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EMC 10-Q 2005 UNITED STATES WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
EMC CORPORATION (Exact name of registrant as specified in its charter)
176
South Street
Hopkinton, Massachusetts 01748 (Address of principal executive offices, including zip code) (508) 435-1000 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.
Indicate by check mark whether
the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
The number of shares of common
stock, par value $.01 per share, of the registrant outstanding as of June 30, 2005 was 2,410,634,778.
EMC CORPORATION
PART I
EMC CORPORATION
The accompanying notes are an integral part of the consolidated financial
statements. 3 EMC CORPORATION
The accompanying notes are an integral part of the consolidated financial
statements. 4 EMC CORPORATION
The accompanying notes are an integral part of the consolidated financial
statements. 5 EMC CORPORATION
The accompanying notes are an integral part of the consolidated financial
statements. 6 EMC CORPORATION
Company
EMC Corporation and its subsidiaries offer a wide
range of systems, software, services and solutions that help organizations get more value from their information and get the most out of their
information technology (IT) assets. EMC helps individuals and organizations store, share, manage, protect and apply information to collaborate, solve
problems, save money, exploit new opportunities and enhance operational results.
EMC has led the market in developing solutions for
customers to manage information intelligently based on its changing value to an organization over time. With a strategy known as information
lifecycle management, we help organizations organize, protect, move and manage information on the lowest-cost storage system appropriate for the
level of protection and the speed of access needed at each point in information’s life. Information lifecycle management simultaneously lowers the
cost and reduces the risk of managing information, no matter what format it is in — documents, images or e-mail — as well as the data that
resides in databases. Information lifecycle management provides for cost-effective business continuity and more efficient compliance with government
and industry regulations. We also provide specialized virtual infrastructure software that can help organizations respond to changing IT requirements
by dynamically altering their computing and storage environments without interruption to their businesses. Our unique capabilities deliver lower total
operating costs, optimized service and performance and a more responsive IT infrastructure.
General
The accompanying interim consolidated financial
statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim
financial information. These statements include the accounts of EMC and its wholly-owned subsidiaries. All intercompany transactions have been
eliminated in consolidation. Certain information and footnote disclosures normally included in our annual consolidated financial statements have been
condensed or omitted. Accordingly, these interim consolidated financial statements should be read in conjunction with the audited consolidated
financial statements for the year ended December 31, 2004 which are contained in our Annual Report on Form 10-K filed with the Securities and Exchange
Commission on March 4, 2005.
The results of operations for the interim periods
are not necessarily indicative of the results of operations to be expected for any future period or the entire fiscal year. The interim consolidated
financial statements, in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary to fairly state the
results as of and for the periods ended June 30, 2005 and 2004.
Presentation
We have changed the method of presenting the
statement of cash flows from the indirect method to the direct method, which is the preferred method of presentation. The consolidated statement of
cash flows for the six months ended June 30, 2004 has been conformed to this method of presentation.
In 2004, we concluded that it was appropriate to
classify our auction rate securities as short-term investments. Previously, such investments had been classified as cash and cash equivalents. We have
made adjustments to our consolidated statement of cash flows for the six months ended June 30, 2004 to reflect the gross purchases and sales of these
securities as investing activities rather than as a component of cash and cash equivalents. This change in classification does not affect previously
reported cash flows from operations or from financing activities in our consolidated statements of cash flows or our previously reported consolidated
statements of operations for any period.
7 EMC CORPORATION New Accounting
Pronouncements
In December 2004, the Financial Accounting Standards
Board (“FASB”) issued Statement of Financial Accounting Standard (“FAS”) No. 123R, “Share-Based Payment.” The statement
replaces FAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees.”
FAS No. 123R focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment transactions. The adoption of the statement will result in the
expensing of the fair value of stock options granted to employees in the basic financial statements. Previously, we elected to only disclose the impact
of expensing the fair value of stock options in the notes to the financial statements. The statement is required to be adopted commencing with our
first quarter of 2006.
FAS No. 123R applies to new equity awards and to
equity awards modified, repurchased or canceled after the effective date. Additionally, compensation cost for the portion of awards for which the
requisite service has not been rendered that are outstanding as of the effective date shall be recognized as the requisite service is rendered on or
after the effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated
from the pro forma disclosures under FAS No. 123. Changes to the grant-date fair value of equity awards granted before the effective date of this
statement are precluded. The compensation cost for those earlier awards shall be attributed to periods beginning on or after the effective date of this
statement using the attribution method that was used under FAS No. 123, except that the method of recognizing forfeitures only as they occur shall not
be continued. Any unearned or deferred compensation (contra-equity accounts) related to those earlier awards shall be eliminated against the
appropriate equity accounts. Additionally, common stock purchased pursuant to stock options granted under our employee stock purchase plan will be
expensed based upon the fair market value of the stock option.
FAS No. 123R also allows for a modified version of
retrospective application to periods before the effective date. Modified retrospective application may be applied either (a) to all prior years for
which FAS No. 123 was effective or (b) only to prior interim periods in the year of initial adoption. An entity that chooses to apply the modified
retrospective method to all prior years for which FAS No. 123 was effective shall adjust financial statements for prior periods to give effect to the
fair-value-based method of accounting for awards granted, modified, or settled in cash in fiscal years beginning after December 15, 1994, on a basis
consistent with the pro forma disclosures required for those periods by FAS No. 123. Accordingly, compensation cost and the related tax effects will be
recognized in those financial statements as though they had been accounted for under FAS No. 123. Changes to amounts as originally measured on a pro
forma basis are precluded.
The adoption of FAS No. 123R will have a material
impact on our results of operations. Future results will be impacted by the number and value of additional equity awards as well as the value of
existing unvested equity awards.
In March 2005, FASB issued FASB Interpretation No.
47, “Accounting for Conditional Asset Retirement Obligations,” which is an interpretation of FASB Statement No. 143, “Accounting for
Asset Retirement Obligations.” The interpretation requires a liability for the fair value of a conditional asset retirement obligation to be
recognized if the fair value of the liability can be reasonably estimated. The interpretation is effective no later than the end of fiscal years ending
after December 15, 2005, and is not expected to have a material impact on our financial position or results of operations.
In June 2005, FASB issued FAS No. 154,
“Accounting Changes and Error Corrections.” This statement replaces APB Opinion No. 20, “Accounting Changes,” and FAS No. 3,
“Reporting Accounting Changes in Interim Financial Statements.” The statement applies to all voluntary changes in accounting for and
reporting of changes in accounting principles. FAS No. 154 requires retrospective application to prior periods’ financial statements of a
voluntary change in accounting principles unless it is not practical to do so. APB No. 20 previously required that most voluntary changes in accounting
principles be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle.
FAS
8 EMC CORPORATION No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and errors made occurring in fiscal years beginning after May 31, 2005. The adoption of FAS No. 154 is not expected to have a material impact on our financial position or results of operations. In June 2005, FASB issued FASB Staff Position
(“FSP”) No. FAS 143-1, “Accounting for Electronic Equipment Waste Obligations” to address the accounting for obligations associated
with EU Directive 2002/96/EC on Waste Electrical and Electronic Equipment (the “Directive”). The Directive requires EU-member countries to
adopt legislation to regulate the collection, treatment, recovery and environmentally sound disposal of electrical and electronic waste equipment.
Under the Directive, the waste management obligation for historical equipment (products put on the market on or prior to August 13, 2005) remains with
the commercial user until the equipment is replaced. Depending upon the law adopted by the particular country, upon replacement, the waste management
obligation for that equipment may be transferred to the producer of the related equipment. The user retains the obligation if they do not replace the
equipment.
FSP No. FAS 143-1 requires a commercial user to
apply the provisions of FASB Statement No. 143, “Accounting for Asset Retirement Obligations” and related FASB Interpretation No. 47,
“Accounting for Conditional Asset Retirement Obligations” to waste obligations associated with historical equipment. The rules require that a
liability be established for the retirement obligation with an offsetting increase to the carrying amount of the related asset. FSP No. FAS 143-1 is
effective for reporting periods ending after June 8, 2005 or the date of adoption of the law by the applicable EU member country. The issuance of FSP
No. 143-1 is not expected to have a material impact on our financial position or results of operations.
Accounting for Stock-Based
Compensation
FAS No. 123, “Accounting for Stock-Based
Compensation” defined a fair value method of accounting for stock options and other equity instruments. Under the fair value method, compensation
cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period.
As provided for in FAS No. 123, we elected to apply APB Opinion No. 25 and related interpretations in accounting for our stock-based compensation
plans. Compensation expense is recognized on a straight-line basis over the vesting period for restricted stock grants and stock options granted where
the exercise price is below the market price on the date of the grant.
