-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IaCeljNsi2tf4BPZ5nBhMKLKFzB0TlBbv+J7ZVXhhaJmytYMsgo1oNIQvMe4jCh7 s+3V8MB6+BfzHQpTxAxmXg== 0000790070-98-000026.txt : 19981116 0000790070-98-000026.hdr.sgml : 19981116 ACCESSION NUMBER: 0000790070-98-000026 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EMC CORP CENTRAL INDEX KEY: 0000790070 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 042680009 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09853 FILM NUMBER: 98746160 BUSINESS ADDRESS: STREET 1: 171 SOUTH STREET CITY: HOPKINTON STATE: MA ZIP: 01748-9103 BUSINESS PHONE: 5084351000 MAIL ADDRESS: STREET 1: 171 SOUTH STREET CITY: HOPKINTON STATE: MA ZIP: 01748-9103 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Quarter Ended: September 30, 1998 Commission File Number 1-9853 EMC CORPORATION (Exact name of registrant as specified in its charter) Massachusetts 04-2680009 (State or other jurisdiction of (I.R.S. Employer organization or incorporation) Identification Number) 35 Parkwood Drive Hopkinton, Massachusetts 01748-9103 (Address of principal executive offices, including zip code) (508) 435-1000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO_____ Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. Common Stock, par value $.01 per share 501,847,214 Class Outstanding as of September 30, 1998 EMC CORPORATION Page No Part I-Financial Information Consolidated Balance Sheets at September 30, 1998 and 3 December 31, 1997 Consolidated Statements of Income for the Three and Nine 4 Months Ended September 30, 1998 and 1997 Consolidated Statements of Cash Flows for the Nine Months 5 Ended September 30, 1998 and 1997 Notes to Interim Consolidated Financial Statements 6-9 Management's Discussion and Analysis of Financial 10-17 Condition and Results of Operations Part II-Other Information 18 Signatures 19 Exhibit Index 20 2 EMC CORPORATION PART I. FINANCIAL INFORMATION CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts) September December 30, 1998 31, 1997 ASSETS Current assets: Cash and cash equivalents $ 903,726 $ 954,595 Short-term investments 446,954 419,262 Trade and notes receivable less allowance for doubtful accounts of $7,495 and $6,773 in 1998 and 1997, respectively 837,647 788,869 Inventories 521,745 404,660 Deferred income taxes 46,184 37,095 Other assets 61,091 22,545 Total current assets 2,817,347 2,627,026 Long-term investments 575,982 276,776 Notes receivable, net 32,927 20,013 Property, plant and equipment, net 584,575 396,511 Deferred income taxes 8,841 14,174 Intangible and other assets, net 235,597 155,609 Total assets $4,255,269 $3,490,109 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term obligations $ 28,216 $ 7,665 Accounts payable 219,249 187,117 Accrued expenses 202,309 151,216 Income taxes payable 147,247 151,088 Deferred revenue 33,673 8,784 Total current liabilities 630,694 505,870 Deferred income taxes 49,414 45,353 Long-term obligations: 3 1/4% convertible subordinated notes due 2002 517,500 517,500 Notes payable 20,657 40,954 Other liabilities 2,687 4,131 Total liabilities $1,220,952 $1,113,808 Commitments and contingencies Stockholders' equity: Series Preferred Stock, par value $.01; authorized 25,000,000 shares, none outstanding -- -- Common Stock, par value $.01; authorized 750,000,000 shares; issued 501,847,214 and 496,792,608 in 1998 and 1997, respectively 5,018 4,968 Additional paid-in capital 787,065 670,297 Deferred compensation (16,231) (12,738) Unrealized gain/(loss) on investments 7,996 (9) Retained earnings 2,248,257 1,711,356 Cumulative translation adjustment 2,212 2,427 Total stockholders' equity 3,034,317 2,376,301 Total liabilities and stockholders' equity $4,255,269 $3,490,109 The accompanying notes are an integral part of the consolidated financial statements. 3 EMC CORPORATION CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) (unaudited) For the Three Months Ended For the Nine Months Ended September September September September 30, 1998 30, 1997 30, 1998 30, 1997 Revenues: Net sales $ 945,806 $ 713,949 $ 2,670,561 $ 2,009,360 Service and rental 56,735 18,621 112,333 55,108 1,002,541 732,570 2,782,894 2,064,468 Costs and expenses: Cost of sales and service 478,187 391,278 1,376,803 1,111,808 Research and development 80,422 56,531 220,325 158,068 Selling, general and administrative 193,068 122,093 523,917 334,357 Operating income 250,864 162,668 661,849 460,235 Investment income 25,765 20,708 72,226 49,804 Interest expense (4,862) (4,706) (14,591) (10,748) Other income/(expense),net (3,380) (294) (3,616) 1,434 Income before taxes 268,387 178,376 715,868 500,725 Income tax provision 67,097 45,754 178,967 128,436 Net income $ 201,290 $ 132,622 $ 536,901 $ 372,289 Net income per weighted average share, basic $0.40 $0.27 $1.08 $0.76 Net income per weighted average share, diluted $0.38 $0.25 $1.01 $0.72 Weighted average shares, basic 501,111 494,667 499,006 492,936 Weighted average shares, diluted 540,299 531,352 537,944 523,271 The accompanying notes are an integral part of the consolidated financial statements. 