General
EMC Corporation (“EMC”) and its subsidiaries develop, deliver and support the Information Technology (“IT”) industry’s broadest range of information infrastructure technologies and solutions that are designed to help individuals and organizations handle their digital information needs.
EMC’s systems, software, and services support our customers’ critical business processes by helping them build information infrastructures from the most comprehensive systems available to store, manage and protect information at the right service levels and the right costs. We refer to this as an information lifecycle management (“ILM”) strategy. Our information management software and solutions empower our customers to capture, manage and leverage structured and unstructured information – documents, images or emails – to support their business processes. Our virtual infrastructure software helps organizations respond to changing IT requirements by dynamically altering their computing and storage environments with flexible virtualization technologies. Our resource management software allows organizations to better understand, manage and automate the operation of their information infrastructure.
Additionally, we also recently created an information security division to help customers systematically and comprehensively secure their information. Through the company’s recent acquisitions of RSA Security Inc. (“RSA”) and Network Intelligence Corporation (“Network Intelligence”) and our organic development initiatives, this new division offers customers security solutions to assess the risk to their information; secure the people accessing information and the infrastructure; protect the confidentiality and integrity of the information itself; and manage security information and events to assure effectiveness and ease the burdens of compliance.
We were incorporated in Massachusetts in 1979. Our corporate headquarters are located at 176 South Street, Hopkinton, Massachusetts.
Products and Offerings
Our principal segments consist of Information storage, Content management and archiving, RSA information security and VMware virtual infrastructure.
Information Storage Segment
The Information storage segment is composed of storage systems, platform-based and multi-platform software and services. We offer a wide range of networked information storage systems to support our customers’ ILM strategies to meet their performance, functionality, scalability, data availability and financial requirements. Our storage systems are the foundation of an information infrastructure and can be deployed in a storage area network (“SAN”), networked attached storage (“NAS”), content addressed storage (“CAS”) or direct attached storage environment.
EMC Symmetrix Systems
The EMC Symmetrix family of high-end networked storage systems delivers the highest levels of functionality, performance, data availability and information protection by enabling customers to incrementally scale the performance and capacity of a single array from seven terabytes to more than a petabyte, the largest and most scalable system of its kind. EMC Symmetrix DMX-3, the industry’s fastest, most scalable and flexible storage system, supports customers’ ILM strategies to address the storage
management challenges of high-end computing systems, mid-sized organizations requiring high-performance storage and stringent data protection, and data centers with constrained space, power and cooling resources. Introduced in 2006, the newest Symmetrix DMX-3 model 950 delivers capacity, performance and functionality in a compact package and is ideal for increasingly space- and power-constrained data centers and as a key element of a business continuity strategy.
EMC CLARiiON Systems
Our EMC CLARiiON family of mid-tier networked storage systems is based on a modular design and provides flexible levels of functionality, performance, scalability and availability for small- and medium-sized businesses (“SMBs”), mid-size enterprises and branch offices. In 2006, we introduced EMC CLARiiON CX3 UltraScale systems, based on the new EMC-developed CLARiiON UltraScale architecture, which doubled the performance and capacity of its predecessor. These are the first storage systems in the industry to feature full end-to-end 4 gigabit-per-second (“Gb/s”) Fibre Channel technology for improved performance, scalability and economics. Additionally, we introduced the EMC CLARiiON AX150 and AX150i networked storage systems for SMBs and distributed enterprises. These new architectures provide new advances in performance, ease-of-use, and data protection and are available in a compact and cost-effective system. We also introduced enhancements to our industry-leading EMC Disk Library family of easy-to-use disk-based backup and recovery solutions. The new EMC Disk Library models are based on the CLARiiON UltraScale architecture and feature new capabilities, improved performance and scalability.
EMC Celerra IP Storage Systems
Our EMC Celerra family of IP (internet protocol) storage systems range from the midrange to the high-end of the network attached storage (“NAS”) market and deliver advanced scalability and functionality, unmatched availability and simplified management for customers that would like to access storage via ubiquitous IP networks as part of an overall ILM strategy. In 2006, we introduced new EMC Celerra NS series systems, which utilize the new UltraScale architecture, and a series of software products to monitor the performance of and improve application performance over IP networks.
