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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the quarterly period ended March 28, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-5296
DIGITAL EQUIPMENT CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts 04-2226590
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
111 Powdermill Road, Maynard, Massachusetts 01754
(Address of principal executive offices) (Zip Code)
(978) 493-5111
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO.
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date. Number of shares of Common
Stock, par value $1, outstanding as of March 28, 1998: 147,429,061.
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DIGITAL EQUIPMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands except per share data)
Three-Month Period Ended
-----------------------------
March 28, March 29,
1998 1997
---------- ----------
REVENUES
Product sales .................................... $1,681,618 $1,836,516
Service revenues ................................. 1,509,392 1,477,794
---------- ----------
TOTAL OPERATING REVENUES ......................... 3,191,010 3,314,310
---------- ----------
COSTS AND EXPENSES
Cost of product sales ............................ 1,094,646 1,188,578
Service expense .................................. 1,022,201 1,019,290
Research and engineering expenses ................ 261,274 256,476
Selling, general and administrative expenses ..... 738,400 798,714
Costs attributable to the sale of assets ......... 33,000 --
---------- ----------
Operating income ................................. 41,489 51,252
Other (income)/expense, net ...................... (337,791) (10,848)
---------- ----------
INCOME BEFORE INCOME TAXES ....................... 379,280 62,100
Provision for income taxes ....................... 37,457 11,134
---------- ----------
NET INCOME ....................................... 341,823 50,966
Dividend on preferred stock ...................... 8,875 8,875
---------- ----------
NET INCOME APPLICABLE TO COMMON STOCK ............ $ 332,948 $ 42,091
========== ==========
NET INCOME APPLICABLE PER COMMON SHARE (1):
BASIC EARNINGS PER SHARE ......................... $ 2.27 $ 0.27
========== ==========
DILUTED EARNINGS PER SHARE ....................... $ 2.23 $ 0.27
========== ==========
(1) Refer to page 8 of this report and Note E.
Cash dividends on common stock have never been paid by the Corporation.
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands except per share data)
Nine-Month Period Ended
--------------------------
March 28, March 29,
1998 1997
---------- ----------
REVENUES
Product sales .............................................. $5,080,232 $5,202,959
Service revenues ........................................... 4,395,566 4,380,739
---------- ----------
TOTAL OPERATING REVENUES ................................... 9,475,798 9,583,698
---------- ----------
COSTS AND EXPENSES
Cost of product sales ...................................... 3,247,158 3,445,203
Service expense ............................................ 3,002,895 3,016,261
Research and engineering expenses .......................... 798,760 763,961
Selling, general and administrative expenses ............... 2,262,562 2,348,297
Costs attributable to the sale of assets ................... 33,000 --
---------- ----------
Operating income ........................................... 131,423 9,976
Other (income)/expense, net ................................ (364,691) (27,465)
---------- ----------
INCOME BEFORE INCOME TAXES ................................. 496,114 37,441
Provision for income taxes ................................. 54,400 20,475
---------- ----------
NET INCOME ................................................. 441,714 16,966
Dividends on preferred stock ............................... 26,625 26,625
---------- ----------
NET INCOME/(LOSS) APPLICABLE TO COMMON STOCK ............... $ 415,089 $ (9,659)
========== ==========
NET INCOME/(LOSS) APPLICABLE PER COMMON SHARE (1):
BASIC EARNINGS/(LOSS) PER SHARE ............................ $ 2.81 $ (0.06)
========== ==========
DILUTED EARNINGS/(LOSS) PER SHARE .......................... $ 2.77 $ (0.06)
========== ==========
(1) Refer to page 9 of this report and Note E.
Cash dividends on common stock have never been paid by the Corporation.