The following is a reconciliation of net income per
weighted average share had we adopted FAS No. 123 (table in thousands, except per share amounts):
9 EMC CORPORATION The fair value of each option granted during the
three and six months ended June 30, 2005 and June 30, 2004 is estimated on the date of grant using the Black-Scholes option-pricing model with the
following assumptions:
Under the EMC Corporation 2003 Stock Plan (the
“2003 Plan”), awards granted to an employee who meets the age and/or length of service requirements for “retirement” set forth in
the plan generally will continue to vest after such employee’s retirement without additional service. In connection with the above reconciliation
of net income assuming adoption of FAS No. 123, our policy with respect to these awards has been to recognize compensation cost over the stipulated
vesting period, which is typically five years. If the employee retires before the end of the vesting period, any remaining unrecognized compensation
cost would be recognized at the date of retirement. The Securities and Exchange Commission has determined that companies that follow this approach
should continue to do so for all applicable equity-based awards issued prior to the effective date of FAS No. 123R. These awards should also continue
to be accounted for in this manner subsequent to the effective date of FAS No. 123R. The cost of applicable equity-based awards issued subsequent to
the effective date of FAS No. 123R should be recognized over the period during which the retention of the award is no longer contingent on providing
subsequent service. The effect of this change would not be material to the pro forma results of operations for the periods reported in the table
above.
Acquisition of Smarts, Inc.
In February 2005, we acquired all of the outstanding
capital stock of System Management Arts Incorporated (“Smarts”). Smarts’ software products automatically locate root-cause problems,
calculate their impacts across technology domains and present the logical action plan required to keep business services up and running. The
acquisition enables us to offer event automation and real-time network systems management software. Additionally, the acquisition will enable us to
apply the modeling, correlation and root cause analysis technology to expand our information and storage management offerings.
The aggregate purchase price, net of cash received,
was approximately $293.5 million, which consisted of $252.6 million of cash, $37.4 million in fair value of our stock options and $3.5 million of
transaction costs, which primarily consisted of fees paid for financial advisory, legal and accounting services. The fair value of our stock options
issued to employees was estimated using a Black-Scholes option-pricing model. The fair value of the stock options was estimated assuming no expected
dividends and the following weighted-average assumptions:
The intrinsic value allocated to the unvested
options issued in the acquisition that had yet to be earned as of the acquisition date was $3.5 million and has been recorded as deferred compensation
in the purchase price allocation. The consolidated financial statements include the results of Smarts from the date of acquisition. Pro forma results
of operations have not been presented because the effects of the acquisition were not material to us. The purchase price has been allocated based on
estimated fair values as of the acquisition date. The
10 EMC CORPORATION purchase price allocation is preliminary and a final determination of required purchase accounting adjustments will be made upon the finalization of our integration activities. The following represents the preliminary allocation
of the purchase price (table in thousands):
In determining the purchase price allocation, we
considered, among other factors, our intention to use the acquired assets and historical demand and estimates of future demand of Smarts’ products
and services. The fair value of intangible assets was primarily based upon the income approach. The rate used to discount the net cash flows to their
present values was based upon a weighted average cost of capital of 16%. The discount rate was determined after consideration of market rates of return
on debt and equity capital, the weighted average return on invested capital and the risk associated with achieving forecasted sales related to the
technology and assets acquired from Smarts.
The total weighted average amortization period for
the intangible assets is 6.0 years. The intangible assets are being amortized based upon the pattern in which the economic benefits of the intangible
assets are being utilized. None of the goodwill is deductible for income tax purposes. The goodwill is classified within our EMC Software Group
products and services segment.
Of the $47.4 million of acquired intangible assets,
$3.1 million was allocated to IPR&D and was written off at the date of acquisition because the IPR&D had no alternative uses and had not
reached technological feasibility. The write-off is included in restructuring and other special charges in our income statement. Three IPR&D
projects were identified relating to real-time management of networks and services. The value assigned to IPR&D was determined utilizing the income
approach by determining cash flow projections relating to the projects. The stage of completion of each in-process project was estimated to determine
the discount rate to be applied to the valuation of the in-process technology. Based upon the level of completion and the risk associated with
in-process technology, we deemed a discount rate of 40% as appropriate for valuing IPR&D.
In connection with the Smarts acquisition, we
commenced integration activities which have resulted in recognizing $6.4 million in liabilities for lease obligations, employee termination benefits
and other contractual obligations, of which $1.1 million was paid through June 30, 2005. The termination benefits will be paid through 2005 and the
lease and contractual liabilities will be paid over the remaining periods through 2008.
11 EMC CORPORATION Goodwill
Changes in the carrying amount of goodwill, net, on
a consolidated basis and by segment for the six months ended June 30, 2005 consist of the following (table in thousands):
Inventories consist of (table in
thousands):
Property, plant and equipment consist of (table in
thousands):
Construction in progress and land owned at June 30,
2005 include $93.1 million and $6.0 million, respectively, of facilities under construction that we are holding for future use.
12 EMC CORPORATION
Accrued expenses consist of (table in
thousands):
Product
Warranties
Systems sales include a standard product warranty.
At the time of the sale, we accrue for systems’ warranty costs. The initial systems’ warranty accrual is based upon our historical experience
and specific identification of systems’ requirements. Upon expiration of the initial warranty, we may sell additional maintenance contracts to our
customers. Revenue from these additional maintenance contracts is deferred and recognized ratably over the service period. The following represents the
activity in our warranty accrual for our standard product warranty (table in thousands):
The current period accrual includes amounts accrued
for systems at the time of shipment, adjustments within the year for changes in estimated costs for warranties on systems shipped in the year and
changes in estimated costs for warranties on systems shipped in prior years. It is not practicable to determine the amounts applicable to each of the
components.
The reconciliation from basic to diluted earnings
per share for both the numerators and denominators is as follows (table in thousands, except per share amounts):
13 EMC CORPORATION Options to acquire 64.1 million and 81.8 million
shares of our common stock for the three and six months ended June 30, 2005, respectively, and options to acquire 113.1 and 90.5 million shares of our
common stock for the three and six months ended June 30, 2004, respectively, were excluded from the calculation of diluted weighted average shares
because of their antidilutive effect. The effect of our senior convertible debt, assumed in connection with our acquisition of Documentum, Inc., on the
calculation of diluted net income per weighted average share for the three and six months ended June 30, 2005 and for the three months ended June 30,
2004 was calculated using the “if converted” method as required by FAS No. 128, “Earnings per Share.” The effect of our senior
convertible debt for the six months ended June 30, 2004, was excluded from the calculation of diluted weighted average shares because of its
anti-dilutive effect.
Line of Credit
We have available for use a credit line of $50.0
million in the United States. As of June 30, 2005, we had no borrowings outstanding on the line of credit. The credit line bears interest at the
bank’s base rate and requires us, upon utilization of the credit line, to meet certain financial covenants with respect to limitations on losses.
In the event the covenants are not met, the lender may require us to provide collateral to secure the outstanding balance. At June 30, 2005, we were in
compliance with the covenants.
Litigation
On September 30, 2002, Hewlett-Packard Company
(“HP”) filed a complaint against us in the United States Federal District Court for the Northern District of California alleging that certain
of our products infringe seven HP patents (the “First HP Lawsuit”). HP sought a permanent injunction as well as unspecified monetary damages
for patent infringement. On July 21, 2003, we answered the complaint and filed counterclaims alleging that certain HP products infringe six EMC
patents. We sought a permanent injunction as well as unspecified monetary damages for patent infringement.
On October 27, 2004, a second complaint was filed by
HP against us in the same court based on six of the seven patents asserted in the First HP Lawsuit (the “Second HP Lawsuit”). The Second HP
Lawsuit was filed shortly after the court had denied HP’s motion for leave to amend its infringement contentions in the First HP Lawsuit to add
certain EMC products. In the Second HP Lawsuit, HP alleged patent infringement by the same EMC products that they attempted to add to the First HP
Lawsuit. On February 3, 2005, the court stayed the Second HP Lawsuit.
In May 2005, EMC and HP jointly announced that the
parties had agreed to amicably dismiss all claims and counterclaims with no findings or admissions of liability in a settlement of all pending patent
infringement litigation between EMC and HP, including the above lawsuits. As part of the settlement between the two companies, HP will pay a net $325
million balancing payment to EMC which can be satisfied through the purchase of complementary EMC products and services, such as the VMware product
line, over the next five years as follows: HP will pre-pay $65 million to EMC prior to the beginning of each of five consecutive periods
(“Purchase Periods”). The Purchase Periods begin on September 1, 2005, December 1, 2006, December 1, 2007, December 1, 2008 and December 1,
2009. The pre-payments will be made on August 29, 2005, November 29, 2006, November 29, 2007, November 29, 2008 and November 30, 2009. During each
Purchase Period, HP may use its pre-payment as credit for product and services purchases from EMC for HP’s resale or internal use. Unused credits
will expire at the end of each Purchase Period. For purposes of computing the amount of credit applied per dollar of EMC products that HP purchases,
hardware products shall be deemed to have been purchased for 50% of the actual purchase price.
If EMC purchases HP products or services during the
Purchase Periods, HP will be required to make an equivalent amount of additional product or services purchases from EMC of up to an aggregate amount of
$108 million over five years, with caps for each Purchase Period as follows: $10,830,000 for the first
14 EMC CORPORATION Purchase Period, $21,660,000 for each of the second, third and fourth Purchase Periods and $32,490,000 for the final Purchase Period. If HP does not make the required amount of additional purchases of EMC products and services attributable to such Purchase Period, HP will be required to pay the difference to EMC in cash. For purposes of computing the amount of credit applied per dollar of HP products that EMC purchases, hardware products shall be deemed to have been purchased for 50% of the actual purchase price. We are a party (either as plaintiff or defendant) to
various other patent litigation matters, including certain matters which we assumed in connection with our acquisitions of LEGATO and
VMware.