EMC Centera Content Addressed Storage (“CAS”) Systems
Our EMC Centera CAS systems provide fast, secure online access to archived fixed content – data that cannot be modified or will not change over time, such as digital x-ray images, movies, check images, medical records, e-mail correspondence and other similar types of digital “objects.” Centera systems help customers worldwide comply with complex governance and regulatory requirements for digital record retention, archiving and access. In 2006, we enhanced the storage capabilities of the Centera systems, including new retention management features to give customers more security, flexibility and control over their archived information for regulatory and legal purposes.
EMC Connectrix directors and switches
Our EMC Connectrix family includes high-end directors and departmental switches to help customers of all sizes increase the connectivity between servers and storage systems in a SAN, consolidate their networked storage systems, improve total cost of ownership and tier their storage environments to support an ILM strategy. In 2006, EMC introduced the EMC Connectrix ED-10000M backbone director and EMC Connectrix MDS 9513 Director, which deliver high levels of flexibility and scalability to enable massive SAN consolidation and tiering.
We intend to continue to enhance our storage systems with additional features and capabilities.
Storage Software
Our storage software offering includes both platform and multi-platform software.
Our platform-based software generally controls and enables functions that take place within the EMC networked storage system, such as replication, optimization and data movement. We are the leading supplier of platform-based software for local and remote replication with products such as EMC SRDF (Symmetrix Remote Data Facility), EMC MirrorView, EMC TimeFinder and EMC SnapView, which customers use to copy, protect and share data across varied distances.
EMC’s multi-platform software includes products to help customers better store, protect, optimize and leverage their rapidly increasing volumes of information in complex IT environments. Among others, this line-up of products includes our EMC ControlCenter and EMC Visual families of storage resource management software; PowerPath automated, non-disruptive path management software, the EMC Smarts family of intelligent, automated IT management solutions; EMC’s recovery management solutions including EMC NetWorker, EMC Retrospect and EMC RecoverPoint; EMC Invista network storage virtualization for mixed Fibre Channel SANs; and Rainfinity Global File Virtualization for seamless management of multi-vendor, IP-based NAS, CAS and file servers.
In 2006, EMC introduced a series of software products to help customers reduce complexity, lower operating costs, improve mean-time-to-repair, and enhance reliability of core business services. EMC Smarts Storage Insight for Availability leverages ControlCenter storage management software and fully automates root-cause and impact analysis of availability problems across the SAN, resulting in significant reduction in downtime and maintenance time. EMC Smarts Application Discovery Manager provides extensive application and infrastructure monitoring, analysis and automation across the enterprise. Rainfinity Global File Virtualization solution now offers customers a single platform to manage both active and inactive files throughout a file’s lifecycle across heterogeneous environments.
In 2006, EMC also introduced the new EMC Infoscape software to help companies discover, classify and manage unstructured enterprise information. This software enables customers to efficiently, accurately and easily search all corporate information in file systems; automatically classify information based on business value; manage the retention of unstructured information for compliance; and facilitate policy-based and automated data migration across a tiered storage infrastructure.
Additionally, EMC introduced in 2006 a number of new and updated software products that enable customers to improve the recovery of critical applications and data. EMC’s recovery management solutions target three pillars in data protection – application-aware protection, disk-based recoverability and enhanced manageability – enabling customers to recover the right data, at the right time, easily and reliably.
We intend to continue to enhance our storage software with additional features and capabilities.
Storage Services
Our services include EMC Consulting Services, Implementation and Integration, EMC Managed Services, EMC Customer Service and EMC Education Services, to help our customers plan, build and manage integrated IT infrastructures to more cost-effectively manage and protect their information throughout its lifecycle. We provide consulting, assessment, implementation, integration and operations management services, day-to-day support, maintenance, education and training to our customers. In 2006, EMC also introduced a managed services portfolio that enables customers to more cost-effectively manage their information infrastructure with help from dedicated, onsite EMC personnel. The EMC Managed Services portfolio helps customers improve storage operations and more efficiently meet demanding service levels associated with administering, protecting and storing information. In conjunction with our new EMC Infoscape software in 2006, EMC also introduced the EMC Information Management Strategy Service to help companies discover, classify and manage unstructured enterprise information.
