EMC CORP (EMC)
Annual Report (SEC form 10-K)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with "Factors that May Affect Future Results" beginning on page 18. All dollar amounts in this MD&A and in Item 7A are in millions.
The following table presents certain consolidated statement of operations information stated as a percentage of total revenues.
Fiscal Year Ended
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December 31, December 31, December 31,
1998 1997 1996
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Revenues
Enterprise storage hardware............ 79.7% 85.0% 86.3%
Enterprise storage software............ 11.2 6.0 3.4
Enterprise switching products
(McDATA).............................. 4.5 6.4 7.9
Service and rental..................... 4.6 2.6 2.4
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Total revenue.......................... 100.0% 100.0% 100.0%
Cost and expenses
Cost of sales and service.............. 48.6 53.5 54.9
Research and development............... 7.9 7.5 7.1
Selling, general and administrative.... 18.8 16.5 16.2
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Operating income....................... 24.7 22.5 21.8
Investment income and interest expense,
net................................... 2.0 1.9 1.0
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Income before income taxes............. 26.7 24.4 22.8
Provision for income taxes............. 6.7 6.1 5.8
----- ----- -----
Net income............................. 20.0% 18.3% 17.0%
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Revenues
Total revenues were $3,973.7, $2,937.9 and $2,273.7 in 1998, 1997 and 1996, respectively; an increase of $1,035.8 or 35% from 1997 to 1998, and $664.2 or 29% from 1996 to 1997.
Enterprise systems revenues from products sold directly and through OEMs and resellers were $3,167.1, $2,496.7 and $1,961.3 in 1998, 1997 and 1996, respectively; an increase of $670.4 or 27% from 1997 to 1998, and $535.4 or 27% from 1996 to 1997. The increase in enterprise systems revenues was primarily due to the continued strong demand for the Company's Symmetrix series of products. These products address the growing demand for enterprise- wide storage solutions, allowing users to move, store and protect mission critical information in UNIX, Windows NT and mainframe environments.
Enterprise software revenues from products sold directly and through OEMs and resellers were $445.4, $176.9 and $76.4 in 1998, 1997 and 1996, respectively; an increase of $268.5 or 152% from 1997 to 1998, and an increase of $100.5 or 131% from 1996 to 1997. The increase in software revenues was primarily due to increased licenses of enterprise storage software on Symmetrix systems, both newly shipped and already installed, and the successful introduction of new software products.
Revenues from products sold by McDATA, primarily the ESCON Director series of products, were $178.8, $189.1 and $180.5 in 1998, 1997 and 1996, respectively; a decrease of $10.3 or 5% from 1997 to 1998, and an increase of $8.6 or 5% from 1996 to 1997. The decrease from 1997 to 1998 was primarily due to the product transition from ESCON-based to fibre-channel-based directors.
Service and rental revenues were $182.4, $75.2 and $55.4 in 1998, 1997 and 1996, respectively; an increase of $107.2 or 143% from 1997 to 1998, and an increase of $19.8 or 36% from 1996 to 1997. The increase from 1997 to 1998 was primarily a result of the growth in EMC professional services and the acquisitions of the professional services businesses Groupe MCI and Millennia III, Inc. in the second and third quarters of 1998, respectively.
In May 1998, EMC and HP expanded their reseller relationship, enabling HP to resell Symmetrix enterprise storage systems with its Windows NT systems, in addition to its UNIX-based platforms. In January 1999, EMC and HP extended their worldwide reseller agreement for another three years. Revenues for 1998, 1997 and 1996 under the Company's reseller agreement with HP were $718.0, $504.1 and $287.4, respectively, representing 18%, 17% and 13% of total revenues, respectively.
In November 1998, the Company entered into a reseller agreement with NEC, under which NEC markets and resells Symmetrix enterprise storage systems worldwide for connection to its UNIX and Windows NT computers.
Revenues on sales into the North American markets were $2,403.9, $1,682.1 and $1,330.9 in 1998, 1997 and 1996, respectively; an increase of $721.8 or 43% from 1997 to 1998, and $351.2 or 26% from 1996 to 1997. The revenue growth reflects continued strong demand for the Company's products and services.