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
March 28, June 28,
1998 1997
---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ............................. $1,498,035 $1,358,750
Short-term investments ................................ 918,855 1,160,265
Accounts receivable, net of allowances
of $213,281 and $263,763 .............................. 2,704,976 2,930,014
Inventories:
Raw materials ......................................... 297,976 421,984
Work-in-process ....................................... 245,074 350,421
Finished goods ........................................ 644,785 730,740
---------- ----------
Total inventories ..................................... 1,187,835 1,503,145
Prepaid expenses, deferred income taxes
and other current assets .............................. 653,417 324,122
---------- ----------
TOTAL CURRENT ASSETS .................................. 6,963,118 7,276,296
---------- ----------
Property, plant and equipment, at cost ................ 3,707,327 4,868,548
Less accumulated depreciation ......................... 2,235,425 2,764,901
---------- ----------
Net property, plant and equipment ..................... 1,471,902 2,103,647
Assets held for resale ................................ 640,000 --
Other assets .......................................... 282,236 312,951
---------- ----------
TOTAL ASSETS .......................................... $9,357,256 $9,692,894
========== ==========
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
CONSOLIDATED BALANCE SHEETS (continued)
(Dollars in thousands)
March 28, June 28,
1998 1997
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Bank loans and current portion of long-term debt ............ $ 28,823 $ 262,835
Accounts payable ............................................ 786,005 871,760
Income taxes payable ........................................ 153,533 101,286
Salaries, wages and related items ........................... 696,391 637,587
Deferred revenues and customer advances ..................... 1,022,252 1,079,003
Accrued restructuring costs ................................. 217,491 382,559
Other current liabilities ................................... 821,492 905,900
---------- ----------
TOTAL CURRENT LIABILITIES ................................... 3,725,987 4,240,930
---------- ----------
Long-term debt .............................................. 741,150 743,440
Postretirement and other postemployment benefits ............ 1,137,368 1,163,568
---------- ----------
TOTAL LIABILITIES ........................................... 5,604,505 6,147,938
---------- ----------
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value (liquidation preference
of $100.00 per share); authorized 25,000,000 shares;
4,000,000 shares of Series A 8-7/8% Cumulative
Preferred Stock issued and outstanding ...................... 4,000 4,000
Common stock, $1.00 par value; authorized
450,000,000 shares; 157,201,693 and
157,232,104 shares issued ................................... 157,202 157,232
Additional paid-in capital .................................. 3,842,957 3,835,697
Retained earnings/(deficit) ................................. 138,485 (234,841)
Treasury stock at cost; 9,772,632 shares
and 6,132,201 shares ........................................ (389,893) (217,132)
---------- ----------
TOTAL STOCKHOLDERS' EQUITY .................................. 3,752,751 3,544,956
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................. $9,357,256 $9,692,894
========== ==========
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Nine-Month Period Ended
-----------------------------
March 28, March 29,
1998 1997
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ..................................................... $ 441,714 $ 16,966
Adjustments to reconcile net income to
net cash from operating activities:
Depreciation ................................................... 289,818 303,327
Amortization ................................................... 36,132 41,252
(Gain)/loss on disposition and write-downs of
other assets ................................................... (338,645) 34,248
Other adjustments to net income ................................ 554,069 53,051
Decrease in accounts receivable ................................ 231,438 337,129
Decrease in inventories ........................................ 263,175 347,421
(Increase)/decrease in prepaid expenses and other
current assets ................................................. (37,144) 7,672
Increase in assets held for resale (640,000) --
Decrease in accounts payable ................................... (85,755) (93,562)
Increase in taxes .............................................. 60,056 9,822
Increase/(decrease) in salaries, wages, benefits
and related items .............................................. 32,604 (9,205)
Decrease in deferred revenues and
customer advances .............................................. (56,751) (42,382)
Decrease in accrued restructuring costs ........................ (165,068) (176,186)
Decrease in other current liabilities .......................... (67,964) (25,283)
----------- -----------
Total adjustments .............................................. 75,965 787,304
----------- -----------
Net cash flows from operating activities ....................... 517,679 804,270