We are a party to other litigation which we consider
routine and incidental to our business.
Management does not expect the results of any of
these actions to have a material adverse effect on our business, results of operations or financial condition.
Management has organized the business around our
product and service offerings. We operate in the following segments: information storage products, information storage and management services, EMC
Software Group products and services, VMware products and services and other businesses. Our management makes financial decisions and allocates
resources based on revenues and gross profit achieved at the segment level. We do not allocate selling, general and administrative expenses, research
and development expenses or assets to each segment, as management does not use this information to measure the performance of the operating
segments.
Our information storage products segment includes
systems revenues and platform-based storage software revenues. Our information storage and management services segment includes hardware and
platform-based software maintenance revenues and professional services revenues. Our EMC Software Group products and services segment includes
multi-platform-based storage and management software, software maintenance services and professional services. Our VMware products and services segment
includes virtual infrastructure software, software maintenance services and professional services. Our other businesses segment includes hardware
maintenance revenues associated with AViiON servers.
In July 2004, we revised our segments and
established the EMC Software Group products and services segment. The EMC Software Group products and services segment includes the LEGATO and
Documentum products and services revenues and cost of sales that were historically presented in separate segments. The EMC Software Group products and
services segment also includes EMC multi-platform license revenues and related software maintenance revenues that were historically included in our
information storage products and information storage and management services segments. Prior years’ segment information has been restated to
conform to the current presentation.
15 EMC CORPORATION The revenue components and gross profit attributable
to these segments are set forth in the following tables (tables in thousands, except percentages):
16 EMC CORPORATION Our revenue is attributed to geographic areas
according to the location of customers. Revenues by geographic area are set forth in the following table (table in thousands):
No single country other than the United States
accounted for 10% or more of revenues during the three or six months ended June 30, 2005 or June 30, 2004.
At June 30, 2005, long-lived assets, excluding
financial instruments, and deferred tax assets, were $5,904.2 million in the United States and $259.6 million internationally. At December 31, 2004,
the long-lived assets, excluding financial instruments, and deferred tax assets, were $5,602.4 million in the United States and $262.3 million
internationally. No single country other than the United States accounted for 10% or more of these assets at June 30, 2005 or December 31,
2004.
For the three and six months ended June 30, 2005,
Dell Inc. accounted for 11.4% and 11.0%, respectively, of our total revenues.
Charges for the Three and Six Months Ended June
30, 2005
There were no restructuring and other special
charges recorded during the quarter ended June 30, 2005. During the first quarter of 2005, we recorded restructuring and other special charges of $1.0
million. This amount included an IPR&D charge of $3.1 million associated with the Smarts acquisition, partially offset by a net restructuring
reduction of $2.1 million. See Note 2. The net restructuring reduction included an aggregate of $5.2 million of reductions associated with our prior
restructuring programs partially offset by a $3.1 million provision for employee termination benefits for individuals in our EMC Software Group
products and services segment. The reductions were primarily attributable to lower than expected lease payout obligations associated with vacated
facilities.
The workforce reduction referred to above impacted
approximately 60 individuals across our major business functions. The expected cash impact of the 2005 restructuring charge is $3.1 million, of which
$0.7 and $1.0 million were paid in the three and six month periods ended June 30, 2005, respectively. Approximately 84% of such employees are or were
based in North America and the remainder are or were based in Europe. As of June 30, 2005, approximately 20 of the 60 individuals have yet to be
terminated. The remaining cash expenditures relating to workforce reduction are expected to be substantially paid by the end of 2006.
17 EMC CORPORATION During 2004, we implemented two restructuring
programs to reduce our cost structure and focus our resources on the highest potential growth areas of our business. The activity for the 2004
restructuring programs for the three and six months ended June 30, 2005 is presented below (tables in thousands):
Three Months Ended June 30,
2005
Six Months Ended June 30,
2005
The 2004 restructuring programs included a reduction
in force of approximately 400 employees across our major business functions and all major geographic regions. Approximately 66% of such employees are
or were based in North America and the remainder are or were based in Europe and the Asia Pacific region. As of June 30, 2005, approximately 100 of the
400 individuals have yet to be terminated.
From 1998 through 2003, we implemented several
restructuring programs. The activity for these restructuring programs for the three and six months ended June 30, 2005 is presented below (tables in
thousands):
Three Months Ended June 30,
2005
Six Months Ended June 30,
2005
The reduction in the provision for the consolidation
of excess facilities for the six months ended June 30, 2005 was attributable to lower than expected lease payout obligations associated with vacated
facilities.
18 EMC CORPORATION Charges for the Three and Six Months Ended June
30, 2004
In the second quarter of 2004, we recorded
restructuring and other special charges of $4.5 million. Included in the charges was $0.8 million of costs associated with excess facilities being
vacated as part of our 2004 restructuring program. The charge also included adjustments associated with our 2003 restructuring program consisting of
$8.8 million of additional costs associated with excess facilities being vacated, partially offset by $1.4 million reversal of the provision for
workforce reduction primarily attributable to finalizing severance packages for employees in foreign jurisdictions. The charges were reduced by $3.7
million associated with prior restructuring programs, primarily due to a favorable resolution related to executive severance obligations attributable
to the acquisition of Data General.
During the first six months of 2004, we recorded
restructuring and other special charges of $32.7 million. These charges included restructuring activities, as well as IPR&D charges of $15.2
million associated with the VMware acquisition. The 2004 restructuring program consisted of employee termination benefits of $11.7 million and
facilities-related charges of $0.8 million. The remaining $5.0 million of charges was associated with prior restructuring programs.
Defined Benefit Pension
Plans
We have a noncontributory defined benefit pension
plan which was assumed as part of the Data General acquisition, which covers substantially all former Data General employees located in the U.S. In
addition, certain of the former Data General foreign subsidiaries also have retirement plans covering substantially all of their employees. All of
these plans have been frozen; therefore, such employees no longer accrue pension benefits for future services.
Benefits under these plans are generally based on
either career average or final average salaries and creditable years of service as defined in the plans. The annual cost for these plans is determined
using the projected unit credit actuarial cost method that includes actuarial assumptions and estimates which are subject to change. Prior service cost
is amortized over the average remaining service period of employees expected to receive benefits under the plan. The measurement date for the plans is
December 31.
The components of net periodic benefit credit of the
Data General U.S. pension plan are as follows (table in thousands):
19 EMC CORPORATION Post-Retirement Medical and Life Insurance
Plan
Our post-retirement benefit plan, which was assumed
in connection with the acquisition of Data General, provides certain medical and life insurance benefits for retired former Data General employees.
With the exception of certain participants who retired prior to 1986, the medical benefit plan requires monthly contributions by retired participants
in an amount equal to insured equivalent costs less a fixed EMC contribution which is dependent on the participant’s length of service and
Medicare eligibility. Benefits are continued to dependents of eligible retiree participants for 39 weeks after the death of the retiree. The life
insurance benefit plan is noncontributory.
The components of net periodic benefit cost of the
plan are as follows (table in thousands):
Stock Option Plans
In the quarter ended June 30, 2005, our shareholders
approved amendments to the 2003 Plan which (i) increased by 100.0 million the number of shares of common stock available for grant under the 2003 Plan
and (ii) increased the number of shares which may be issued pursuant to awards of restricted stock and/or restricted stock units to 30% of the total
authorized shares under the 2003 Plan.
During the six months ended June 30, 2005,
approximately 8.4 million shares of restricted stock were granted under the 2003 Plan. A substantial majority of these shares were granted to employees
of VMware as restricted stock awards designed to retain and motivate highly qualified personnel. The shares of restricted stock granted to VMware
employees cliff vest at the end of five years; however, in the event that certain performance-related criteria are met, the vesting accelerates. All
restricted stock awards are recorded as deferred compensation and are being amortized over the vesting period of the awards.
Common Stock Repurchase
Program
Our Board of Directors has authorized the repurchase
of up to 300.0 million shares of our common stock. The purchased shares will be available for various corporate purposes, including our stock option
and employee stock purchase plans. We repurchased 20.8 million shares at a cost of $270.9 million during the six months ended June 30, 2005. As of June
30, 2005, we had reacquired a total of 129.5 million shares at a cost of $1,325.8 million.
20 EMC CORPORATION
Our effective income tax rate was 26.9% for the
three months ended June 30, 2005, and 26.2% for the six months ended June 30, 2005. The effective income tax rate is based upon the estimated income
(loss) for the year, the composition of the income (loss) in different countries, and adjustments, if any, for the potential tax consequences, benefits
or resolutions of tax audits. For the three and six months ended June 30, 2005, the effective tax rate varied from the statutory tax rate primarily as
a result of the mix of income attributable to foreign versus domestic jurisdictions. Our aggregate income tax rate in foreign jurisdictions is lower
than our income tax rate in the United States. Additionally, we recognized a net tax benefit of $7.4 million during the six months ended June 30, 2005,
primarily due to the reversal of certain tax contingency accruals upon the expiration of certain statutes of limitation. Partially offsetting this
benefit was a non-deductible IPR&D charge of $3.1 million incurred in connection with the Smarts acquisition.