Content Management and Archiving Segment
Our content management software, which includes the EMC Documentum family, helps customers optimize business processes and create, manage, deliver and archive information, ranging from documents and discussions to e-mail, Web pages, images, XML, reports, records, rich media and application data. Additionally, the EMC Captiva family of input management software provides for conversion, indexing and processing of paper-based information to digital formats.
In 2006, EMC modified its family of enterprise archiving software products to a single, unified archiving platform for collecting, retaining and securing all types of document images for compliance and legal discovery, content re-use, improved decision-making and operational efficiency. These include EMC Documentum Archive Services for Email, EMC Documentum Archive Services for Reports, EMC Documentum Archive Services for Imaging, EMC Documentum OEM Edition, EMC Documentum Information Rights Management (“IRM”) Services, EMC Documentum Records Manager 5.3, EMC Documentum Page Builder web content management (“WCM”) and new versions of the EMC Captiva document capture software.
Additionally, in 2006 EMC introduced the EMC e-Discovery Solution. This services-led, integrated offering consists of EMC information and content management software, networked storage and professional services designed to help customers of all sizes better manage the legal discovery process.
We intend to continue to enhance our products and services in this segment with additional features and capabilities and to introduce new software products and services.
RSA Information Security Segment
In September 2006, EMC acquired RSA and Network Intelligence. These two organizations, combined with our organic development initiatives, form the foundation of EMC’s new RSA information security segment.
RSA adds industry-leading enterprise identity and access management products, consumer identity and fraud protection solutions, encryption and key management software and security knowledge and expertise to EMC’s expanding, information-centric security product and service portfolio. Network Intelligence advances EMC’s information-centric security strategy by
providing tools that enable companies to collect, monitor, analyze and report on security event-related activity throughout the IT infrastructure – in the network, in enterprise applications, on mainframes, on desktops, in storage devices or elsewhere. Solutions from Network Intelligence ease the burden of proving compliance with security policies and regulations.
In 2006, RSA introduced its RSA Key Manager software, which enables businesses to effectively manage the lifecycle of encryption keys. The solution also helps companies comply with the key lifecycle management guidelines of the Payment Card Industry (“PCI”) Data Security Standard, a global initiative of leading payment card companies which strives to protect consumers’ transaction data.
We intend to continue to enhance RSA’s products and services with additional features and capabilities and to introduce new products and services.
VMware Virtual Infrastructure Segment
VMware, Inc. (“VMware”) is a subsidiary of EMC. Its virtual infrastructure solutions and services are used by more than 20,000 enterprises for server consolidation and containment, disaster recovery and business continuity, capacity planning and development, enterprise desktop hosting, test optimization and software distribution. By helping customers virtualize their enterprises, VMware enables them to build a more flexible and highly available IT infrastructure.
VMware virtual infrastructure simplifies IT so companies better leverage their storage, network and computing resources to control costs and increase response time. The VMware virtual infrastructure approach to IT management creates virtual resources from the physical IT infrastructure, enabling administrators to allocate these virtual resources quickly to the business units that need them most.
In 2006, VMware introduced Infrastructure 3, the third generation of its virtualization software. VMware Infrastructure 3 delivers an unprecedented ability to automate maximum power savings, guaranteed response times and newly added capacity and consolidated backup.
In 2006, VMware also launched Virtual Desktop Infrastructure, a solution that moves desktop management to a centralized server and secures its data there; shipped VMware Lab Manager, which enables enterprise software development organizations to more efficiently utilize software development and test lab assets, accelerate software development cycles and increase the quality of delivered software products; introduced VMware Converter 3, the next generation of its conversion tool that enables fast and reliable Physical-to-Virtual and Virtual-to-Virtual conversions through a simple and centralized management product; expanded its customer base with the release of VMware Server, the free, feature-packed hosted virtualization product that provides companies a first step to enterprise-wide infrastructure virtualization and offers the option to purchase enterprise-class VMware support; and launched the Virtual Appliance Marketplace.
VMware intends to continue to enhance its products and services with additional features and capabilities and to introduce new software products and services.
In 2007, we announced our intention to sell approximately 10% of VMware via an initial public offering of newly-issued VMware stock. We will retain ownership in the remaining shares of VMware.
Markets and Distribution Channels
Markets
We focus on providing information storage, content management and archiving, security and virtualization to support customers’ information infrastructures and their ILM strategies. We target organizations of all sizes.