Revenues on sales into the markets of Europe, the Middle East and Africa were $1,231.7, $951.8 and $720.8 in 1998, 1997 and 1996, respectively; an increase of $279.9 or 29% from 1997 to 1998, and $231.0 or 32% from 1996 to 1997. The Company incorporated direct sales subsidiaries in Spain and Poland during 1998, in Austria during 1997, and in Israel during 1996.
Revenues on sales into the markets in the Asia Pacific region were $284.8, $279.5 and $206.6 in 1998, 1997 and 1996, respectively; an increase of $5.3 or 2% from 1997 to 1998, and $72.9 or 35% from 1996 to 1997. The reduced growth rate in 1998 was principally attributable to a downturn in economic trends in the Asia Pacific market.
Revenues on sales into the markets of Latin America were $53.3, $24.4 and $15.4 in 1998, 1997 and 1996, respectively; an increase of $28.9 or 118% from 1997 to 1998, and $9.0 or 59% from 1996 to 1997. The increase in both periods was primarily due to the Company's efforts to expand its business in this region. The Company incorporated a direct sales subsidiary in Brazil during 1996.
Gross Margins
Gross margins increased to 51.5% in 1998, compared to 46.5% in 1997 and 45.1% in 1996. The increase in both periods is primarily attributable to increased licensing of the Company's enterprise software, which has higher gross margins than sales of enterprise systems. Software revenue as a percentage of total revenues increased to 11.2% in 1998 from 6.0% in 1997 and 3.4% in 1996. Other factors affecting gross margins in 1998 include the impact of component cost declines being greater than the impact of product price declines. The Company currently believes that product price declines will continue.
Research and Development
Research and development ("R&D") expenses were $315.2, $220.9 and $161.1 in 1998, 1997 and 1996, respectively. As a percentage of revenues, R&D expenses were 7.9%, 7.5% and 7.1% in 1998, 1997 and 1996, respectively. The increase in R&D spending levels from 1997 to 1998 reflects the Company's ongoing research and development efforts in a variety of areas, including EMC ESN technologies, enhancements to the Symmetrix family of products, new enterprise storage software products and fibre channel connectivity. R&D for 1998 also includes costs associated with the integration of Conley, acquired in August 1998, which became the EMC Cambridge Software Development Center. The increase in R&D spending levels from 1996 to 1997 reflects the cost of technical staff and equipment to support a variety of projects, including both fibre channel connectivity and enterprise storage software.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses were $747.5, $484.1 and $367.1 in 1998, 1997 and 1996, respectively. As a percentage of revenues, SG&A expenses were 18.8%, 16.5% and 16.2% in 1998, 1997 and 1996, respectively. The increase in spending levels in both periods is primarily due to continued investment in additional sales and support personnel and their related overhead costs, both domestically and internationally, in connection with the Company's increased revenue levels. The increase from 1997 to 1998 primarily reflects the Company's objective of building an infrastructure to achieve broader coverage and greater account depth around the world and to expand its technical sales organization to support the current and expected growth in software sales. The increase from 1996 to 1997 primarily reflects the Company's expansion of its international direct sales force, particularly in the Asia Pacific region, as well as OEM, reseller, alliance and partnership programs.
Investment Income and Interest Expense
Investment income increased to $101.4 in 1998, from $70.5 in 1997 and $34.5 in 1996. Investment income was earned primarily from investments in cash equivalents and short and long-term investments. Investment income increased in 1998 and 1997 primarily due to higher average cash and investment balances which were derived from operations and proceeds from the Company's 3 1/4% Convertible Subordinated Notes due 2002 issued in March of 1997 (the "3 1/4% Notes").
Interest expense increased to $20.2 in 1998, from $15.5 in 1997 and $12.0 in 1996. The increase in 1998 from 1997 and in 1997 from 1996 is primarily due to the 3 1/4% Notes. Interest expense in 1996 was primarily due to the Company's 4 1/4% Convertible Subordinated Notes due 2001 (the "4 1/4% Notes"), all of which were redeemed or converted into Common Stock by January 1997.
Other Income/(Expense), Net
The net other expense was $5.2 in 1998 compared with the net other income of $1.1 in 1997 and $0.4 in 1996. The increase in the net expense from 1997 to 1998 is primarily attributable to costs associated with a bond offering which was cancelled during the third quarter, gains and losses on foreign exchange transactions and losses on sales of fixed assets.