Our effective income tax rate was 29.0% for the
three months ended June 30, 2004, and 30.0% for the six months ended June 30, 2004. The effective tax rate varied from the statutory tax rate primarily
as a result of the mix of income attributable to foreign versus domestic jurisdictions. Partially offsetting this benefit were non-deductible IPR&D
charges of $15.2 million incurred in connection with the VMware acquisition during the six months ended June 30, 2004.
In October 2004, the American Jobs Creation Act of
2004 (the “AJCA”) was passed. The AJCA provides a deduction for income from qualified domestic production activities which will be phased in
from 2005 through 2010. In return, the AJCA also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales
that was viewed to be inconsistent with international trade protocols by the European Union. In December 2004, the FASB issued FASB Staff Position No.
109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities by the
American Jobs Creation Act of 2004.” FSP 109-1 treats the deduction as a “special deduction” as described in FAS No. 109. As such, the
special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be
reported in the same period in which the deduction is claimed in our tax return.
The AJCA also created a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled
foreign corporations. The deduction is subject to a number of limitations. We are currently evaluating the AJCA and are not yet in a position to decide
whether, or to what extent, we might repatriate foreign earnings that have not yet been remitted to the U.S.; however, upon finalization of our
assessment, it is reasonably possible that we will repatriate some amount, up to $2.7 billion. We will make a final determination by the end of 2005.
The amount of income tax we would incur should we repatriate some level of earnings cannot be reasonably estimated at this time.
21 Item 2. 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 our interim consolidated financial statements
and notes thereto which appear elsewhere in this Quarterly Report on Form 10-Q and the MD&A contained in our Annual Report on Form 10-K filed with
the Securities and Exchange Commission (the “SEC”) on March 4, 2005. The following discussion contains forward-looking statements and should
also be read in conjunction with “FACTORS THAT MAY AFFECT FUTURE RESULTS” beginning on page 32. The forward-looking statements do not include
the potential impact of any mergers, acquisitions, divestitures or business combinations that may be announced after the date hereof.
All dollar amounts in this MD&A are in millions. INTRODUCTION Our financial objective is to achieve profitable
growth. Management believes that by providing a combination of systems, software, services and solutions to meet customers’ needs, we will be able
to further increase revenues. Our operating income as a percentage of revenues increased from 10.7% for the six months ended June 30, 2004 to 14.9% for
the six months ended June 30, 2005. Our efforts in 2004 and 2005 have been primarily focused on improving operating margins by increasing gross margins
and reducing operating expenses as a percentage of revenues. Additionally, we have been expanding our portfolio of offerings to satisfy our
customers’ requirements. We plan to continue to focus our efforts in 2005 on improving our operating and gross margins and expanding our product
offerings. One of our objectives is to increase operating income as a percentage of revenues to the high teens in the fourth quarter of
2005.
Results of Operations Revenues The following table presents revenues by our
segments. Certain columns may not add due to rounding:
22 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION Information storage products revenues include
information storage systems and information storage software license revenues. Information storage systems revenues were $1,068.7 and $930.2 for the
second quarters of 2005 and 2004, respectively, representing an increase of 15%, and were $2,094.7 and $1,825.2 for the first six months of 2005 and
2004, respectively, also representing an increase of 15%. The increases were due to greater demand for these products attributable to wider customer
acceptance of information lifecycle management-based solutions, increased demand for IT infrastructure products and enhanced distribution channels.
Information storage software license revenues were $312.8 and $263.2 for the second quarters of 2005 and 2004, respectively, representing an increase
of 19%, and were $597.3 and $514.3 for the first six months of 2005 and 2004, respectively, representing an increase of 16%. Information storage
software license revenues consist of revenues from platform-based software whose operation generally controls and enables functions that take place
within an EMC storage system. The increases in information storage software license revenues were attributable to expanded product offerings, a greater
demand for software to manage increasingly complex high-end and midrange networked storage environments and enhanced distribution
channels.
Information storage and management services revenues
include platform-based software maintenance revenues, systems maintenance revenues and professional services revenues. Information storage and
management services revenues increased due to greater demand for both software and system maintenance contracts associated with increased sales of
information storage products. Additionally, increased demand for professional services, largely to support and implement information lifecycle
management-based solutions, contributed to the revenue increases.
The increases in the EMC Software Group products and
services revenues were attributable to greater demand for backup and archive software, storage and management software, content management software and
related maintenance and other services revenues. Software license revenues increased 8% from $223.6 for the second quarter of 2004 to $240.9 for the
second quarter of 2005, and increased 16% from $422.9 for the first six months of 2004 to $488.6 for the first six months of 2005. Related services
revenues increased 30% from $129.2 for the second quarter of 2004 to $167.4 for the second quarter of 2005, and increased 27% from $253.4 for the first
six months of 2004 to $321.0 for the first six months of 2005. The growth in services revenues was primarily due to increased software maintenance
revenues.
The increases in VMware products and services
revenues were attributable to increased demand for virtual infrastructure software and the introduction of new product offerings. License revenues
increased 70% from $38.8 for the second quarter of 2004 to $65.9 for the second quarter of 2005, and increased 78% from $72.0 for the first six months
of 2004 to $128.2 for the first six months of 2005. Maintenance and other services revenues increased 198% from $8.4 for the second quarter of 2004 to
$25.0 for the second quarter of 2005, and increased 195% from $14.5 for the first six months of 2004 to $42.8 for the first six months of 2005. The
growth in services revenues was primarily due to increased software maintenance revenues.
Other businesses revenues consist of revenues from
AViiON maintenance services. These revenues are expected to continue to decline in future quarters as we have discontinued selling AViiON
servers.
Revenues by geography were as
follows:
23 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
Revenue increased in the three and six months ended
June 30, 2005 compared to the three and six months ended June 30, 2004 in these markets due to greater demand for our products and services and
enhanced distribution channels. Changes in exchange rates favorably impacted consolidated revenue growth by 1.7% for the three and six months ended
June 30, 2005. The impact of the change in rates was most significant in the European market, primarily Germany, the United Kingdom, Italy and
France.
For 2005, we expect our consolidated revenues to
grow at approximately 17%. However, our revenues could be negatively impacted by a number of factors, including the economy, demand for IT
infrastructure, product availability, competitive factors and changes in exchange rates.
Costs and expenses The following tables present our costs, gross
margins, expenses and net income. Certain columns may not add due to rounding.
24 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
Gross Margins
Information storage products gross margin
percentages were 44.8% and 41.3% for the second quarters of 2005 and 2004, respectively and were 43.7% and 41.4% for the first six months of 2005 and
2004, respectively. The increases in the gross margin percentages were attributable to achieving higher sales volumes and a reduction of component
costs as a percentage of revenues.
The gross margin percentages for information storage
and management services were 53.2% and 50.9% for the second quarters of 2005 and 2004, respectively, and were 52.7% and 50.7% for the first six months
of 2005 and 2004, respectively. The improvement was driven by a shift in the mix of our maintenance services offerings with a greater proportion of
revenues being derived from software maintenance contracts compared to systems maintenance contracts. Software maintenance contracts provide a higher
gross margin than systems maintenance contracts. Improvements in the gross margins earned from professional services also contributed to the increase
in gross margin percentage.
The gross margin percentages for the EMC Software
Group products and services segment were 77.7% and 78.2% for the second quarters of 2005 and 2004, respectively. The decrease in the gross margin
percentage was primarily attributable to a greater proportion of revenues being derived from service contracts compared to software licenses. Software
licenses provide a higher gross margin than services contracts. The gross margin percentages for the EMC Software Group products and services segment
were 78.4% and 77.4% for the first six months of 2005 and 2004, respectively. The increase in the gross margin percentage was
25 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION primarily attributable to a more efficient cost structure for software maintenance and professional services offerings, slightly offset by a greater proportion of revenues in the six months ended June 30, 2005 being derived from services contracts compared to software licenses. The gross margin percentages for the VMware products
and services segment were 80.8% and 78.3% for the second quarters of 2005 and 2004, respectively, and were 81.1% and 77.4% for the first six months of
2005 and 2004, respectively. The gross margin improvements were attributable to achieving higher sales volumes while controlling our operating cost
structure. Additionally, amortization expense associated with acquired intangible assets was spread over a larger revenue base, resulting in margin
improvement. Partially offsetting these improvements in the gross margin percentages was a shift in the mix of software license revenue and services
revenues, with a greater proportion of revenues being derived from services.
The gross margin percentages for other businesses
were 50.1% and 52.5% for the second quarters of 2005 and 2004, respectively, and were 47.1% and 54.1% for the first six months of 2005 and 2004,
respectively. The decreases in the gross margin percentages resulted from declining revenues in this segment as the volume of AViiON maintenance
contracts decreased.
We expect our overall gross margin to be 53% to 54%
for the full year of 2005. However, if sales volumes decline or competitive pricing pressures or component costs increase, gross margins may be
negatively impacted.