Distribution Channels
We market our products through direct sales and through multiple distribution channels. We have a direct sales presence throughout North America, Latin America, Europe, the Middle East, South Africa and the Asia Pacific region. We also have agreements in place with many distributors, systems integrators, resellers and OEMs. These agreements, subject to certain terms and conditions, enable these companies to market and resell certain EMC systems and software. In 2006, we expanded our distribution capabilities through both new and enhanced partner and channel relationships. VMware generally distributes its products and services through its own distribution channels that include distributors, systems integrators, resellers and OEM hardware vendors. In 2006, EMC and Dell, Inc. (“Dell”) announced an extension of a strategic alliance enabling Dell to offer EMC technology through 2011. Also, EMC formed an OEM and technology relationship with Intel Corporation (“Intel”), enabling Intel to offer certain EMC storage systems under the Intel brand name. In addition, EMC and NEC Corporation announced an expansion of their strategic business and technology alliance in 2006.
Technology Alliances
We have technology alliances with leading software, networking and services companies. We intend to continue to form additional alliances. Our strategy is to work closely with these and other companies to provide added value to our customers by integrating our solutions with software and networking applications that customers rely on to manage their day-to-day business operations. In 2006, EMC expanded its major alliances with Microsoft Corporation and Oracle Corporation.
Manufacturing and Quality
Our products are assembled and tested primarily at our facilities in the United States and Ireland or at global manufacturing service suppliers. See Item 2 “Properties.” We work closely with our suppliers to design, assemble and test product components in accordance with production standards and quality controls established by us. Our software products are designed, developed and tested primarily at our facilities in the United States and abroad. The products are tested to meet quality standards established by us.
We have implemented a formal, documented quality management system to ensure that our products and services satisfy customer needs and expectations and to provide the framework for continual improvement of our processes and products. This system is certified to the ISO 9001 International Standard. Several additional ISO 9001 certifications are maintained for sales and service operations worldwide. We have also implemented Six Sigma, Lean Manufacturing and other quality methodologies to ensure that the quality of our designs, manufacturing, test processes and supplier relationships are continually improved. Our storage systems manufacturing and test facilities in Massachusetts, North Carolina and Ireland are certified to the ISO 14001 International Standard for environmental management systems. We also maintain Support Center Practices (“SCP”) certification for our primary customer support centers. These internationally recognized endorsements of ongoing quality and environmental management are among the highest levels of certifications available.
Raw Materials
We purchase many sophisticated components and products from one or a limited number of qualified suppliers, including some of our competitors. Our products utilize industry-standard and semi-custom components and subsystems. Among the most important components that we use are disk drives, high density memory components, microcontrollers and power supplies. While such components are generally available, we 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.
Research and Development
We continually enhance our existing products and develop new products to meet changing customer requirements. In 2006, 2005 and 2004, our research and development (“R&D”) expenses totaled $1,254.2 million, $1,004.8 million, and $847.9 million, respectively. We support our R&D efforts through state-of-the-art development labs worldwide.
Backlog
We produce our products on the basis of our forecast of near-term demand and maintain inventory in advance of receipt of firm orders from customers. We configure to customer specifications and generally deliver products shortly after receipt of the order. Service engagements are also included in certain orders. Customers may reschedule or cancel orders with little or no penalty. We believe that our backlog at any particular time is not meaningful because it is not necessarily indicative of future sales levels.
Competition
We compete with many companies in the markets we serve, including companies that offer a broad spectrum of IT products and services and others that offer specific information storage, content management, security or server virtualization products or services. We believe that most of these companies compete based on their market presence, products, service or price. Some of these companies also compete by offering information storage, content management or virtualization-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.
We believe that we have a number of competitive advantages over these companies, including product, distribution and service. We believe the advantages in our products include quality, breadth of offerings, performance, functionality, scalability, availability, interoperability, connectivity, time-to-market enhancements and total value of ownership. We believe our advantages in distribution include the world’s largest information infrastructure-focused direct sales force and a broad network of channel partners. We believe our advantages in service include our ability to provide our customers with a full range of expertise before, during and after their purchase of solutions from us or other vendors.
Seasonality
We generally experience the lowest demand for our products and services in the first quarter of the year and the greatest demand for our products and services in the last quarter of the year.