4 EMC CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited) For the Nine Months Ended September September 30, 1998 30, 1997 Cash flows from operating activities: Net income $536,901 $372,289 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 142,995 95,499 Deferred income taxes 305 6,579 Net loss on disposal of property and equipment 646 491 Tax benefit from stock options exercised 23,470 16,500 Changes in assets and liabilities: Trade and notes receivable (60,745) (45,001) Inventories (117,088) (112,448) Other assets (32,554) (42,678) Accounts payable 32,689 (52,731) Accrued expenses 51,039 (6,250) Income taxes payable (3,817) 26,020 Other liabilities 23,585 (3,984) Net cash provided by operating activities 597,426 254,286 Cash flows from investing activities: Additions to property, plant and equipment (280,683) (125,837) Proceeds from sales of property and equipment 6 313 Capitalized software development costs (27,294) (19,385) Purchase of short-term and long-term investments, net (318,893) (157,193) Business acquisitions (53,903) --- Net cash used by investing activities (680,767) (302,102) Cash flows from financing activities: Issuance of common stock 33,012 26,342 Redemption of 4 1/4% convertible subordinated notes due 2001 --- (65) Issuance of 3 1/4% convertible subordinated notes due 2002, net of issuance costs --- 506,671 Payment of long-term and short-term obligations (11,304) (9,763) Issuance of long-term and short-term obligations 11,558 1,713 Net cash provided by financing activities 33,266 524,898 Effect of exchange rate changes on cash (794) (2,218) Net increase/(decrease) in cash and cash equivalents (50,075) 477,082 Cash and cash equivalents at beginning of period 954,595 496,377 Cash and cash equivalents at end of period $903,726 $971,241 Non-cash activity: Conversion of notes --- $140,682 Business acquisitions $ 51,755 --- The accompanying notes are an integral part of the consolidated financial statements. 5 EMC CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share amounts) 1. Basis of Presentation Company EMC Corporation and its subsidiaries ("EMC" or the "Company") design, manufacture, market and support a wide range of enterprise systems and software products and related services for the worldwide enterprise storage market. EMC's products provide solutions for a wide range of customer information storage requirements, from the highest performance mission critical applications to extremely high capacity business support applications. EMC's solutions integrate with major open systems operating systems such as UNIX, Microsoft Corporation's Windows NT and International Business Machines Corporation's ("IBM") OS400 as well as major mainframe operating systems such as IBM's MVS. EMC's products are sold as storage solutions for customers utilizing a variety of computer system platforms including, but not limited to, IBM and IBM-compatible mainframe, Unisys Corporation, Compagnie des Machines Bull S.A., Hewlett-Packard Company ("HP"), NCR Corporation, Sequent Computer Systems, Inc., Siemens Nixdorf Informationssysteme AG, Silicon Graphics, Inc. ("SGI"), International Computers Limited ("ICL") and other open systems and mainframe platforms. Accounting The accompanying consolidated interim financial statements are unaudited and have been prepared in accordance with generally accepted accounting principles. These statements include the accounts of EMC and its subsidiaries. Certain information and footnote disclosures normally included in the Company's annual consolidated financial statements have been condensed or omitted. The interim consolidated financial statements, in the opinion of management, reflect all adjustments (consisting only of normal recurring accruals) necessary for a fair statement of the results for the interim periods ended September 30, 1998 and 1997. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the entire fiscal year. It is suggested that these interim consolidated financial statements be read in conjunction with the audited consolidated financial statements for the year ended December 31, 1997, which are contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 6, 1998. 