Research and
Development
As a percentage of revenues, research and
development (“R&D”) expenses were 10.8% and 10.4% for the second quarters of 2005 and 2004, respectively, and were 10.6% and 10.7% for
the first six months of 2005 and 2004, respectively. In addition, we spent $40.4 and $44.5 in the second quarters of 2005 and 2004, respectively, and
$82.5 and $86.4 in the first six months of 2005 and 2004, respectively, on software development, which costs were capitalized. R&D spending
includes enhancements to our software and information storage systems. R&D expenses increased from $205.1 in the second quarter of 2004 to $253.3
in the second quarter of 2005 and increased from $409.7 in the first six months of 2004 to $487.6 in the first six months of 2005. The increases in
R&D expenses were primarily attributable to increased headcount and related compensation costs to further enhance our development efforts on both
software and systems.
Selling, General and
Administrative
As a percentage of revenues, selling, general and
administrative (“SG&A”) expenses were 27.4% and 27.8% for the second quarters of 2005 and 2004, respectively, and were 27.4% and 28.2%
for the first six months of 2005 and 2004, respectively. SG&A expenses increased from $548.9 in the second quarter of 2004 to $642.7 in the second
quarter of 2005 and increased from $1,083.5 in the first six months of 2004 to $1,258.4 in the first six months of 2005. The increases in SG&A
expenses were primarily attributed to higher selling costs associated with the growth in revenues, the acquisition of Smarts in February 2005 and
higher levels of general and administrative expenses to support the overall growth in the business.
Restructuring and Other Special
Charges
There were no restructuring and other special
charges recorded during the quarter ended June 30, 2005. During the quarter ended March 31, 2005, we recorded restructuring and other special charges
of $1.0. This amount included an IPR&D charge of $3.1 associated with the Smarts acquisition, partially offset by a net restructuring reduction of
$2.1. The net restructuring reduction included an aggregate of $5.2 of reductions associated with our prior restructuring programs partially offset by
a $3.1 provision for employee termination benefits for individuals in our EMC Software Group products and services segment. The reductions were
primarily attributable to lower than expected lease payout obligations associated with vacated facilities.
26 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION The workforce reduction referred to above impacted
approximately 60 individuals across our major business functions. The expected cash impact of the 2005 restructuring charge is $3.1, of which $0.7 was
paid in the three months ended June 30, 2005 and $1.0 was paid in the six months ended June 30, 2005. Approximately 84% of such employees are or were
based in North America and the remainder are or were based in Europe. As of June 30, 2005, approximately 20 of the 60 individuals have yet to be
terminated. The remaining cash expenditures relating to workforce reduction are expected to be substantially paid by the end of 2006.
During 2004, we implemented two restructuring
programs to reduce our cost structure and focus our resources on the highest potential growth areas of our business. The activity for the 2004
restructuring programs for the three and six months ended June 30, 2005 is presented below:
The 2004 restructuring programs included a reduction
in force of approximately 400 employees across our major business functions and all major geographic regions. Approximately 66% of such employees are
or were based in North America and the remainder are or were based in Europe and the Asia Pacific region. As of June 30, 2005, approximately 100 of the
400 individuals have yet to be terminated.
From 1998 through 2003, we implemented several
restructuring programs. The activity for these restructuring programs for the three and six months ended June 30, 2005 is presented
below:
The reduction in the provision for the consolidation
of excess facilities for the six months ended June 30, 2005 was attributable to lower than expected lease payout obligations associated with vacated
facilities.
27 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION Charges for the Three and Six Months Ended June
30, 2004
In the second quarter of 2004, we recorded
restructuring and other special charges of $4.5. Included in the charges was $0.8 of costs associated with excess facilities being vacated as part of
the 2004 restructuring program. The charge also included adjustments associated with the 2003 restructuring program consisting of $8.8 of additional
costs associated with excess facilities being vacated, partially offset by $1.4 reversal of the provision for workforce reduction primarily
attributable to finalizing severance packages for employees in foreign jurisdictions. The charges were reduced by $3.7 associated with prior
restructuring programs, primarily due to a favorable resolution related to executive severance obligations attributable to the acquisition of Data
General.
During the first six months of 2004, we recorded
restructuring and other special charges of $32.7. These charges included restructuring activities, as well as IPR&D charges of $15.2 associated
with the VMware acquisition. The 2004 restructuring program consisted of employee termination benefits of $11.7 and facilities-related charges of $0.8.
The remaining $5.0 of charges was associated with prior restructuring programs.
Investment Income
Investment income increased to $43.5 for the second
quarter of 2005 from $36.0 for the second quarter of 2004 and increased to $86.5 for the first six months of 2005 from $77.0 for the first six months
of 2004. The increases were due to higher yields and a larger outstanding investment balance, partially offset by realized losses from the sale of
investments. The weighted average return on investments, excluding realized gains and losses, was 3.3% and 2.4% for the second quarters of 2005 and
2004, respectively, and was 3.2% and 2.4% for the first six months of 2005 and 2004, respectively. Realized losses were $16.2 and $3.2 for the second
quarters of 2005 and 2004, respectively, and were $26.6 and $0.3 for the first six months of 2005 and 2004, respectively.
Other Expense, net
Other expense, net was $1.1 for the second quarter
of 2005 compared to $2.2 for the second quarter of 2004 and was $3.4 for the first six months of 2005 compared to $8.0 for the first six months of
2004. The decreases in the first six months of 2005 compared to 2004 were primarily due to lower foreign currency losses.
Provision for Income
Taxes
The effective income tax rate was 26.9% for the
second quarter of 2005 compared to 29.0% for the second quarter of 2004 and was 26.2% for the first six months of 2005 compared to 30.0% for the first
six months of 2004. The effective income tax rate is based upon the estimated income (loss) for the year, the composition of the income (loss) in
different countries, and adjustments, if any, for the potential tax consequences, benefits or resolutions of tax audits. For the three and six months
ended June 30, 2005 and 2004, the effective tax rate varied from the statutory rate primarily as a result of the mix of income attributable to foreign
versus domestic jurisdictions. Our aggregate income tax rate in foreign jurisdictions is lower than our income tax rate in the United States.
Additionally, in the six months ended June 30, 2005, we recognized a net tax benefit of $7.4, primarily due to the reversal of certain tax contingency
accruals upon the expiration of certain statutes of limitation. Partially offsetting this benefit was a non-deductible IPR&D charge of $3.1
incurred in connection with the Smarts acquisition. In the six months ended June 30, 2004, we incurred non-deductible IPR&D charges of $15.2
related to the VMware acquisition.
From time to time we are subject to income tax
audits in the United States and various foreign jurisdictions. The Internal Revenue Service is currently completing an audit of our income tax returns
for the years 2001 and 2002. We expect the audit to be completed by the end of 2005.
28 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION In October 2004, the American Jobs Creation Act of
2004 (the “AJCA”) was passed. The AJCA provides a deduction for income from qualified domestic production activities which will be phased in
from 2005 through 2010. In return, the AJCA also provides for a two-year phase-out of the existing extra-territorial income exclusion for foreign sales
that was viewed to be inconsistent with international trade protocols by the European Union. In December 2004, the FASB issued FASB Staff Position
(“FSP”) No. 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities by the American Jobs Creation Act of 2004.” FSP 109-1 treats the deduction as a “special deduction” as described in FAS No.
109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this
deduction will be reported in the same period in which the deduction is claimed in our tax return.
The AJCA also created a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled
foreign corporations. The deduction is subject to a number of limitations. We are currently evaluating the AJCA and are not yet in a position to decide
whether, or to what extent, we might repatriate foreign earnings that have not yet been remitted to the U.S.; however, upon finalization of our
assessment, it is reasonably possible that we will repatriate some amount, up to $2,700. We will make a final determination by the end of 2005. The
amount of income tax we would incur should we repatriate some level of earnings cannot be reasonably estimated at this time.
Financial Condition Cash and cash equivalents and short and long-term
investments were $7,674.3 and $7,440.8 at June 30, 2005 and December 31, 2004, respectively, an increase of $233.5.
Cash provided by operating activities for the first
six months of 2005 was $1,028.8 compared to $884.7 for the first six months of 2004. Cash received from customers was $4,722.5 and $4,030.2 for the
first six months of 2005 and 2004, respectively. The increase was attributable to higher sales volume and greater cash proceeds from the sale of
maintenance contracts. Cash paid to suppliers and employees was $3,761.9 and $3,147.1 for the first six months of 2005 and 2004, respectively. The
increase was partially attributable to higher headcount associated with the acquisitions of Dantz Development Corporation in 2004, Smarts in 2005 and
the general growth of the business. Additionally, greater levels of component purchases to meet customer demand for information storage systems
contributed to the increased amount of payments to suppliers. As part of our transition plan for our new high end storage system product line announced
in July 2005, we also began increasing the inventory levels for such new products at the end of the second quarter of 2005. Cash received from
dividends and interest was $111.1 and $78.3 for the first six months of 2005 and 2004, respectively. The increase was due to higher rates of return
earned on our investments. In the first six months of 2005 and 2004, we paid $37.7 and $73.9, respectively, in income taxes.