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in property, plant and equipment .................... (340,733) (275,056)
Proceeds from the disposition of
property, plant and equipment .................................. 65,341 67,600
Purchases of short-term investments ............................ (1,646,963) (2,806,784)
Maturities of short-term investments ........................... 1,888,373 1,745,054
Investments in other assets .................................... (31,425) (4,518)
Proceeds from the disposition of other assets .................. 165,625 14,067
----------- -----------
Net cash flows from investing activities ....................... 100,218 (1,259,637)
----------- -----------
Net cash flows from operating and
investing activities ........................................... 617,897 (455,367)
----------- -----------
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
Nine-Month Period Ended
----------------------------
March 28, March 29,
1998 1997
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of debt ................... 31,089 6,240
Payments to retire debt .............................. (268,018) (10,713)
Purchase of treasury shares .......................... (326,758) (214,546)
Issuance of common and treasury shares, including
tax effects .......................................... 111,700 81,831
Dividends on preferred stock ......................... (26,625) (26,625)
---------- ----------
Net cash flows from financing activities ............. (478,612) (163,813)
---------- ----------
Net increase/(decrease) in cash
and cash equivalents ................................. 139,285 (619,180)
Cash and cash equivalents at the
beginning of the year ................................ 1,358,750 1,791,754
---------- ----------
Cash and cash equivalents at end of period ........... $1,498,035 $1,172,574
========== ==========
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
COMPUTATION OF NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
(Dollars in thousands except per share data)
Three-Month Period Ended
------------------------------
March 28, March 29,
1998 1997
------------ ------------
Net income ....................................................... $ 341,823 $ 50,966
Less: Dividend on preferred stock ................................ 8,875 8,875
------------ ------------
Net income applicable to common stock ............................ $ 332,948 $ 42,091
============ ============
Weighted average number of common shares
outstanding during the period .................................... 146,928,739 154,282,203
Effect of common equivalent shares from application
of "treasury stock" method to unexercised
and outstanding stock options .................................... 2,469,137 1,017,100
------------ ------------
Total weighted average number of common
and common equivalent shares outstanding
during the period ................................................ 149,397,876 155,299,303
============ ============
Net income applicable per common share (1):
Basic earnings per share ......................................... $ 2.27 $ 0.27
============ ============
Diluted earnings per share ....................................... $ 2.23 $ 0.27
============ ============
(1) Basic earnings per share is based on the weighted average number of common
shares outstanding during the period. Diluted earnings per share is based on the
weighted average number of common and common equivalent shares outstanding
during periods of net income.
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
COMPUTATION OF NET INCOME/(LOSS) PER COMMON AND COMMON EQUIVALENT SHARE
(Dollars in thousands except per share data)
Nine-Month Period Ended
-------------------------------
March 28, March 29,
1998 1997
------------ -------------
Net income ....................................................... $ 441,714 $ 16,966
Less: Dividends on preferred stock ............................... 26,625 26,625
============ =============
Net income /(loss) applicable to common stock .................... $ 415,089 $ (9,659)
------------ -------------
Weighted average number of common shares
outstanding during the period .................................... 147,574,003 154,598,774
Effect of common equivalent shares from application
of "treasury stock" method to unexercised
and outstanding stock options .................................... 2,043,116 --
------------ -------------
Total weighted average number of common
and common equivalent shares outstanding
during the period ................................................ 149,617,119 154,598,774
============ =============
Net income/(loss) applicable per common share (1):
Basic earnings/(loss) per share .................................. $ 2.81 $ (0.06)
============ =============
Diluted earnings/(loss) per share ................................ $ 2.77 $ (0.06)
============ =============
(1) Basic earnings per share is based on the weighted average number of common
shares outstanding during the period. Diluted earnings per share is based on the
weighted average number of common and common equivalent shares outstanding
during periods of net income. Diluted loss per share is based only on the
weighted average number of common shares outstanding during the period.
The accompanying notes are an integral part of these financial statements.