2. Inventory Inventories consist of: September 30, 1998 December 31, 1997 Purchased parts $ 35,047 $ 24,641 Work-in-process 307,382 240,845 Finished goods 179,316 139,174 $521,745 $404,660 6 EMC CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (Continued) (in thousands, except share and per share amounts) 3. Net Income Per Share Calculation of earnings per share is as follows: For the Three Months Ended September September 30, 1998 30, 1997 Basic: Net income $ 201,290 $ 132,622 Weighted average shares, basic 501,110,827 494,666,658 Net income per share, basic $ 0.40 $ 0.27 Diluted: Net income $ 201,290 $ 132,622 Add back of interest expense 4,205 4,205 on convertible notes Less tax effect of interest expense on convertible notes (1,682) (1,682) Net income for calculating diluted earnings per share $ 203,813 $ 135,145 Weighted average shares 501,110,827 494,666,658 Weighted common stock equivalents 39,188,009 36,684,946 Total weighted average shares, diluted 540,298,836 531,351,604 Net income per share, diluted $ 0.38 $ 0.25 For the Nine Months Ended September September 30, 1998 30, 1997 Basic: Net income $ 536,901 $ 372,289 Weighted average shares, basic 499,005,954 492,936,168 Net income per share, basic $ 1.08 $ 0.76 Diluted: Net income $ 536,901 $ 372,289 Add back of interest expense on convertible notes 12,614 9,297 Less tax effect of interest expense on convertible notes (5,046) (3,719) Net income for calculating diluted earnings per share $ 544,469 $ 377,867 Weighted average shares 499,005,954 492,936,168 Weighted common stock equivalents 38,938,173 30,334,904 Total weighted average shares, diluted 537,944,127 523,271,072 Net income per share, diluted $ 1.01 $ 0.72 7 EMC CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (in thousands, except share and per share amounts) 4. Comprehensive Income Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement requires the classification of items of comprehensive income by their nature in a financial statement and the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. Financial statements for prior periods must be restated. The Company's total comprehensive income is as follows: For the Three For the Nine Months Ended Months Ended September September September September 30, 1998 30,1997 30, 1998 30, 1997 Net income $201,290 $132,622 $536,901 $372,289 Other comprehensive income/(expense), net of tax: Unrealized gain on investments 5,888 --- 6,004 --- Cumulative translation adjustment 47 (619) (162) (1,923) Total other comprehensive income/(expense) 5,935 (619) 5,842 (1,923) Total comprehensive income $207,225 $132,003 $542,743 $370,366 5. Litigation In August 1997, TM Patents, L.P. ("TM") filed suit against the Company in the United States District Court for the Southern District of New York alleging that the Company is infringing two patents and seeking unspecified damages. The Company filed a motion to transfer the case to the United States District Court for the District of Massachusetts and a motion to dismiss the suit. The Company's motion to transfer was granted with leave for the plaintiff to amend the complaint to overcome the grounds for dismissal. In the amended complaint, TM alleged infringement only as to one of the two patents originally at issue. Discovery in this case has concluded. The Company's motions for summary judgment based on invalidity and noninfringement were heard on November 5, 1998. A trial is set for January 1999. The Company believes TM's claims are without merit. 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 Company believes NewFrame's claims are without merit. 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 purported to cover virtual tape and seeking unspecified damages. The Company's response to the complaint was to raise 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. As a result, the Court found that STK's suit was without foundation and awarded costs to EMC. In October 1998, STK filed a Notice of Appeal of the Court's ruling. 8 EMC CORPORATION NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (in thousands, except share and per share amounts) 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. 6. Acquisitions In April, July and August of 1998, the Company acquired all of the outstanding common stock of Groupe MCI, Millennia III, Inc., and Conley Corporation, respectively, in exchange for cash and common stock. The acquisitions were accounted for using the purchase method. Accordingly, the purchase price was allocated to assets and liabilities acquired based on their fair values. Pro forma presentations have not been included as the acquisitions were not material to the results of operations or financial condition of the Company. 7. 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 ("FAS 133"). FAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company). FAS 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 is assessing the impact of FAS 133, and currently believes it will not have a material impact on its earnings or statement of financial position. 9 EMC CORPORATION 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 17 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 - Third Quarter of 1998 compared to Third Quarter of 1997 Revenues Total revenues for the third quarter of 1998 were $1,002.5 compared to $732.6 for the third quarter of 1997, an increase of $269.9 or 37%. Enterprise systems revenues from products sold directly and through OEMs and resellers were $792.0 in the third quarter of 1998, compared to $621.0 in the third quarter of 1997, an increase of $171.0 or 28%. 