Cash used for investing activities was $485.5 for
the first six months of 2005, compared to $1,084.0 for the first six months of 2004. In the first six months of 2005, we acquired all the outstanding
shares of Smarts for $256.1, net of cash received. In the first six months of 2004, we acquired all the outstanding shares of VMware for $537.7, net of
cash received. Capital additions were $253.7 and $174.5 for the first six months of 2005 and 2004, respectively. The increase in capital additions was
primarily due to greater infrastructure to support the overall growth of the business. Depreciation and amortization expense on property, plant and
equipment and intangible assets increased from $297.1 for the first six months of 2004 to $316.5 for the first six months of 2005. The increase was
primarily due to incremental amortization associated with capitalized software made available for resale, greater depreciation associated with our
investment in property, plant and equipment and incremental intangible amortization expense associated with acquisitions. Net purchases and
(maturities) of investments, consisting primarily of debt securities, were $115.0 and $(263.0) for the first six months of 2005 and 2004,
respectively.
29 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION Amortization of deferred compensation increased from
$26.5 for the first six months of 2004 to $34.4 for the first six months of 2005. The increase was attributable to the issuance of restricted stock to
certain employees, partially offset by reduced levels of amortization expense associated with unvested stock options exchanged in connection with
acquisitions. We expect the amount of amortization to increase in future periods as we issue additional shares of restricted stock.
Cash used for financing activities was $134.0 for
the first six months of 2005 compared to $206.5 for the first six months of 2004. During the first six months of 2005 we repurchased 20.8 million
shares of our common stock at a cost of $270.9. During the first six months of 2004 we repurchased 26.6 million shares of our common stock at a cost of
$309.6. We generated $136.8 and $106.2 in the first six months of 2005 and 2004, respectively, from the exercise of stock options and the purchase of
shares under the employee stock purchase plan.
We employ several strategies to enhance our
liquidity and income. We derive revenues from both selling and leasing activity. We customarily sell the notes receivable resulting from our leasing
activity. Generally, we do not retain any recourse on the sale of these notes. We also lend certain fixed income securities to generate investment
income.
We have available for use a credit line of $50.0 in
the United States. As of June 30, 2005, we had no borrowings outstanding on the line of credit. The credit line bears interest at the bank’s base
rate and requires us, upon utilization of the credit line, to meet certain financial covenants with respect to limitations on losses. In the event the
covenants are not met, the lender may require us to provide collateral to secure the outstanding balance. At June 30, 2005, we were in compliance with
the covenants.
Based on our current operating and capital
expenditure forecasts, we believe that the combination of funds currently available, funds generated from operations and our available lines of credit
will be adequate to finance our ongoing operations for at least the next twelve months.
New Accounting Pronouncements In December 2004, the Financial Accounting Standards
Board (“FASB”) issued Statement of Financial Accounting Standard (“FAS”) No. 123R, “Share-Based Payment.” The statement
replaces FAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees.”
FAS No. 123R focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment transactions. The adoption of the statement will result in the
expensing of the fair value of stock options granted to employees in the basic financial statements. Previously, we elected to only disclose the impact
of expensing the fair value of stock options in the notes to the financial statements. The statement is required to be adopted commencing with our
first quarter of 2006.
FAS No. 123R applies to new equity awards and to
equity awards modified, repurchased or canceled after the effective date. Additionally, compensation cost for the portion of awards for which the
requisite service has not been rendered that are outstanding as of the effective date shall be recognized as the requisite service is rendered on or
after the effective date. The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated
from the pro forma disclosures under FAS No. 123. Changes to the grant-date fair value of equity awards granted before the effective date of this
statement are precluded. The compensation cost for those earlier awards shall be attributed to periods beginning on or after the effective date of this
statement using the attribution method that was used under FAS No. 123, except that the method of recognizing forfeitures only as they occur shall not
be continued. Any unearned or deferred compensation (contra-equity accounts) related to those earlier awards shall be eliminated against the
appropriate equity accounts. Additionally, common stock purchased pursuant to stock options granted under our employee stock purchase plan will be
expensed based upon the fair market value of the stock option.
30 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION FAS No. 123R also allows for a modified version of
retrospective application to periods before the effective date. Modified retrospective application may be applied either (a) to all prior years for
which FAS No. 123 was effective or (b) only to prior interim periods in the year of initial adoption. An entity that chooses to apply the modified
retrospective method to all prior years for which FAS No. 123 was effective shall adjust financial statements for prior periods to give effect to the
fair-value-based method of accounting for awards granted, modified, or settled in cash in fiscal years beginning after December 15, 1994, on a basis
consistent with the pro forma disclosures required for those periods by FAS No. 123. Accordingly, compensation cost and the related tax effects will be
recognized in those financial statements as though they had been accounted for under FAS No. 123. Changes to amounts as originally measured on a pro
forma basis are precluded.
The adoption of FAS No. 123R will have a material
impact on our results of operations. Future results will be impacted by the number and value of additional equity awards as well as the value of
existing unvested equity awards.
In March 2005, FASB issued FASB Interpretation No.
47, “Accounting for Conditional Asset Retirement Obligations,” which is an interpretation of FASB Statement No. 143, “Accounting for
Asset Retirement Obligations.” The interpretation requires a liability for the fair value of a conditional asset retirement obligation to be
recognized if the fair value of the liability can be reasonably estimated. The interpretation is effective no later than the end of fiscal years ending
after December 15, 2005, and is not expected to have a material impact on our financial position or results of operations.
In June 2005, FASB issued FAS No. 154,
“Accounting Changes and Error Corrections.” This statement replaces APB Opinion No. 20, “Accounting Changes,” and FAS No. 3,
“Reporting Accounting Changes in Interim Financial Statements.” The statement applies to all voluntary changes in accounting for and
reporting of changes in accounting principles. FAS No. 154 requires retrospective application to prior periods’ financial statements of a
voluntary change in accounting principles unless it is not practical to do so. APB No. 20 previously required that most voluntary changes in accounting
principles be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS
No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is
permitted for accounting changes and errors made occurring in fiscal years beginning after May 31, 2005. The adoption of FAS No. 154 is not expected to
have a material impact on our financial position or results of operations.
In June 2005, FASB issued FASB Staff Position
(“FSP”) No. FAS 143-1, “Accounting for Electronic Equipment Waste Obligations” to address the accounting for obligations associated
with EU Directive 2002/96/EC on Waste Electrical and Electronic Equipment (the “Directive”). The Directive requires EU-member countries to
adopt legislation to regulate the collection, treatment, recovery and environmentally sound disposal of electrical and electronic waste equipment.
Under the Directive, the waste management obligation for historical equipment (products put on the market on or prior to August 13, 2005) remains with
the commercial user until the equipment is replaced. Depending upon the law adopted by the particular country, upon replacement, the waste management
obligation for that equipment may be transferred to the producer of the related equipment. The user retains the obligation if they do not replace the
equipment.
FSP No. FAS 143-1 requires a commercial user to
apply the provisions of FASB Statement No. 143, “Accounting for Asset Retirement Obligations” and related FASB Interpretation No. 47,
“Accounting for Conditional Asset Retirement Obligations” to waste obligations associated with historical equipment. The rules require that a
liability be established for the retirement obligation with an offsetting increase to the carrying amount of the related asset. FSP No. FAS 143-1 is
effective for reporting periods ending after June 8, 2005 or the date of adoption of the law by the applicable EU member country. The issuance of FSP
No. 143-1 is not expected to have a material impact on our financial position or results of operations.
31 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION FACTORS THAT MAY AFFECT FUTURE RESULTS This Quarterly Report on Form 10-Q contains
forward-looking statements, within the meaning of the Federal securities laws, about our business and prospects. The forward-looking statements do not
include the potential impact of any mergers, acquisitions, divestitures or business combinations that may be announced after the date hereof. Our
future results may differ materially from our past results and from those projected in the forward-looking statements due to various uncertainties and
risks, including but not limited to those set forth below, one-time events and other important factors disclosed previously and from time to time in
our other filings with the SEC. We disclaim any obligation to update any forward-looking statements contained herein after the date of this Quarterly
Report.
Our business could be materially adversely affected as a result of general economic and market conditions. We are subject to the effects of general global
economic and market conditions. If these conditions deteriorate, our business, results of operations or financial condition could be materially
adversely affected.
Our business could be materially adversely affected as a result of a lessening demand in the information technology market. Our revenue and profitability depend on the overall
demand for our products and services. Delays or reductions in IT spending, domestically or internationally, could materially adversely affect demand
for our products and services which could result in decreased revenues or earnings.
Component costs, competitive pricing, and sales volume and mix could materially adversely affect our revenues, gross margins and earnings. Our gross margins are impacted by a variety of
factors, including competitive pricing, component and product design costs as well as the volume and relative mixture of product and services revenues.
Increased component costs, increased pricing pressures, the relative and varying rates of increases or decreases in component costs and product price,
changes in product and services revenue mixture or decreased volume could have a material adverse effect on our revenues, gross margins or
earnings.