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DIGITAL EQUIPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A - Significant Accounting Policies
Principles of consolidation: The accompanying unaudited financial statements as
of and for the three-month and nine-month periods ended March 28, 1998 and March
29, 1997 have been prepared on substantially the same basis as the annual
consolidated financial statements, reflecting all adjustments of a normal
recurring nature. In the opinion of management, the financial statements reflect
all adjustments necessary for a fair presentation of the results for those
periods and the financial condition at those dates.
Certain prior year's amounts have been reclassified to conform with the current
year presentation.
Other (income)/expense, net Nine-Month Period Ended Three-Month Period Ended
- ---------------------------------------------------------------------------------------------------
(in thousands) March 28, March 29, March 28, March 29,
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------
Interest income $ (84,689) $(82,706) $ (25,341) $(30,207)
Interest expense 58,643 64,311 17,387 21,542
Net (gain)/loss on divestments (338,645) (9,070) (329,837) (2,183)
- ---------------------------------------------------------------------------------------------------
Other (income)/expense, net $(364,691) $(27,465) $(337,791) $(10,848)
- ---------------------------------------------------------------------------------------------------
Note B - Restructuring Actions
During the first nine months of fiscal 1998, the Corporation incurred costs of
$61 million for approximately 915 employee separations and for separation
actions taken at the end of fiscal 1997. In addition, the Corporation incurred
costs of $104 million for facilities closures and other related actions. Cash
expenditures for restructuring activities were $116 million for the first nine
months of fiscal 1998.
Note C - Litigation
Several purported class action lawsuits were filed against the Corporation
during the fourth quarter of fiscal 1994 alleging violations of the Federal
securities laws arising from alleged misrepresentations and omissions in
connection with the Corporation's issuance and sale of Series A 8-7/8%
Cumulative Preferred Stock and the Corporation's financial results for the
quarter ended April 2, 1994. During fiscal 1995, the lawsuits were consolidated
into three cases, which were pending before the United States District Court for
the District of Massachusetts. On August 8, 1995, the Massachusetts federal
court granted the defendants' motion to dismiss all three cases in their
entirety. On May 7, 1996, the United States Court of Appeals for the First
Circuit affirmed in part and reversed in part the dismissal of the two cases,
and remanded for further proceedings.
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The Corporation and Intel Corporation ("Intel") have been involved in litigation
commenced in the fourth quarter of fiscal 1997 in the U.S. District Courts for
the Districts of Massachusetts and Northern California, and in September 1997 in
the U.S. District Court for the District of Oregon claiming, respectively,
willful infringement by Intel of certain of the Corporation's patents through
the manufacture, sale and use of Intel's families of Pentium microprocessors,
breach of contract and various other unfair or unlawful business practices by
the Corporation, and willful infringement by the Corporation of certain of
Intel's patents through the manufacture, sale and use of various computer
products. On October 27, 1997, the Corporation and Intel announced that they had
reached agreement to settle the pending litigation between the parties and to
request a stay of all pending litigation, subject to receipt of government
approval necessary to finalize the transactions contemplated by the parties'
agreement. At the request of the parties, all proceedings have been stayed. On
April 23, 1998, the Federal Trade Commission ("FTC") notified the Corporation
and Intel that it will not seek to enjoin the settlement of the legal dispute
between the companies. As part of the FTC review process, the Corporation agreed
to a consent order that provides for the licensing of the Corporation's Alpha
technology to other semiconductor manufacturers. Accordingly, the Corporation
and Intel expect to complete the transactions contemplated by the agreement
prior to May 31, 1998 (see Note F).
Note D - Treasury Stock
During the first nine months of fiscal 1998, the Corporation purchased in the
open market 7.5 million shares of its common stock for an aggregate purchase
price of $327 million, or an average of $43.60 per common share. Approximately
3.9 million shares were issued under employee stock plans and the remaining
shares are held in treasury.