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 mainframe, UNIX and Windows NT environments. Enterprise software revenues from products sold directly and through OEMs and resellers were $117.5 in the third quarter of 1998 compared to $49.8 in the third quarter of 1997, an increase of $67.7 or 136%. Enterprise software products provide primary and extended functionality for the Company's enterprise storage products. Revenues from products sold by McDATA Corporation, primarily the ESCON Director series of products, were $36.2 in the third quarter of 1998, compared to $43.1 in the third quarter of 1997, a decrease of $6.9 or 16%, due primarily to the product transition from ESCON-based to fibre channel-based directors. Revenues from service and rental income were $56.7 in the third quarter of 1998, compared to $18.6 in the third quarter of 1997, an increase of $38.1 or 205%, primarily as a result of the acquisitions of the professional services businesses Groupe MCI and Millennia III, Inc. in the second and third quarters of 1998. In May 1998, the Company announced the expansion of the terms and scope of its original reseller agreement with HP. This enables HP to resell the Company's enterprise systems and software for connection to its Intel-based HP NetServer Systems, a leading Windows NT platform. Revenues for the third quarter of 1998 and 1997 under this agreement were $164.7 and $134.6, or 16% and 18% of total revenues, respectively. In July 1998, the Company announced a reseller agreement under which ICL will resell the Company's enterprise systems and software for connection to ICL's Trimetra range of servers running VME, Unix and Windows NT. Revenues on sales into the North American markets were $624.1 in the third quarter of 1998 compared to $426.7 in the third quarter of 1997, an increase of $197.4 or 46%. The revenue growth in North America reflects continued strong demand for the Company's products and services. Revenues on sales into the markets of Europe, Africa and the Middle East were $294.9 in the third quarter of 1998 compared to $221.6 in the third quarter of 1997, an increase of $73.3 or 33%. Revenues on sales into the markets of the Asia Pacific region were $67.9 in the third quarter of 1998 compared to $77.4 in the third quarter of 1997, a decrease of $9.5 or 12%. The decrease is principally attributable to the current economic trends affecting the Asia Pacific markets. 10 Revenues on sales into the markets of South America were $15.6 in the third quarter of 1998 compared to $6.9 in the third quarter of 1997, an increase of $8.7 or 127%, as a result of the Company's efforts to expand its business in this region. Gross Margins Gross margins increased to 52.3% of revenues in the third quarter of 1998, compared to 46.6% of revenues in the third quarter of 1997. 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 affecting gross margins in the third quarter of 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 $80.4 and $56.5 in the third quarters of 1998 and 1997, respectively, an increase of $23.9 or 42%. R&D expenses were 8.0% and 7.7% of revenues in the third quarters of 1998 and 1997, respectively. The dollar increase was primarily due to the cost of technical staff and equipment to support a variety of projects including both ongoing development of enterprise software products and fibre channel connectivity and also includes the integration of Conley Corporation in August 1998. The Company expects to continue to spend substantial amounts for R&D for the balance of 1998 and thereafter. Selling, General and Administrative Selling, general and administrative ("SG&A") expenses were $193.1 and $122.1 in the third quarters of 1998 and 1997, respectively, an increase of $71.0 or 58%. SG&A expenses were 19.3% and 16.7% of revenues in the third quarters of 1998 and 1997, respectively. The dollar and percentage increase is due primarily to costs associated with a continued investment in additional worldwide sales and support personnel and their related overhead costs, with the objective of building an infrastructure to achieve broader coverage and greater account depth around the world. SG&A expenses are expected to increase in dollar terms for the balance of 1998 and thereafter. Investment Income and Interest Expense Investment income was $25.8 in the third quarter of 1998 compared with $20.7 in the same period a year ago. Interest income was earned from investments in cash equivalents, and short and long-term investments. Investment income increased in the third quarter of 1998 primarily due to higher cash and investment balances which were derived from operations. Interest expense was $4.9 in the third quarter of 1998 as compared to $4.7 in the third quarter of 1997 and relates primarily to the $517.5 of 3 1/4% convertible subordinated notes due 2002 issued in March 1997. Other Income/(Expense), Net The net other expense was $3.4 in the third quarter of 1998 compared with the net expense of $0.3 in the same period a year ago. The increase 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. 