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May 13, 1999
EMC CORP (EMC)
Quarterly Report (SEC form 10-Q)
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 should be read in conjunction with ''Factors That May Affect Future Results'' set forth on page 16 and in EMC's other filings with the U.S. Securities and Exchange Commission.
All dollar amounts in this Management's Discussion and Analysis are in millions.
Results of Operations - First Quarter of 1999 compared to First Quarter of 1998
Revenues
Total revenues for the first quarter of 1999 were $1,128.0 compared to $828.4 for the first quarter of 1998, an increase of $299.6 or 36%.
Enterprise systems revenues from products sold directly and through resellers and original equipment manufacturers ("OEMs") were $861.1 in the first quarter of 1999, compared to $698.8 in the first quarter of 1998, an increase of $162.3 or 23%. The increase was due to 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 resellers and OEMs were $155.4 in the first quarter of 1999 compared to $66.0 in the first quarter of 1998, an increase of $89.4 or 136%. 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 and enhanced software products.
Revenues from products sold by McDATA Corporation, primarily the ESCON Director series of products, were $39.0 in the first quarter of 1999, compared to $41.2 in the first quarter of 1998, a decrease of $2.2 or 5%, due primarily to the product transition from ESCON-based to fibre-channel-based directors.
Service and rental revenues were $72.4 in the first quarter of 1999, compared to $22.4 in the first quarter of 1998, an increase of $50.0 or 223%, primarily as a result of the growth of EMC professional services and the revenues from the professional services businesses Groupe MCI and Millennia III, Inc., acquired during the second and third quarters of 1998.
In January 1999, EMC and HP extended their worldwide reseller agreement for another three years. Revenues under this agreement were $146.7 and $156.8, or 13% and 19% of total revenues, for the first quarters of 1999 and 1998, respectively. On May 5, 1999, HP announced that it had entered into joint technology and OEM agreements with Hitachi, Limited and Hitachi Data Systems for high- end enterprise storage systems.
In March 1999, the Company announced a five-year strategic technology and business alliance with IBM. Under the terms of the accord, the Company will continue to purchase IBM disk drives for incorporation into EMC's Symmetrix Enterprise Storage systems. The alliance also provides for a broad patent cross-license between the two companies for storage and other technologies.
Revenues on sales into the North American markets were $704.1 in the first quarter of 1999 compared to $481.7 in the first quarter of 1998, an increase of $222.4 or 46%. 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 $339.6 in the first quarter of 1999 compared to $262.1 in the first quarter of 1998, an increase of $77.5 or 30%.
Revenues on sales into the markets of the Asia Pacific region were $67.8 in the first quarter of 1999 compared to $77.0 in the first quarter of 1998, a decrease of $9.2 or 12%. The decrease is principally attributable to the current economic trends affecting the Asia Pacific markets.
Revenues on sales into the markets of Latin America were $16.5 in the first quarter of 1999 compared to $7.5 in the first quarter of 1998, an increase of $9.0 or 119%. The increase was primarily due to the Company's efforts to expand its business in this region.
Gross Margins
Gross margins increased to 53.2% of revenues in the first quarter of 1999, compared to 48.0% of revenues in the first quarter of 1998. This increase is primarily attributable to increased licensing of the Company's enterprise software, which has higher gross margins than sales of enterprise systems. Other factors contributing to the increase include the impact of component cost declines being greater than the impact of product price declines and a trend towards larger configurations of enterprise systems. The Company currently believes that product price declines will continue.
Research and Development
Research and development ("R&D") expenses were $100.7 and $65.7 in the first quarters of 1999 and 1998, respectively, an increase of $35.0 or 53%. R&D expenses were 8.9% and 7.9% of revenues in the first quarters of 1999 and 1998, respectively. The increase reflects the Company's ongoing research and development efforts in a variety of areas, including EMC Enterprise Storage Network technologies, enhancements to the Symmetrix family of products, new and enhanced enterprise storage software products and fibre channel connectivity. The Company expects to continue to spend substantial amounts for R&D for the balance of 1999 and thereafter.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses were $224.6 and $153.5 in the first quarters of 1999 and 1998, respectively, an increase of $71.1 or 46%. SG&A expenses were 19.9% and 18.5% of revenues in the first quarters of 1999 and 1998, respectively. The dollar increase 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 revenues.
