers are committed to customer satisfaction • their contributions are valued by their manager • free to take reasonable risks • their manager is available when they have questions or need help

  6. VOW SurveyLess Favorable Items • 45% - 65% of people feel • process and procedures allow them to effectively meet their customer’s needs. • this is a better place to work now than it was last year. • they are rewarded according to their job performance. • their organization does not sacrifice the quality of our products or services in order to meet schedules or deadlines. • sufficient effort is made to get the opinions and thinking of employees who work here. • their organization will use the survey feedback to make improvements. • they have the opportunity to advance to positions of higher responsibility. • their manager provides ongoing feedback that helps them improve their performance. • they were able to take advantage of opportunities to enhance their skills in the last 12 months. • they were able to balance demands on their work life and their personal life.

  7. 2000 Management Incentives Discussion

  8. Desired Meeting Outcome • Discuss status of 2000 Management Incentive Bonus program • Approval of the 2000 Management Incentive Stock Option program • Discussion on overall share usage for stock incentive programs • Future Meetings: • December HR Committee Meeting • Determination and approval of Executive Officer cash bonus (initial review), stock option, and performance share awards • Approval of 2000 Management Incentive Bonus pool • February HR Committee Meeting • Final approval of Executive Officer cash bonus awards

  9. 2000 Management Incentive BonusStatus • Recommend implementation of bonus program in mid-December: • better links funding and distribution of budgets to full year financial results • better understanding of total bonus affordability based on 4Q00 performance • Will require HR Committee approval of cash bonus pool in December

  10. Stock Option PoolRecommendation • Increase overall share usage this year for annual program to 62.5M options (vs. 51M for annual grant in 1999): • Allows for greater coverage at the non-executive level • Provides more competitive posture outside US • Maintains competitive posture at all levels • Maintain upper quartile competitiveness and coverage for highest performing employees and “hot skills” • Resulting 3.7% burn rate is within industry competitive norms

  11. Stock Option TimingRecommendation • To remain consistent with 1999, make all stock option grants in December 2000 • Focuses employees on a positive message before the holidays • Secures exercise price before January earnings announcement and analyst meeting • Separates positive message about the equity opportunity from what may be perceived as a less positive message resulting from below market bonus levels

  12. Stock Option TermsRecommendation • Maintain existing terms and conditions: • Four-year vesting (1/48 vest per month) • Options begin vesting one month after grant • New Hire options begin vesting one year after grant • Thirty days to exercise post-termination • Options accelerate upon change-in-control

  13. Competitive Long-Term Incentive Values(on a Black-Scholes Value Basis) Survey Source: TriComp Survey of Executive Compensation - 2000 Report. Compaq jointly sponsors this survey with AT&T, HP, and IBM.

  14. Market Competitive Option Grant Levels if Only Options Were Granted (on a Black-Scholes basis and $30 stock price *) * Assume Black-Scholes value of one Compaq option is 65% of stock price, or in this case ~$20

  15. Sr. Staff Long-Term IncentivesBalancing Stock Options and Performance Shares

  16. Sr. Staff Long-Term IncentivesYTD Awards and December Potential

  17. 2000 Expected Grant Levels and Projected Stock Option Usage

  18. Summary of Option Targets

  19. Current Shares Issued and Available for Options

  20. Share Usage

  21. Total Overhang of Key Competitors Source: Company Annual Reports

  22. 1999 (98) Competitive Share Usage Source: 2000 iQuantic Equity Practices Survey Top 200: 1999 Pearl Meyer Equity Stake Survey

  23. 1999 (98) Competitive Share Usage Source: 2000 iQuantic Equity Practices Survey

  24. New Hire Stock Options (1)

  25. Monthly Option Program UsageJune through September 2000

  26. Long-Term Incentive Plan Proposal

  27. Desired Meeting Outcome • Recommend and approve discontinuation of Long-Term Bonus (LTB) program • Recommend and approve new Performance Share program for current LTB participants • Recommend and approve transition plan for current LTB participants

  28. Background • Long-Term Bonus (LTB) program developed in 1993 to: • Encourage executive retention • Leverage the Management Incentive Bonus program • Reward sustained corporate performance • Support shareholder value creation • There was no LTB deposit/distribution this year due to 1999 Compaq performance, and 2001 outlook is unclear

  29. Currently Sr. Staff, VPs, Directors, and Executive Managers (US grade 110 and non-US equivalents) ~3,500 participants Total outstanding balances ~$21.5M Current LTB Participants