Intellectual Property
We generally rely on patent, copyright, trademark and trade secret laws and contract rights to establish and maintain our proprietary rights in our technology and products. While our intellectual property rights are important to our success, we believe that our business as a whole is not materially dependent on any particular patent, trademark, license or other intellectual property right.
We have been granted or own by assignment approximately 1,390 patents issued by, and have more than approximately 1,500 patent applications pending with, the U.S. Patent and Trademark Office, as well as a corresponding number of international patents and patent applications. While the duration of our patents varies, we believe that the duration of our patents is adequate relative to the expected lives of our products.
We have used, registered or applied to register certain trademarks and copyrights in the United States and in other countries. We also license certain technology from third parties for use in our products and processes and license some of our technologies to third parties.
Employees
As of December 31, 2006, we had approximately 31,100 employees worldwide. None of our domestic employees is represented by a labor union, and we have never suffered an interruption of business as a result of a labor dispute. We consider our relations with our employees to be good.
Financial Information About Segments, Foreign and Domestic Operations and Export Sales
We operate in four business segments: Information storage, Content management and archiving, RSA information security and VMware virtual infrastructure. Sales and marketing operations outside the United States are conducted through sales subsidiaries and branches located principally in Europe, Latin America and the Asia Pacific region. We have five manufacturing facilities: two in Massachusetts, which manufacture storage products and security products for the North American markets; two in Ireland, which manufacture storage products and security products for markets outside of North America; and one in North Carolina, which manufactures storage products for worldwide markets. See Note Q to the Consolidated Financial Statements for information about revenues by segment and geographic area.
Available Information
Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are made available free of charge on or through our website at www.emc.com as soon as reasonably practicable after such reports are filed with, or furnished to, the Securities and Exchange Commission (the “SEC”). Copies of our (i) Corporate Governance Guidelines, (ii) charters for the Audit Committee, Compensation Committee, Corporate Governance and Nominating Committee, Mergers and Acquisitions Committee and Finance Committee and (iii) Business Conduct Guidelines (code of business conduct and ethics) are available at www.emc.com/about/governance. Copies will be provided to any shareholder upon request. Please go to www.emc.com/ir to submit an electronic request, or send a written request to EMC Investor Relations, 176 South Street, Hopkinton, MA 01748. None of the information posted on our website is incorporated by reference into this Annual Report.
CEO Certification
An annual CEO Certification was submitted by our CEO to the New York Stock Exchange (the “NYSE”) on May 26, 2006 in accordance with the NYSE’s listing standards.
This Annual Report on Form 10-K 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 Annual Report.
The risk factors that appear below could materially affect our business, financial condition and results of operations. The risks and uncertainties described below are not the only risks and uncertainties facing us. Our business is also subject to general risks and uncertainties that affect many other companies.
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.
Competitive pricing, sales volume, mix and component costs 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. 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 information infrastructure 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 and service prices, and reductions in product and service 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 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:
| • | the effect of the acquisition on our financial and strategic position and reputation |
| • | the failure of an acquired business to further our strategies |
| • | the failure of the acquisition to result in expected benefits, which may include benefits relating to enhanced revenues, technology, human resources, cost savings, operating efficiencies and other synergies |
| • | the difficulty and cost of integrating the acquired business, including costs and delays in implementing common systems and procedures and costs and delays caused by communication difficulties or geographic distances between the two companies’ sites |
| • | the assumption of liabilities of the acquired business, including litigation-related liability |
| • | the potential impairment of acquired assets |
| • | the lack of experience in new markets, products or technologies or the initial dependence on unfamiliar supply or distribution partners |
| • | the diversion of our management’s attention from other business concerns |
| • | the impairment of relationships with customers or suppliers of the acquired business or our customers or suppliers |
| • | the potential loss of key employees of the acquired company |
| • | the potential incompatibility of business cultures |
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.
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 virtualization, infrastructure management, information security and operating system technologies which could require us to modify existing products. Risks inherent in the transition to new products include:
| • | the difficulty in forecasting customer preferences or demand accurately |
| • | the inability to expand production capacity to meet demand for new products |
| • | the impact of customers’ demand for new products on the products being replaced, thereby causing a decline in sales of existing products and an excessive, obsolete supply of inventory |
| • | delays in initial shipments of new products |
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.
We may have difficulty managing operations.