Note E - Statement of Financial Accounting Standard No. 128 - Earnings per Share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128 - Earnings per Share. SFAS No. 128
establishes standards for computing and presenting earnings per share (EPS) and
requires a dual presentation of basic and dilutive EPS. SFAS No. 128 is
effective for financial statements issued for periods ending after December 15,
1997 and earlier adoption is not permitted. The financial statements presented
have been prepared in accordance with SFAS 128 and prior periods amounts have
been restated to conform to current year presentation.
Note F - Agreement with Intel Corporation
On October 27, 1997, the Corporation and Intel announced that they had reached
an agreement to establish a broad-based business relationship, including the
sale of the Corporation's semiconductor manufacturing operations to Intel for a
purchase price equal to the net book value of the transferred assets (currently
estimated to be approximately $640 million), cross-licensing of patents, supply
of both Intel and Alpha microprocessors
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and development of future systems based on Intel's 64-bit microprocessors. The
agreement provides that Intel will make offers of employment to employees of the
Corporation's semiconductor manufacturing operations, except for those employees
associated with the Alpha and Alpha-related semiconductor design teams.
Approximately 1,800 employees are expected to transfer to Intel. The Corporation
and Intel expect to complete the transactions contemplated by the agreement
prior to May 31, 1998 (see Note C).
Note G - Agreement with Cabletron Systems, Inc.
The Corporation and Cabletron Systems, Inc. ("Cabletron Systems") entered into
an asset purchase agreement on November 24, 1997, and consummated the
transaction on February 7, 1998. The Corporation received net proceeds of
approximately $416 million and realized a gain of $316 million related to this
transaction. The proceeds reflect $133 million of cash and product credits of
$301 million before reduction for imputed interest and other adjustments
totaling $18 million. The Corporation is confident the credits are fully
realizable and any loss thereof is remote. Other costs associated with the sale
have been reflected in two lines in the Statement of Operations, as described
below.
Costs attributable to the sale of assets consist of (in millions):
Write-off of surplus raw material inventory $12
Severance and other employee expenses 8
Supplier/vendor cancellation costs 6
Employee retention and pension expense 5
Litigation expense 2
---
Total $33
Other (income)/expense, net includes costs directly related to this sale of $5
million for professional services and $3 million for facilities restoration
costs.
Note H - Debt
During the quarter, the Corporation terminated its agreement with a major
financial institution (i) providing for the transfer and sale by the Corporation
to a wholly-owned subsidiary of the Corporation of a designated pool of domestic
trade accounts receivable (the "Receivables"), and (ii) allowing the Corporation
to sell to a group of investors an undivided ownership interest in the
Receivables for proceeds of up to $500 million. During the term of the
agreement, no interests in the Receivables had been sold.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
REVENUES
Total operating revenues for the first nine months of fiscal 1998 were $9.5
billion, down 1% from the comparable period a year ago. Total operating revenues
include product sales of $5.1 billion and service revenues of $4.4 billion.
Total operating revenues for the third quarter of fiscal 1998 were $3.2 billion,
down 4% from the comparable quarter last year. Total operating revenues include
product sales of $1.7 billion and service revenues of $1.5 billion.
Revenues (dollars in millions) Nine-Month Period Ended Three-Month Period Ended
- --------------------------------------------------------------------------------------
March 28, March 29, March 28, March 29,
1998 1997 1998 1997
- --------------------------------------------------------------------------------------
Product sales $5,080 $5,203 $1,682 $1,836
% of total revenues 54% 54% 53% 55%
- --------------------------------------------------------------------------------------
Service revenues $4,396 $4,381 $1,509 $1,478
% of total revenues 46% 46% 47% 45%
- --------------------------------------------------------------------------------------
Total revenues $9,476 $9,584 $3,191 $3,314
- --------------------------------------------------------------------------------------
Product sales for the first nine months and third quarter of fiscal 1998 were
down 2% and 8%, respectively, from the comparable periods last year. Product
sales for the first nine months and third quarter of fiscal 1998 reflect a
decrease in revenues from the sales of certain client and component products,
partially offset by increased revenues from the sale of server (Intel and
Alpha-based) and storage products.