The costs of third party components comprise a
significant portion of our product costs. While we generally have been able to manage our component and product design costs, we may have difficulty
managing such costs if supplies of certain components become limited or component prices increase. The availability of certain disk drives was limited
in the first half of 2005 and may continue to be limited for the remainder of 2005. Any such limitation could result in an increase in our component
costs. An increase in component or design costs relative to our product prices could have a material adverse effect on our gross margins and earnings.
Moreover, certain competitors may have advantages due to vertical integration of their supply chain, which may include disk drives, microprocessors,
memory components and servers.
The markets in which we do business are highly
competitive and we encounter aggressive price competition for all of our products and services from numerous companies globally. There also has been
and may continue to be a willingness on the part of certain competitors to reduce prices or provide storage-related products or services, together with
other IT products or services, at minimal or no additional cost in order to preserve or gain market share. Such price competition may result in
pressure on our product prices and reductions in product prices may have a material adverse effect on our revenues, gross margins and earnings. We
currently believe that pricing pressures are likely to continue.
If our suppliers are not able to meet our requirements, we could have decreased revenues and earnings. We purchase or license many sophisticated components
and products from one or a limited number of qualified suppliers, including some of our competitors. These components and products include disk drives,
high density memory components, power supplies and software developed and maintained by third parties. We
32 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION have experienced delivery delays from time to time because of high industry demand or the inability of some vendors to consistently meet our quality or delivery requirements. If any of our suppliers were to cancel or materially change contracts or commitments with us or fail to meet the quality or delivery requirements needed to satisfy customer orders for our products, we could lose time-sensitive customer orders, be unable to develop or sell certain products cost-effectively or on a timely basis, if at all, and have significantly decreased quarterly revenues and earnings, which would have a material adverse effect on our business, results of operations and financial condition. Additionally, we periodically transition our product line to incorporate new technologies. The importance of transitioning our customers smoothly to new technologies, along with our historically uneven pattern of quarterly sales, intensifies the risk that the failure of a supplier to meet our quality or delivery requirements will have a material adverse impact on our revenues and earnings. Our business could be materially adversely affected as a result of the risks associated with acquisitions and investments. As part of our business strategy, we seek to acquire
businesses that offer complementary products, services or technologies. These acquisitions are accompanied by the risks commonly encountered in an
acquisition of a business, which may include, among other things:
These factors could have a material adverse effect
on our business, results of operations or financial condition. To the extent that we issue shares of our common stock or other rights to purchase our
common stock in connection with any future acquisition, existing shareholders may experience dilution and our earnings per share may
decrease.
In addition to the risks commonly encountered in the
acquisition of a business as described above, we may also experience risks relating to the challenges and costs of closing a transaction. Further, the
risks described above may be exacerbated as a result of managing multiple acquisitions at the same time.
We also seek to invest in businesses that offer
complementary products, services or technologies. These investments are accompanied by risks similar to those encountered in an acquisition of a
business.
33 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION We may be unable to keep pace with rapid industry, technological and market changes. The markets in which we compete are characterized by
rapid technological change, frequent new product introductions, evolving industry standards and changing needs of customers. There can be no assurance
that our existing products will be properly positioned in the market or that we will be able to introduce new or enhanced products into the market on a
timely basis, or at all. We spend a considerable amount of money on research and development and introduce new products from time to time. There can be
no assurance that enhancements to existing products and solutions or new products and solutions will receive customer acceptance. As competition in the
IT industry increases, it may become increasingly difficult for us to maintain a technological advantage and to leverage that advantage toward
increased revenues and profits.
Risks associated with the development and
introduction of new products include delays in development and changes in data storage, networking and operating system technologies which could
require us to modify existing products. Risks inherent in the transition to new products include:
Further risks inherent in new product introductions
include the uncertainty of price-performance relative to products of competitors, competitors’ responses to the introductions and the desire by
customers to evaluate new products for extended periods of time. Our failure to introduce new or enhanced products on a timely basis, keep pace with
rapid industry, technological or market changes or effectively manage the transitions to new products or new technologies could have a material adverse
effect on our business, results of operations or financial condition.
The markets we serve are highly competitive and we may be unable to compete effectively. We compete with many companies in the markets we
serve, certain of which offer a broad spectrum of IT products and services and others which offer specific information storage, management or
virtualization products or services. Some of these companies (whether independently or by establishing alliances) may have substantially greater
financial, marketing and technological resources, larger distribution capabilities, earlier access to customers and greater opportunity to address
customers’ various IT requirements than us. In addition, as the IT industry consolidates, companies may improve their competitive position and
ability to compete against us. We compete on the basis of our products’ features, performance and price as well as our services. Our failure to
compete on any of these bases could affect demand for our products or services, which could have a material adverse effect on our business, results of
operations or financial condition.
Companies may develop new technologies or products
in advance of us or establish business models or technologies disruptive to us. Our business may be materially adversely affected by the announcement
or introduction of new products, including hardware and software products and services by our competitors, and the implementation of effective
marketing or sales strategies by our competitors. The material adverse effect to our business could include a decrease in demand for our products and
services and an increase in the length of our sales cycle due to customers taking longer to compare products and services and to complete their
purchases.
34 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION We may have difficulty managing operations. Our future operating results will depend on our
overall ability to manage operations, which includes, among other things:
An unexpected decline in revenues without a
corresponding and timely reduction in expenses or a failure to manage other aspects of our operations could have a material adverse effect on our
business, results of operations or financial condition.
Our business could be materially adversely affected as a result of war or acts of terrorism. Terrorist acts or acts of war may cause damage or
disruption to our employees, facilities, customers, partners, suppliers, distributors and resellers, which could have a material adverse effect on our
business, results of operations or financial condition. Such conflicts may also cause damage or disruption to transportation and communication systems
and to our ability to manage logistics in such an environment, including receipt of components and distribution of products.
Our business may suffer if we are unable to retain or attract key personnel. Our business depends to a significant extent on the
continued service of senior management and other key employees, the development of additional management personnel and the hiring of new qualified
employees. There can be no assurance that we will be successful in retaining existing personnel or recruiting new personnel. The loss of one or more
key or other employees, our inability to attract additional qualified employees or the delay in hiring key personnel could have a material adverse
effect on our business, results of operations or financial condition.
In addition, we have historically used stock options
and other equity awards as key elements of our compensation packages for many of our employees. Under recent accounting rules, we will be required to
treat stock-based compensation as an expense commencing in our first quarter of 2006. In addition, changes to regulatory or stock exchange rules and
regulations and in institutional shareholder voting guidelines on equity plans may result in additional requirements or limitations on our equity
plans. As a result, we may change our compensation practices with respect to the number of shares and type of equity awards used. The value of our
equity awards may also be adversely affected by the volatility of our stock price. These factors may impair our ability to attract, retain and motivate
employees.
35 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION Our quarterly revenues and earnings could be materially adversely affected by uneven sales patterns and changing purchasing behaviors. Our quarterly sales have historically reflected an
uneven pattern in which a disproportionate percentage of a quarter’s total sales occur in the last month and weeks and days of each quarter. This
pattern makes prediction of revenues, earnings and working capital for each financial period especially difficult and uncertain and increases the risk
of unanticipated variations in quarterly results and financial condition. We believe this uneven sales pattern is a result of many factors
including:
Our uneven sales pattern also makes it extremely
difficult to predict near-term demand and adjust manufacturing capacity accordingly. If predicted demand is substantially greater than orders, there
will be excess inventory. Alternatively, if orders substantially exceed predicted demand, the ability to assemble, test and ship orders received in the
last weeks and days of each quarter may be limited, which could materially adversely affect quarterly revenues and earnings.
In addition, our revenues in any quarter are
substantially dependent on orders booked and shipped in that quarter and our backlog at any particular time is not necessarily indicative of future
sales levels. This is because:
Loss of infrastructure, due to factors such as an
information systems failure, loss of public utilities or extreme weather conditions, could impact our ability to ship products in a timely manner.
Delays in product shipping or an unexpected decline in revenues without a corresponding and timely slowdown in expenses, could intensify the impact of
these factors on our business, results of operations and financial condition.
In addition, unanticipated changes in our
customers’ purchasing behaviors such as customers taking longer to negotiate and complete their purchases or making smaller, incremental purchases
based on their current needs, also make the prediction of revenues, earnings and working capital for each financial period difficult and uncertain and
increase the risk of unanticipated variations in our quarterly results and financial condition.
Risks associated with our distribution channels may materially adversely affect our financial results. In addition to our direct sales force, we have
agreements in place with many distributors, systems integrators, resellers and original equipment manufacturers to market and sell our products and
services. We may, from time to time, derive a significant percentage of our revenues from such distribution channels. Our financial results could be
materially adversely affected if our contracts with channel partners were terminated, if our relationship with channel partners were to deteriorate or
if the financial condition of our channel partners were to weaken. In addition, as our market opportunities change, we may have an
increased
36 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION reliance on channel partners, which may negatively impact our gross margins. There can be no assurance that we will be successful in maintaining or expanding these channels. If we are not successful, we may lose sales opportunities, customers and market share. Furthermore, the partial reliance on channel partners may materially reduce the visibility to our management of potential customers and demand for products and services, thereby making it more difficult to accurately forecast such demand. In addition, there can be no assurance that our channel partners will not develop, market or sell products or services in competition with us in the future. In addition, as we focus on new market opportunities
and additional customers through our various distribution channels, including small-to-medium sized businesses, we may be required to provide different
levels of service and support than we typically provided in the past. We may have difficulty managing directly or indirectly through our channels these
different service and support requirements and may be required to incur substantial costs to provide such services which may adversely affect our
business, results of operations or financial condition.