Investment Income and Interest Expense
Investment income was $25.6 in the first quarter of 1999 compared with $22.5 in the first quarter of 1998. Interest income was earned from investments in cash equivalents and short and long- term investments. Investment income increased in the first quarter of 1999 primarily due to higher cash and investment balances which were derived from operations.
Interest expense increased to $5.2 in the first quarter of 1999 from $4.7 in the first quarter of 1998.
Provision for Income Taxes
The provision for income taxes was $73.6 and $48.7 in the first quarters of 1999 and 1998, respectively, which resulted in an effective tax rate of 25.0% in each period. 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 $2,275.1 and $2,092.8 at March 31, 1999 and December 31, 1998, respectively, an increase of $182.3. Cash provided by operating activities for the first three months of 1999 was $268.6, generated primarily from net income. Cash used by investing activities was $159.9, principally from the purchases of short and long-term investments and additions to property, plant and equipment. Cash provided by financing activities was $2.1, principally from the issuance of common stock from stock option exercises, offset by payments of short and long-term obligations.
At March 31, 1999, the Company had available for use its credit line of $50.0 and may elect to borrow at any time. 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.
Adoption of New Accounting Pronouncement
In June 1998, FASB issued 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 accumulated other comprehensive
income/(expense), 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 accumulated other
comprehensive income/(expense). The gains and losses on the
derivative instrument that are reported in accumulated other
comprehensive income/(expense) 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 on January 1, 1999. (See Note 5 to the Company's
Interim Consolidated Financial Statements.)
Year 2000 Issues
The information provided below constitutes a ''Year 2000 Readiness Disclosure'' under the Year 2000 Information and Readiness Disclosure Act.
Certain computer hardware and software is unable to appropriately interpret the upcoming calendar year 2000. These systems and software refer to years in terms of their final two digits only and may interpret the year 2000 as the year 1900 in error. Therefore, they will need to be modified prior to the year 2000 in order to remain functional. The Company has established a Year 2000 program that involves assessing the Company's key hardware and software, assessing Year 2000 compliance by third parties with which the Company has a material relationship, assessing Year 2000 compliance of the Company's products, and modifying and testing hardware and software in the Company's internal systems and products, where necessary.
The Company has completed an assessment of the hardware and software in its core business information systems and has substantially completed the necessary modifications. The Company has also completed an assessment of the hardware and software in other information systems used in its operations and has completed a majority of the necessary modifications. In addition, the Company has completed an assessment of the hardware and software used in its business that is not supported by the Company's information system department. A majority of the necessary modifications have also been completed for such hardware and software.
The Company has contacted key vendors and suppliers and other third parties whose systems failures could potentially have a significant impact on the Company's operations. The Company has received certifications of Year 2000 compliance from many of its key vendors and suppliers. The Company continues to make progress in receiving certifications of Year 2000 compliance from other key vendors and suppliers and in assessing questionnaire responses and related information from such third parties.
The Company has designed and tested the current versions of its Symmetrix series of products and the current versions of its other products to be Year 2000 compliant. Some of the Company's customers are running earlier versions of its Symmetrix series of products and other products that have not been tested for Year 2000 compliance. The Company has made upgrades available for the older versions of its Symmetrix series of products and for certain other of its older products so that such products will test as Year 2000 compliant.
The Company currently anticipates that the assessment and remediation phases of its Year 2000 conversion program will be substantially complete by the middle of 1999, although the testing phase and the contingency planning phase, if any, will continue extensively throughout 1999. The Company does not anticipate that the total cost of such program will have a material effect on its business, results of operations or financial condition.
The most reasonably likely worst case scenarios regarding the Year 2000 issue would include a hardware failure, the corruption or loss of data contained in the Company's internal information systems, a failure affecting the Company's key vendors, suppliers or customers, the failure of infrastructure services provided by government agencies or other third parties, and customer dissatisfaction related to the performance of the Company's products.
The Company continues to assess the need for a Year 2000 contingency plan. However, the Company anticipates that its Year 2000 conversion program will be completed far enough in advance of January 1, 2000 so as to formulate a contingency plan at such time, if necessary. The Company expects its contingency plan, if developed, would include, among other things, manual ''work- arounds'' for hardware and software failures, as well as substitution of systems, if required.
Further information about the Company's Year 2000 readiness is
available at the Company's website at
emc.com.