11 Provision for Income Taxes The provision for income taxes was $67.1 and $45.8 in the third quarters of 1998 and 1997, respectively, which resulted in an effective tax rate of 25.0% in the third quarter of 1998 and 25.7% in the third quarter of 1997. The decrease in the effective tax rate is mainly attributable to the realization of benefits associated with the continued progress on the Company's various tax strategies. 12 Results of Operations - First Nine Months of 1998 compared to First Nine Months of 1997 Revenues Total revenues for the first nine months ended September 30, 1998 were $2,782.9 compared to $2,064.5 for the first nine months of 1997, an increase of $718.4 or 35%. Enterprise systems revenues from products sold directly and through OEMs and resellers were $2,256.6 in the first nine months of 1998, compared to $1,756.0 in the first nine months of 1997, an increase of $500.6 or 29%. 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 mainframe, UNIX and Windows NT environments. Enterprise software revenues from products sold directly and through OEMs and resellers were $281.4 in the first nine months of 1998 compared to $117.2 in the first nine months of 1997, an increase of $164.2 or 140%. Enterprise software products provide primary and extended functionality for the Company's enterprise storage products. Revenues from products sold by McDATA Corporation, primarily the ESCON Director series of products, were $132.5 in the first nine months of 1998, compared to $136.2 in the first nine months of 1997, a decrease of $3.7 or 3%, due primarily to the product transition from ESCON-based to fibre channel-based directors. Revenues from service and rental income were $112.3 in the first nine months of 1998, compared to $55.1 in the first nine months of 1997, an increase of $57.2 or 104%, primarily as a result of the acquisitions of the professional services businesses Groupe MCI and Millennia III, Inc. in the second and third quarters of 1998. In May 1998, the Company announced the expansion of the terms and scope of its original reseller agreement with HP. This enables HP to resell the Company's enterprise systems and software for connection to its Intel-based HP NetServer Systems, a leading Windows NT platform. Revenues for the first nine months of 1998 and 1997 under this agreement were $507.7 and $360.7, or 18% and 17% of total revenues, respectively. Revenues on sales into the North American markets were $1,683.0 in the first nine months of 1998 compared to $1,188.9 in the first nine months of 1997, an increase of $494.1 or 42%. The revenue growth in North America reflects continued strong demand for the Company's products and services. Revenues on sales into the markets of Europe, Africa and the Middle East were $852.3 in the first nine months of 1998 compared to $656.7 in the first nine months of 1997, an increase of $195.6 or 30%. Revenues on sales into the markets of the Asia Pacific region were $216.0 in the first nine months of 1998 compared to $204.5 in the first nine months of 1997, an increase of $11.5 or 6%. The reduced growth rate in 1998 is principally attributable to a downturn in economic trends in the Asia Pacific markets. Revenues on sales into the markets of South America were $31.6 in the first nine months of 1998 compared to $14.4 in the first nine months of 1997, an increase of $17.2 or 119%, as a result of the Company's efforts to expand its business in this region. 13 Gross Margins Gross margins increased to 50.5% of revenues in the first nine months of 1998, compared to 46.1% of revenues in the first nine months of 1997. 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 affecting gross margins in the first nine months of 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 $220.3 and $158.1 in the first nine months of 1998 and 1997, respectively, an increase of $62.2 or 39%. R&D expenses were 7.9% and 7.7% of revenues in the first nine months of 1998 and 1997, respectively. The dollar increase was primarily due to the cost of technical staff and equipment to support a variety of projects including both ongoing development of enterprise software products and fibre channel connectivity and also includes the integration of Conley Corporation in August 1998. The Company expects to continue to spend substantial amounts for R&D for the balance of 1998 and thereafter. Selling, General and Administrative Selling, general and administrative ("SG&A") expenses were $523.9 and $334.4 in the first nine months of 1998 and 1997, respectively, an increase of $189.5 or 57%. SG&A expenses were 18.8% and 16.2% of revenues in the first nine months of 1998 and 1997, respectively. The dollar and percentage increase is due primarily to costs associated with a continued investment in additional worldwide sales and support personnel and their related overhead costs, with the objective of building an infrastructure to achieve broader coverage and greater account