Changes in foreign conditions could impair our international operations. A substantial portion of our revenues is derived
from sales outside the United States. In addition, a substantial portion of our products is manufactured outside of the United States. Accordingly, our
future results could be materially adversely affected by a variety of factors, including changes in foreign currency exchange rates, changes in a
specific country’s or region’s political or economic conditions, trade restrictions, import or export licensing requirements, the overlap of
different tax structures or changes in international tax laws, changes in regulatory requirements, compliance with a variety of foreign laws and
regulations and longer payment cycles in certain countries.
Undetected problems in our products could directly impair our financial results. If flaws in design, production, assembly or testing
of our products (by us or our suppliers) were to occur, we could experience a rate of failure in our products that would result in substantial repair,
replacement or service costs and potential damage to our reputation. Continued improvement in manufacturing capabilities, control of material and
manufacturing quality and costs and product testing are critical factors in our future growth. There can be no assurance that our efforts to monitor,
develop, modify and implement appropriate test and manufacturing processes for our products will be sufficient to permit us to avoid a rate of failure
in our products that results in substantial delays in shipment, significant repair or replacement costs or potential damage to our reputation, any of
which could have a material adverse effect on our business, results of operations or financial condition.
Our business could be materially adversely affected as a result of the risks associated with alliances. We have alliances with leading information
technology companies and we plan to continue our strategy of developing key alliances in order to expand our reach into markets. There can be no
assurance that we will be successful in our ongoing strategic alliances or that we will be able to find further suitable business relationships as we
develop new products and strategies. Any failure to continue or expand such relationships could have a material adverse effect on our business, results
of operations or financial condition.
There can be no assurance that companies with which
we have strategic alliances, certain of which have substantially greater financial, marketing or technological resources than us, will not develop or
market products in competition with us in the future, discontinue their alliances with us or form alliances with our competitors.
37 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION Our business may suffer if we cannot protect our intellectual property. We generally rely upon patent, copyright, trademark
and trade secret laws and contract rights in the United States and in other countries to establish and maintain our proprietary rights in our
technology and products. However, there can be no assurance that any of our proprietary rights will not be challenged, invalidated or circumvented. In
addition, the laws of certain countries do not protect our proprietary rights to the same extent as do the laws of the United States. Therefore, there
can be no assurance that we will be able to adequately protect our proprietary technology against unauthorized third-party copying or use, which could
adversely affect our competitive position. Further, there can be no assurance that we will be able to obtain licenses to any technology that we may
require to conduct our business or that, if obtainable, such technology can be licensed at a reasonable cost.
From time to time, we receive notices from third
parties claiming infringement by our products of third-party patent or other intellectual property rights. Responding to any such claim, regardless of
its merit, could be time-consuming, result in costly litigation, divert management’s attention and resources and cause us to incur significant
expenses. In the event there is a temporary or permanent injunction entered prohibiting us from marketing or selling certain of our products or a
successful claim of infringement against us requiring us to pay royalties to a third party, and we fail to develop or license a substitute technology,
our business, results of operations or financial condition could be materially adversely affected.
We may become involved in litigation that may materially adversely affect us. From time to time in the ordinary course of our
business, we may become involved in various legal proceedings, including patent, commercial, product liability, employment, class action, whistleblower
and other litigation and claims, and governmental and other regulatory investigations and proceedings. Such matters can be time-consuming, divert
management’s attention and resources and cause us to incur significant expenses. Furthermore, because litigation is inherently unpredictable,
there can be no assurance that the results of any of these actions will not have a material adverse effect on our business, results of operations or
financial condition.
We may have exposure to additional income tax liabilities. As a multinational corporation, we are subject to
income taxes in both the United States and various foreign jurisdictions. Our domestic and international tax liabilities are subject to the allocation
of revenues and expenses in different jurisdictions and the timing of recognizing revenues and expenses. Additionally, the amount of income taxes paid
is subject to our interpretation of applicable tax laws in the jurisdictions in which we file. From time to time, we are subject to income tax audits.
While we believe we have complied with all applicable income tax laws, there can be no assurance that a governing tax authority will not have a
different interpretation of the law and assess us with additional taxes. Should we be assessed with additional taxes, there could be a material adverse
effect on our results of operations or financial condition.
Changes in regulations could materially adversely affect us. Our business, results of operations or financial
conditions could be materially adversely affected if laws, regulations or standards relating to us or our products are newly implemented or changed. In
addition, our compliance with existing regulations, such as the Sarbanes-Oxley Act of 2002, may have a material adverse impact on us. Under
Sarbanes-Oxley, we are required to evaluate and determine the effectiveness of our internal control structure and procedures for financial reporting.
Compliance with this legislation may divert management’s attention and resources and cause us to incur significant expense. Should we or our
independent auditors determine that we have material weaknesses in our internal controls, our results of operations or financial condition may be
materially adversely affected or our stock price may decline.
38 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION Our stock price is volatile. Our stock price, like that of other technology
companies, is subject to significant volatility because of factors such as:
In addition, our stock price is affected by general
economic and market conditions and has been negatively affected by unfavorable global economic and market conditions. If such conditions deteriorate,
our stock price could decline.
39
For quantitative and qualitative disclosures about
market risk affecting us, see Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K filed
with the SEC on March 4, 2005. Our exposure to market risks has not changed materially from that set forth in our Annual Report.
Item 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and
Procedures. Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the “Exchange Act”)), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our
principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were designed
to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in applicable SEC rules and forms and were effective.
Changes in Internal Control Over Financial
Reporting. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
40 PART II
On September 30, 2002, Hewlett-Packard Company
(“HP”) filed a complaint against us in the United States Federal District Court for the Northern District of California alleging that certain
of our products infringe seven HP patents (the “First HP Lawsuit”). HP sought a permanent injunction as well as unspecified monetary damages
for patent infringement. On July 21, 2003, we answered the complaint and filed counterclaims alleging that certain HP products infringe six EMC
patents. We sought a permanent injunction as well as unspecified monetary damages for patent infringement.
On October 27, 2004, a second complaint was filed by
HP against us in the same court based on six of the seven patents asserted in the First HP Lawsuit (the “Second HP Lawsuit”). The Second HP
Lawsuit was filed shortly after the court had denied HP’s motion for leave to amend its infringement contentions in the First HP Lawsuit to add
certain EMC products. In the Second HP Lawsuit, HP alleged patent infringement by the same EMC products that they attempted to add to the First HP
Lawsuit. On February 3, 2005, the court stayed the Second HP Lawsuit.
In May 2005, EMC and HP jointly announced that the
parties had agreed to amicably dismiss all claims and counterclaims with no findings or admissions of liability in a settlement of all pending patent
infringement litigation between EMC and HP, including the above lawsuits. As part of the settlement between the two companies, HP will pay a net $325
million balancing payment to EMC which can be satisfied through the purchase of complementary EMC products and services, such as the VMware product
line, over the next five years as follows: HP will pre-pay $65 million to EMC prior to the beginning of each of five consecutive periods
(“Purchase Periods”). The Purchase Periods begin on September 1, 2005, December 1, 2006, December 1, 2007, December 1, 2008 and December 1,
2009. The pre-payments will be made on August 29, 2005, November 29, 2006, November 29, 2007, November 29, 2008 and November 30, 2009. During each
Purchase Period, HP may use its pre-payment as credit for product and services purchases from EMC for HP’s resale or internal use. Unused credits
will expire at the end of each Purchase Period. For purposes of computing the amount of credit applied per dollar of EMC products that HP purchases,
hardware products shall be deemed to have been purchased for 50% of the actual purchase price.
If EMC purchases HP products or services during the
Purchase Periods, HP will be required to make an equivalent amount of additional product or services purchases from EMC of up to an aggregate amount of
$108 million over five years, with caps for each Purchase Period as follows: $10,830,000 for the first Purchase Period, $21,660,000 for each of the
second, third and fourth Purchase Periods and $32,490,000 for the final Purchase Period. If HP does not make the required amount of additional
purchases of EMC products and services attributable to such Purchase Period, HP will be required to pay the difference to EMC in cash. For purposes of
computing the amount of credit applied per dollar of HP products that EMC purchases, hardware products shall be deemed to have been purchased for 50%
of the actual purchase price.
We are a party (either as plaintiff or defendant) to
various other patent litigation matters, including certain matters which we assumed in connection with our acquisitions of LEGATO Systems, Inc. and
VMware, Inc.
We are a party to other litigation which we consider
routine and incidental to our business.
Management does not expect the results of any of
these actions to have a material adverse effect on our business, results of operations or financial condition.
41
ISSUER PURCHASES OF EQUITY SECURITIES IN THE SECOND QUARTER OF 2005
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