There can be no assurance that conversion of the Company's hardware and software will be successful, that key third parties will have successful conversion programs, that the Company's products do not contain undetected errors or defects associated with Year 2000 date functions, or that other factors relating to Year 2000 compliance, including but not limited to litigation, will not have a material adverse effect on the Company's business, results of operations or financial condition.
Euro Conversion
On January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their existing sovereign currencies and the Euro. The Euro is currently the common legal currency in such countries. The Euro trades on currency exchanges and is available for non-cash transactions. The participating countries are issuing sovereign debt exclusively in Euros, and have redenominated outstanding sovereign debt. The participating countries no longer control their own monetary policies by directing independent interest rates for the legacy currencies. Instead, the authority to direct monetary policy, including money supply and official interest rates for the Euro, is exercised by the European Central Bank.
The legacy currencies will remain legal tender in the participating countries as denominations of the Euro between January 1, 1999 and January 1, 2002 ( the ''transition period''). During the transition period, public and private parties may pay for goods and services using either the Euro or the participating country's legacy currency on a ''no compulsion, no prohibition'' basis. However, conversion rates are no longer computed directly from one legacy currency to another. Instead, a triangular process is applied whereby an amount denominated in one legacy currency is first converted into the Euro. The resultant Euro-denominated amount is then converted into the third legacy currency.
The Company has developed and implemented the necessary modifications for the technical adaptation of its internal IT and other systems to accommodate Euro-denominated transactions. The Company is continuing to assess certain business implications of conversion to the Euro, including the long term competitive implications of the conversion and the impact on market risk with respect to financial instruments. Management is also continuing to evaluate other impacts of this conversion on the Company, including the potential actions which may or may not be taken by the Company's competitors and suppliers.
Factors That May Affect Future Results
This Quarterly Report on Form 10-Q contains forward-looking statements as defined under the Federal Securities Laws. 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: (i) component quality and availability; (ii) delays in the development of new technology and the transition to new products; (iii) competitive factors, including but not limited to pricing pressures, in the computer storage market; (iv) the relative and varying rates of product price and component cost declines; (v) economic trends in various geographic markets and fluctuating currency exchange rates; (vi) deterioration or termination of the agreements with certain of the Company's resellers or OEMs; (vii) the uneven pattern of quarterly sales; (viii) risks associated with acquisitions; (ix) Year 2000 issues; and (x) other one-time events and other important factors disclosed previously and from time to time in EMC's other filings with the U.S. Securities and Exchange Commission.
EMC CORPORATION
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings
In December 1997, NewFrame Corporation Ltd. (''NewFrame'') filed suit against the Company in the United States District Court for the District of Massachusetts. The suit contains a variety of allegations relating to the Company's use of NewFrame's software developments, including various contract claims and breach of fiduciary duty, and seeks monetary damages relating primarily to lost future profits. The Company filed a motion to dismiss the complaint, which was granted in part. The parties reached a negotiated resolution of this matter in April 1999.
In January 1998, Storage Technology Corporation (''STK'') filed suit against the Company in the United States District Court for the Northern District of California alleging that the Company was infringing a patent covering virtual tape and seeking preliminary and permanent injunctions and unspecified damages. The Company's response raised as an affirmative defense that EMC was licensed to promote the use of, market, sell and make virtual tape products pursuant to a patent license agreement between EMC and STK dated April 11, 1996 (the ''License Agreement''). After a trial held in August 1998, the court ruled that EMC is licensed to promote the use of, market, sell and make virtual tape products pursuant to the License Agreement. The Court found that STK's suit was without foundation and awarded costs to EMC. In October 1998, STK filed an appeal of the Court's ruling.
The Company is a party to other litigation which it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material adverse effect on the Company's business, results of operations or financial condition.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Articles of Amendment to EMC Corporation's Restated Articles of Organization, as amended (filed herewith).
27 Financial Data Schedule (filed herewith).
(b) Reports on Form 8-K
On February 25, 1999, the registrant filed a report on Form 8-K reporting under Item 5, Board approval of a 2-for-1 stock split of its common stock to be effected in the form of a 100% stock dividend, with a record date of May 14, 1999 and a distribution date of May 28, 1999, subject to obtaining stockholder approval of an amendment to the registrant's charter to increase the number of shares of authorized common stock.
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