Our future operating results will depend on our overall ability to manage operations, which includes, among other things:
| • | retaining and hiring, as required, the appropriate number of qualified employees |
| • | managing, protecting and enhancing, as appropriate, our infrastructure, including but not limited to, our information systems and internal controls |
| • | accurately forecasting revenues |
| • | training our sales force to sell more software and services |
| • | successfully integrating new acquisitions |
| • | managing inventory levels, including minimizing excess and obsolete inventory, while maintaining sufficient inventory to meet customer demands |
| • | controlling expenses |
| • | managing our manufacturing capacity, real estate facilities and other assets |
| • | executing on our plans |
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 are required to treat stock-based compensation as an expense. 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.
Changes in generally accepted accounting principles may adversely affect us.
From time to time, the Financial Accounting Standards Board (“FASB”) promulgates new accounting principles that are applicable to us. In the first quarter of 2006, we adopted Financial Accounting Standard (“FAS”) FAS No. 123R “Share-based Payment” (“FAS No. 123R”). This standard requires us to expense the fair value of stock options issued to employees in our basic financial statements. This has adversely affected our results of operations. The FASB has proposed or promulgated other standards, including modifying the accounting for income taxes, accounting for business combinations and fair value measurements. These proposed and new standards or other proposals could have a material adverse impact on our results of operations or financial condition.
The Financial Accounting Standards Board’s Emerging Issues Task Force (the “Task Force”) has on its agenda a plan to review the accounting for convertible debt instruments that require or permit partial cash settlement upon conversion. The Task Force has proposed to discuss whether the current accounting treatment should be retained or if it should be modified to require the debt portion to be recorded at the fair market value of a similar liability. If the Task Force concludes that the accounting should be modified, this would result in incremental interest expense being recognized on our convertible debt instrument over the life of the debt, negatively impacting our diluted earnings per share.
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:
| • | the relative dollar amount of our product and services offerings in relation to many of our customers’ budgets, resulting in long lead times for customers’ budgetary approval, which tends to be given late in a quarter |
| • | the tendency of customers to wait until late in a quarter to commit to purchase in the hope of obtaining more favorable pricing from one or more competitors seeking their business |
| • | the fourth quarter influence of customers’ spending their remaining capital budget authorization prior to new budget constraints in the first six months of the following year |
| • | seasonal influences |
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:
| • | we assemble our products on the basis of our forecast of near-term demand and maintain inventory in advance of receipt of firm orders from customers |
| • | we generally ship products shortly after receipt of the order |
| • | customers may reschedule or cancel orders with little or no penalty |
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. For 2006, Dell Inc., one of our channel partners, accounted for 14.5%
of our revenues. 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, if the financial condition of our channel partners were to weaken, if our channel partners are not able to timely and effectively implement their planned actions or if the level of demand for our channel partners’ products and services decreases. In addition, as our market opportunities change, we may have an increased 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.
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.
There are risks associated with our previously-announced proposed initial public offering of VMware.
We announced that we intend to sell approximately 10% of our wholly-owned subsidiary, VMware, via an initial public offering (an “IPO”). We may not complete the IPO, in which event we will have incurred significant expenses which we will be unable to recover, and for which we will not receive any benefit. Additionally, our strategic objectives for the IPO, including improving visibility into VMware’s performance and growth relative to the market and strengthening VMware employee retention and recruitment, are based on the completion of the IPO. If we do not complete the IPO, we will need to pursue alternative means of accomplishing these strategic objectives.
If the IPO is completed, VMware would be a new public company. We are unable to predict what the market price of our common stock would be after the IPO. We cannot assure you that the IPO, if completed, will produce any increase for our shareholders in the market value of their holdings in our company. In addition, the market price of our common stock could be volatile for several months after the IPO and may continue to be more volatile than our common stock would have been if a transaction had not occurred.
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 may have a material adverse impact on us. Under applicable federal securities laws, including the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine the effectiveness of our internal control structure and procedures for financial reporting. 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.
Our stock price is volatile.
Our stock price, like that of other technology companies, is subject to significant volatility because of factors such as:
| • | the announcement of acquisitions, new products, services or technological innovations by us or our competitors |
| • | quarterly variations in our operating results |
| • | changes in revenue or earnings estimates by the investment community |
| • | speculation in the press or investment community |
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.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