  30. Reasons to Discontinue/Change LTB • Retention value of LTB is minimal • Award levels are not meaningful • LTB is complex and difficult to understand, and has minimal motivational value • The program focuses on annual results — Compaq has no program that focuses on intermediate (e.g., three-year) results • We can maintain competitiveness through other programs

  31. Recommendation • Create Performance Share Plan for current LTB participants • The Plan would have overlapping 3-year Performance Cycles, focusing on 3-year results • Position total compensation program so that overall competitiveness is obtained through: • Base Salary • Annual Bonus • Long-Term Incentives • Stock Options • Performance Shares • Balance Stock Options and Performance Shares so that the overall long-term incentive package is market competitive

  32. What is a Performance Share? • A conditional grant of stock • Could use either actual or “phantom” shares • Actual shares earned is based on performance at the end of a performance period (e.g., 3 years) • No time-based vesting • No automatic vesting if performance goals aren’t met • Value of shares earned (i.e., compensation to employee) is based on stock price on day of payout

  33. VP Compensation Mix Present value of stock options at grant (i.e., Black-Scholes value) Value of Performance Shares at Target on date of grant All figures in $000’s

  34. Performance Share Example (Actual Performance Matrix to be determined *) * Some possible metrics: • 3-Year Revenue Growth and/or Profit Growth • Absolute or relative to industry growth rate • 3-Year Cumulative Cash Flow • 3-Year Cumulative EPS • 3-Year Cumulative EVA • 3-Year Relative Total Shareholder Return Below threshold performance results in no Performance Shares earned

  35. Award Cycle 1 (2001-2003) Award Cycle 2 (2002-2004) Award Cycle 3 (2003-2005) 1/1/2005 1/1/2001 1/1/2002 1/1/2003 1/1/2004 Performance Share PlanPerformance Cycles • Performance Cycles would run concurrently, resulting in annual award payments from 2004 onwards Payout occurs in first quarter of 2004

  36. Performance Share PlanGeneral Description • At the beginning of each Performance Cycle, the number of target Performance Shares will be determined as a % of base salary: • Sr Staff: 100% of base salary • VP: 50% of base salary • Directors and Other Executives: 10% of base salary • At the end of each Performance Cycle, the number of Performance Shares earned will be based on Company performance • Award value at payout will be equal to the stock price on the day of payout times the number of Performance Shares earned • Participants will have a choice to receive their payout in cash or shares of stock (or a combination) • US participants will have the opportunity to defer payouts into Deferred Compensation plan if desired

  37. Transition Plan for Current LTB Participants • There is no requirement under the LTB program to cash out (or convert) balances; however, it is prudent to do so given current competitive environment • Proposed transition approach: • Pay out a maximum of $10k of each participant’s balance in cash in 2001 • Would cost ~$9.7M in 2001 • Convert remaining balances (amounts above $10k) into immediately vested stock options: • Cost: No income statement expense, but would require ~750k options • More shares may be required if a minimum number of shares per participant approach is used (e.g., 200 shares minimum)

  38. Advantages of Performance Share Plan • Bridges the gap between short-term perspective (annual bonus) and long-term perspective (stock options) • Provides additional retention hook • Diversifies overall compensation program: • Stock options would no longer be sole source of long-term wealth creation • Payout approach of Performance Shares has high leverage based on stock price growth, yet can still provide competitive compensation when stock price has not grown significantly • Reduced use of stock options at executive levels provides opportunity to push stock options deeper into organization • Competitive context - our two largest competitors use a similar approach

  39. Disadvantages of Performance Share Plan • Cost: • Shift from options adds quarterly expense • May result in short-term mismatch between Company earnings and Plan expense (but in long-term will be closely aligned) • Plan gets variable accounting treatment • Open-ended liability on upside (but is good news when it happens)

  40. Potential Cost of Program • Cost depends on: • 3-Year Performance (dictates numbers of shares paid out) • Stock Price at time of Payout (i.e., at end of 3-year performance period) • Estimated Cost:

  41. Proposed Changes to Executive Severance Agreements

  42. Background • Agreements cover Compaq’s section 16(b) officers at SVP level and above (currently 11 executives) • Market data indicates that current terms are not competitive • Candidates for key executive positions have consistently raised concerns with current terms • undercuts recruiting efforts • indicates potential retention issues • Changes proposed are consistent with terms prevalent in agreements at other companies