Revenues from the sale of servers represented 37% and 39% of product sales for
the first nine months and third quarter of fiscal 1998, respectively, up from
34% and 33% for the comparable periods last year. Client sales represented 29%
and 31% of product sales for the first nine months and third quarter of fiscal
1998, respectively, compared to 30% and 29% for the same periods in fiscal 1997.
Revenues from the Corporation's components and other products represented 34%
and 30% of product sales for the first nine months and third quarter of fiscal
1998, respectively, compared to 36% and 38% of product sales for the same
periods last year.
Service revenues for the first nine months and third quarter of fiscal 1998 were
$4.4 billion and $1.5 billion, respectively, essentially unchanged from the
first nine months and up 2% from the third quarter of fiscal 1997. Service
revenues reflect growth in network and integration services, multivendor
services, and client/server outsourcing services, offset by an anticipated
decrease in revenues from Digital products maintenance services.
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Operating revenues from customers outside of the United States were $6.2 billion
and $2.1 billion for the first nine months and third quarter of fiscal 1998,
respectively, in each case representing 65% of total operating revenues,
compared to $6.5 billion and $2.3 billion for the first nine months and third
quarter of fiscal 1997, or 68% and 69% of total operating revenues,
respectively. The Corporation's operating results for the first nine months and
third quarter of fiscal 1998 were adversely impacted by the continued
strengthening of the U.S. dollar. Removing the effects of foreign currency
exchange rate movements, the increase in total operating revenues would have
been 5% and 3% for the first nine months and third quarter of fiscal 1998,
respectively, when compared to the same periods last year.
EXPENSES AND PROFIT MARGINS
Gross margin (dollars in millions) Nine-Month Period Ended Three-Month Period Ended
- ------------------------------------------------------------------------------------------------
March 28, March 29, March 28, March 29,
1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------
Product sales gross margin $1,833 $1,758 $587 $648
% of related revenues 36% 34% 35% 35%
- ------------------------------------------------------------------------------------------------
Service revenues gross margin $1,393 $1,364 $487 $459
% of related revenues 32% 31% 32% 31%
- ------------------------------------------------------------------------------------------------
Product gross margin was 36% and 35% of product sales for the first nine months
and third quarter of fiscal 1998, respectively, compared to 34% and 35% for the
same periods a year ago. The improvement in product gross margin for the first
nine months was due principally to manufacturing cost efficiencies and an
increased proportion of higher-margin server revenues, and in the third quarter,
offset by a $21 million increase in cost of product sales related to the
repurchase of inventory from Cabletron Systems, Inc. (see discussion below and
Note G).
Service gross margin was 32% of service revenues for the first nine months and
third quarter of fiscal 1998, compared to 31% for the first nine months and
third quarter of fiscal 1997. Service gross margin reflects the continued focus
on more profitable systems integration contracts, as well as the implementation
of gross margin improvement programs, offset by the continued shift in the mix
of service revenues toward lower-margin service offerings.
Operating expenses (dollars in millions) Nine-Month Period Ended Three-Month Period Ended
- ------------------------------------------------------------------------------------------------
March 28, March 29, March 28, March 29,
1998 1997 1998 1997
- ------------------------------------------------------------------------------------------------
Research and engineering $ 799 $ 764 $261 $256
% of total revenues 8% 8% 8% 8%
- ------------------------------------------------------------------------------------------------
Selling, general and administrative $2,263 $2,348 $738 $799
% of total revenues 24% 25% 23% 24%
- ------------------------------------------------------------------------------------------------
Costs attributable to the sale of assets $ 33 -- $ 33 --
% of total revenues N/M -- 1% --
- ------------------------------------------------------------------------------------------------
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Research and engineering (R&E) spending totaled $799 million and $261 million
for the first nine months and third quarter of fiscal 1998, respectively, up
from $764 million and $256 million for the same periods in fiscal 1997. The
Corporation believes that this level of R&E investment is appropriate for the
Corporation to continue to provide competitive products and services.