Provision for Income Taxes
The provision for income taxes was $264.5 in 1998, $179.5 in 1997 and $133.2 in 1996, which resulted in effective tax rates of 25.0%, 25.0% and 25.7% in 1998, 1997 and 1996, respectively. The effective tax rate is mainly attributable to the realization of benefits associated with the Company's various tax strategies and benefits related to offshore manufacturing.
Financial Condition
Cash and cash equivalents and short and long-term investments were $2,092.8 and $1,650.6 at December 31, 1998 and 1997, respectively, an increase of $442.2. In 1998, cash and cash equivalents decreased by $249.4 and short and long-term investments increased by $691.6. This reflects the Company's continued efforts to invest excess cash in short and long-term investments, which generate a higher yield than cash and cash equivalents.
Cash provided by operating activities was $855.2. This was primarily generated from net income, offset by an increase in working capital, primarily attributed to an increase in accounts receivable and an increase in inventory, consistent with the growth of the business. Cash used by investing activities was $1,156.0, principally for additions to property, plant and equipment and the purchase of short and long-term investments. The year-over-year increase in additions to property, plant and equipment is primarily attributable to the construction of manufacturing facilities in Franklin, Massachusetts and Cork, Ireland.
Cash provided by financing activities was $54.9, principally from the issuance of Common Stock from stock option exercises.
The Company has available for use a credit line of $50.0 and may elect to borrow at any time. In March 1997, the Company sold $517.5 of the 3 1/4% Notes. The 3 1/4% Notes are generally convertible into shares of Common Stock at any time prior to the redemption date at a conversion price of $22.655 per share. As of December 31, 1998, none of the 3 1/4% Notes have been converted into Common Stock. Based on its current operating and capital expenditure forecasts, the Company believes that the combination of funds currently available, funds generated from operations and its available line of credit will be adequate to finance its ongoing operations.
To date, inflation has not had a material impact on the Company's financial results.
New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in either current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. For fair-value hedge transactions in which the Company is hedging changes in fair value of an asset, liability or firm commitment, changes in the fair value of the derivative instrument will generally be offset in the income statement by changes in the fair value of the hedged item. For cash-flow hedge transactions, in which the Company is hedging the variability of cash flows related to a variable-rate asset, liability or a forecasted transaction, changes in the fair value of the derivative instrument will be reported in other comprehensive income. The gains and losses on the derivative instrument that are reported in other comprehensive income will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges will be recognized in current earnings.
The Company adopted SFAS 133 as of January 1, 1999. The Company believes that the adoption of this Statement will not have a material effect on its financial statements. In connection with the adoption of SFAS 133, the Company intends to reclassify its held-to-maturity securities to available for sale securities.
FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company's prospects are subject to certain uncertainties and risks. This Annual Report on Form 10-K also contains certain forward-looking statements within the meaning of the Federal Securities Laws. The Company's future results may differ materially from its current results and actual results could differ materially from those projected in the forward-looking statements as a result of certain risk factors, including but not limited to those set forth below, other one-time events and other important factors disclosed previously and from time to time in EMC's other filings with the Securities and Exchange Commission.
Dependence on Suppliers
The Company purchases certain components and products from one or a limited number of qualified suppliers that meet its requirements. In addition, certain of the Company's suppliers are competitors of the Company. Among the most important components that EMC uses are disk drives, high density memory components and power supplies. A failure by any supplier of components to meet EMC's delivery or quality requirements for an extended period of time could have a material adverse effect on the Company's business, results of operations or financial condition. The Company periodically transitions its product line to new disk drive technologies. These transitions may intensify the above risks. From time to time, because of high industry demand or the inability of certain vendors to consistently meet on a timely basis the Company's component quality standards, the Company has experienced delays in deliveries of components needed to satisfy orders for its products. The Company is currently working with such vendors to proactively maintain or improve component quality standards and also continues to seek alternative sources of supply. If such shortages or performance problems were to intensify, the Company could lose some time-sensitive customer orders which could adversely affect quarterly revenues or earnings. The adverse effect of a supplier's failure to meet EMC's requirements may be intensified by the uneven pattern of the Company's sales and the necessity of meeting critical manufacturing schedules.
New Products
Technology and user needs change rapidly in the computer storage industry, which requires ongoing market research, development of highly complex hardware and software and introduction of new products. Sales of the Symmetrix series of products constitute the principal source of revenues for EMC and such sales are expected to c
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