  43. Current Provisions and Proposed Changes Provision Current Terms Proposed terms Severance Payment 1.5 times base salary for any qualifying termination (e.g., termination without cause, resignation for good reason) or separation due to disability • 2 times base salary and target annual bonus for qualifying termination with no change in control (“CIC”) • 3 times base salary and target annual bonus for qualifying termination following a CIC • 1.5 times base salary and target annual bonus in event of separation due to death or disability Circumstances under which Executive is Eligible for Severance • Termination without cause • Resignation for good reason:” • Material change in duties • 25% or greater reduction in base salary • Notice of non-renewal of agreement • Any resignation or involuntary termination following CIC • Separation due to disability • Termination without cause • Resignation for “good reason:” • Material change in duties • 10% or greater reduction in base salary • Notice of non-renewal • Require notice of intent to resign for good reason to give company opportunity to “cure” • Resignation for “good reason” or involuntary termination following CIC • Separation due to death or disability

  44. Current Provisions and Proposed Changes (continued) Provision Current Terms Proposed terms Excise Tax Assistance (“Golden Parachute”/280g tax) Will apply cap on payments under agreement if will result in higher after-tax income for executive Provide gross-up of any excise tax under 280g Restrictive Covenants • Non-competition – precludes executive from providing services to competitors in enumerated manufacturing/systems fields • No solicitation of Compaq employees • Both applicable for 18 months following separation • Non-competition – preclude executive from engaging in activities competitive with areas for which executive had responsibility at any time during 24 months prior to separation • No solicitation of Compaq employees • Both applicable for 24 months following separation

  45. Background Data on Proposed Severance Changes Prevalence • Of the 350 companies analyzed in the Mercer 350 Survey (an index of 350 major industrial and service companies with median revenues over $5 billion), 226 companies (65%) have change-in-control provisions in place for its CEO and executive staff • While still in the minority, a smaller number of companies have implemented “Silver Parachutes” covering management level employees to lower-level executives. Trigger Elements • The following are three possible trigger elements: • Single trigger - provide payments and benefits automatically upon a change-in-control or upon a voluntary termination by the executive for any reason during the term of the agreement • Double trigger - require that there be both a change-in-control and a subsequent termination of employment either by the Company without cause or by the Executive for good reason – constructive termination – during the term of the agreement • Modified single trigger - require that there be both a change-in-control and a subsequent termination of employment either by the Company without cause or by the Executive for good reason during the term of the agreement, or a termination by the Executive for any reason during a limited window period • More than two-thirds of the companies surveyed have a “double-trigger” change-in-control provision.

  46. Background Data on Proposed Severance Changes (continued) • Most agreements provide coverage for termination of employment during a specified time period following a change-in-control. • The most common time period for change-in-control protection is two to three years:

  47. Background Data on Proposed Severance Changes (continued) • The most common change-in-control benefit for CEOs and other proxy-named executive officers is three times salary plus bonus:

  48. Background Data on Proposed Severance Changes (continued) Tax Considerations • Of those companies with golden parachutes: • 68% provide for an excise tax gross-up (i.e., provide the executive with sufficient additional amounts to pay the parachute and income taxes on the gross-up amount and the parachute tax on the benefits to which the executive is entitled without the gross-up) • 12% provide a cap or net after-tax positionmaximization (i.e., cap below level that triggers excise tax, or reduce amount the executive is otherwise entitled to receive upon a CIC if such reduction would put the executive in a better net after-tax position) Additional Severance Benefits • In addition, golden parachutes typically provide for: • Continuation of welfare benefits for the same period as is used to compute the severance multiple (e.g., if three times salary and bonus is paid, benefits are continued for three years). • Enhanced benefits, funding or accelerated payouts under deferred compensation. • Acceleration of stock-based and other performance-related awards if not already covered under the plan pursuant to which they were awarded • 85% of companies accelerate option vesting in the event of a change-in-control

  49. Background Data on Proposed Severance Changes (continued) • Based on a Mercer study of 350 large industrial and service companies: • 36.6% of CEOs have severance/termination agreements • Approximately 28% of the other named executive officers have severance agreements • In most cases, these severance benefits are provided for as a provision of an employment contract • As an alternative, some companies enter into special agreements or plans with the executive(s) to provide for severance benefits upon the termination of the executive’s employment • The payment upon termination without cause is typically expressed as a multiple of pay, or the continuation of pay through to the end of the contract term

  50. Venture Capital Investment Fund Program Status

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