Selling, general and administrative (SG&A) expenses were $2.3 billion and $738
million for the first nine months and third quarter of fiscal 1998,
respectively, down 4% from the first nine months of fiscal 1997 and down 8%
compared to the third quarter of fiscal 1997. The decline in SG&A expenses
reflects the positive effects of currency rate movements and the Corporation's
continued focus on achieving a competitive cost structure through reductions in
population and facilities expenditures, partially offset by increases in
investment in demand generation activities and salaries and wages.
Costs attributable to the sale of assets are comprised of $33 million of costs
which are solely related to the sale of certain assets to Cabletron Systems,
Inc.(see Note G).
At the end of fiscal 1996, the Corporation approved a restructuring plan
intended to increase sales productivity, further consolidate manufacturing
plants and distribution sites, improve service delivery and further reduce
overhead in support areas. The number of involuntary separations is expected to
be lower than originally planned due principally to a higher than anticipated
level of voluntary separations. However, associated restructuring-related cost
savings are expected to be offset by an increase in estimated separation costs
for certain employees. The total estimated cost of restructuring actions is
unchanged (see Note B).
Total employee population decreased by 800 during the third quarter of fiscal
1998 to approximately 53,500, and by 1,600 from the end of the third quarter of
fiscal 1997.
Net other income was $365 million and $27 million for the first nine months of
fiscal 1998 and 1997, respectively. Net gains on divestments were $339 million
for the first nine months of fiscal 1998, compared to $9 million for the same
period a year ago. The increase in net other income is principally due to
increased gains on divestments, a reduction in interest expense and increased
interest income in the first nine months of fiscal 1998. Net other income was
$338 million and $11 million for the third quarter of fiscal 1998 and 1997,
respectively. The increase was principally due to net gains on divestments of
$330 million for the third quarter of fiscal 1998, compared to $2 million of net
gains on divestments for the same period a year ago. In the third quarter of
fiscal 1998 the Corporation recognized a $316 million gain related to the sale
of certain assets of its network products business to Cabletron Systems, Inc.
(see discussion below and Note G).
Income tax expense for the first nine months and third quarter of fiscal 1998
was $54 million and $37 million, respectively, compared to $20 million and $11
million for the same periods last year. Income tax expense reflects several
factors, including income taxes for profitable operations, benefits taken from
net operating loss carryforwards and an inability to recognize currently certain
tax benefits from operating losses.
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AVAILABILITY OF FUNDS TO SUPPORT CURRENT AND FUTURE OPERATIONS AND SPENDING FOR
OPERATIONS
Cash, cash equivalents and short-term investments totaled $2.4 billion at the
end of the third quarter of fiscal 1998, down from $2.5 billion at the end of
fiscal 1997.
Net cash generated from operating activities was $518 million for the first nine
months of fiscal 1998, reflecting a decrease in accounts receivable and
inventories from the end of fiscal 1997, offset by an increase in prepaid
expenses and a decrease in accounts payable and various other liabilities. Cash
expenditures for restructuring activities were $116 million for the first nine
months of fiscal 1998. Future cash expenditures for currently planned
restructuring activities are estimated to be $200 million for fiscal 1998 and
beyond.
Net cash from investing activities was $100 million in the first nine months of
fiscal 1998. The increase in cash from investing activities was due principally
to proceeds from the disposition of assets and maturities of short-term
investments. As investments mature, the proceeds are reinvested as cash, cash
equivalents or short-term investments, as conditions warrant.
Net cash used for financing activities was $479 million in the first nine months
of fiscal 1998. The principal financing activities were the Corporation's
purchase on the open market of 7.5 million shares of its common stock for $327
million and the retirement of $250 million of five-year notes.