depth around the world. SG&A expenses are expected to increase in dollar terms for the balance of 1998 and thereafter. Investment Income and Interest Expense Investment income was $72.2 in the first nine months of 1998 compared with $49.8 in the same period a year ago. Interest income was earned from investments in cash equivalents, and short and long-term investments. Investment income increased in the first nine months of 1998 primarily due to higher cash and investment balances which were derived from operations. Interest expense increased by $3.9 to $14.6 in the first nine months of 1998 from $10.7 in the first nine months of 1997. The increase was attributable to the $517.5 of 3 1/4% convertible subordinated notes due 2002 issued in March 1997. Other Income/(Expense), Net The net other expense was $3.6 in the first nine months of 1998 compared with the net other income of $1.4 in the same period a year ago. The increase in the net expense 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 $179.0 and $128.4 in the first nine months of 1998 and 1997, respectively, which resulted in an effective tax rate of 25.0% in the first nine months of 1998 and 25.7% in the first nine months of 1997. The decrease in the effective tax rate is mainly attributable to the realization of benefits associated with the continued progress on the Company's various tax strategies. 14 Financial Condition Cash and cash equivalents and short and long-term investments were $1,926.7 and $1,650.6 at September 30, 1998 and December 31, 1997, respectively, an increase of $276.1. Cash provided by operating activities for the first nine months of 1998 was $597.4, generated primarily from net income. Cash used by investing activities was $680.8, principally for the purchase of short-term and long-term investments and additions to property, plant and equipment. The year-over-year increase in additions to property, plant and equipment is primarily attributable to the construction of the manufacturing facilities in Franklin, Massachusetts and Cork, Ireland. The increase includes approximately $10.1 accrued for construction of the manufacturing facility in Massachusetts. Cash provided by financing activities was $33.3, principally from the issuance of common stock from stock option exercises. At September 30, 1998, the Company had available for use its credit line of $50 and may elect to borrow at any time. Based on its current operating and capital expenditure forecasts, the Company presently 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. 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 ("FAS 133"). FAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999 (January 1, 2000 for the Company). FAS 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 is assessing the impact of FAS 133, and currently believes it will not have a material impact on its earnings or statement of financial position. Year 2000 Issues 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 is now extending the assessment and remediation process to the hardware and software in other information systems used in its operations. 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 and is currently assessing questionnaire responses and related information from such third parties. 15 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 anticipates that its Year 2000 conversion program will be completed in a timely manner. The Company does not anticipate that the total cost of such program will have a material effect on the Company's business, results of operations or financial condition. The most reasonably likely worst case scenario 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 is currently assessing 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. 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 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 are scheduled to establish fixed conversion rates between their existing sovereign currencies and the euro. The participating countries have agreed to adopt the euro as their common legal currency on that date. The euro will then trade on currency exchanges and be available for non-cash transactions. The participating countries will issue sovereign debt exclusively in euros, and will redenominate outstanding sovereign debt. At that time, the participating countries will 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 will be exercised by the new European Central Bank. Following the introduction of the euro, the legacy currencies are scheduled to 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 no longer will be computed directly from one legacy currency to another. Instead, a triangular process will apply whereby an amount denominated in one legacy currency will first be converted into the euro. The resultant euro-denominated amount will then be converted into the third legacy currency. The Company has established plans and has begun developing the necessary modifications for the technical adaptation of its internal information technology and other systems to accommodate euro-denominated transactions. The Company is currently assessing the business implications of conversion to the euro, including the long term competitive implications of the conversions and the effect on market risk with respect to financial instruments. At this time, management is also in the process of evaluating 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. The Company is currently unable to determine the ultimate financial impact, if any, of the conversion on its operations. 16 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) a failure by any supplier of high density DRAMs, disk drives or other components to meet EMC's requirements for an extended period of time; (ii) delays in the development of new technology and the transition to new products; (iii) the historic and recurring "hockey stick" pattern of the Company's sales by which a disproportionate percentage of a quarter's total sales occur in the last month and weeks and days of each quarter; (iv) the "hockey stick" pattern of the Company's sales, making it extremely difficult to predict near- term demand and adjust production capacity accordingly; (v) competitive factors, including but not limited to pricing pressures, in the computer storage market; (vi) economic trends in various geographic markets and fluctuating currency exchange rates; (vii) the relative and varying rates of product price and component cost declines; (viii) deterioration or termination of the agreements with certain of the Company's OEMs or resellers; (ix) risks associated with acquisitions; (x) Year 2000 issues; (xi) 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. 17 EMC CORPORATION PART II. OTHER INFORMATION Item 1. Legal Proceedings In August 1997, TM Patents, L.P. ("TM") filed suit against the Company in the United States District Court for the Southern District of New York alleging that the Company is infringing two patents and seeking unspecified damages. The Company filed a motion to transfer the case to the United States District Court for the District of Massachusetts and a motion to dismiss the suit. The Company's motion to transfer was granted with leave for the plaintiff to amend the complaint to overcome the grounds for dismissal. In the amended complaint, TM alleged infringement only as to one of the two patents originally at issue. Discovery in this case has concluded. The Company's motions for summary judgment based on invalidity and noninfringement were heard on November 5, 1998. A trial is set for January 1999. The Company believes TM's claims are without merit. 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 Company believes NewFrame's claims are without merit. 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 purported to cover virtual tape and seeking unspecified damages. The Company's response to the complaint was to raise 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. As a result, the Court found that STK's suit was without foundation and awarded costs to EMC. In October 1998, STK filed a Notice of 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 2. Changes in Securities and Use of Proceeds On July 1, 1998, the Company issued 504,464 shares of its common stock, $.01 par value per share, in connection with the acquisition of Millennia III, Inc, a professional services firm. These shares were issued pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act"), provided for in Section 4(2) thereunder. The Company filed a Registration Statement on Form S-3 with the Securities and Exchange Commission under the Securities Act, which became effective on August 5, 1998 and which permits the resale, on a registered basis, of these shares from time to time by the securityholders named therein. The Company also listed these shares of common stock on the New York Stock Exchange. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 27 Financial Data Schedule (filed herewith). (b) Reports on Form 8-K No reports on Form 8-K were filed by the Company for the quarter ended September 30, 1998. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. EMC CORPORATION Date: November 12, 1998 By: /s/ COLIN G. PATTESON Colin G. Patteson Senior Vice President, Chief Administrative Officer and Treasurer (Principal Financial Officer) By: /s/ WILLIAM J. TEUBER, JR. William J. Teuber, Jr. Vice President and Chief Financial Officer (Principal Accounting Officer) 19 < Page> EXHIBIT INDEX Exhibit 27 Financial Data Schedule (filed herewith) 20 EX-27 2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM EMC CORPORATION FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1998 SEP-30-1998 903,726 446,954 837,647 7,495 521,745 2,817,347 584,575 326,324 4,255,269 630,694 517,500 0 0 5,018 3,029,299 4,255,269 2,670,561 2,782,894 1,376,803 2,121,045 0 0 14,591 715,868 178,967 536,901 0 0 0 536,901 1.08 1.01
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