During the quarter, the Corporation terminated its U.S. accounts receivable
securitization facility (see Note H).
On October 27, 1997, the Corporation and Intel Corporation ("Intel") announced
that they had reached an agreement to establish a broad-based business
relationship, including the sale of the Corporation's semiconductor
manufacturing operations to Intel for a purchase price equal to the net book
value of the transferred assets (currently estimated to be approximately $640
million), cross-licensing of patents, supply of both Intel and Alpha
microprocessors and development of future systems based on Intel's 64-bit
microprocessors. The agreement provides that Intel will make offers of
employment to employees of the Corporation's semiconductor manufacturing
operations, except for those employees associated with the Alpha and
Alpha-related semiconductor design teams. On April 23, 1998, the Federal Trade
Commission ("FTC") notified the Corporation and Intel that it will not seek to
enjoin the settlement of the legal dispute between the companies. Accordingly,
the parties expect to consummate the transactions contemplated by the settlement
agreement prior to May 31, 1998. Approximately 1,800 employees are expected to
transfer to Intel (see Notes C and F).
On November 24, 1997, the Corporation entered into an asset purchase agreement
with Cabletron Systems, Inc. ("Cabletron Systems") and Ctron Acquisition Co.,
Inc., a wholly-
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owned subsidiary of Cabletron Systems (collectively, "Cabletron"), pursuant to
which the Corporation agreed to sell certain assets of its network products
business to Cabletron. The agreement was first amended on December 8, 1997 and
again on February 7, 1998 to adjust the purchase price to approximately $133
million in cash and $301 million in product credits (to be applied to the
Corporation's future purchase of products from Cabletron Systems), before
reduction for imputed interest and other adjustments totaling $18 million. The
transaction was consummated as of February 7, 1998. The Corporation has
recognized a gain of $316 million related to this transaction in the third
quarter of fiscal 1998. Approximately 800 employees have been or will be
transferred to Cabletron Systems in connection with this transaction. The
Corporation and Cabletron Systems also entered into a Reseller and Services
Agreement ("Reseller Agreement") dated November 24, 1997, pursuant to which the
Corporation has agreed to resell certain Cabletron Systems' products (including
the products sold by the Corporation's network products business) and the
Corporation is designated a services provider for certain of Cabletron Systems'
products. Under the Reseller Agreement, the Corporation has committed to
purchase for resale and internal use network products from Cabletron Systems
during the term of the Reseller Agreement, which extends through June 30, 2001
(see Note G).
On January 26, 1998, the Corporation and Compaq Computer Corporation ("Compaq")
announced the completion of a definitive merger agreement. Upon consummation of
the merger, common stockholders of the Corporation will receive $30 in cash and
0.945 shares of Compaq common stock for each share of the Corporation's common
stock. Based on conditions at the time the merger agreement was signed,
approximately $4.4 billion of cash and 139 million shares of Compaq common stock
would be issued to the Corporation's common stockholders. Under the terms of the
agreement, the Corporation will become a wholly owned subsidiary of Compaq upon
completion of the merger. The Corporation has filed a Proxy Statement with
respect to the pending transaction, and a Special Meeting of Stockholders is
scheduled to be held on June 11, 1998 at which the holders of common stock of
the Corporation will vote upon the approval and adoption of the merger
agreement.
The Corporation's need for, cost of and access to funds are dependent on future
operating results, as well as conditions external to the Corporation. The
Corporation historically has maintained a conservative capital structure, and
believes that its cash position and its sources of and access to capital markets
are adequate to support current operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Corporation or statements made by
its employees may contain "forward-looking" information, as that term is defined
in the Private Securities Litigation Reform Act of 1995. The Corporation
cautions investors that there can be no assurance that actual results or
business conditions will not differ materially from those projected or suggested
in such forward-looking statements as a result of various factors, including but
not limited to the following:
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- -- The Corporation's future operating results are dependent on its ability to
develop, produce and market new and innovative products and services. There are
numerous risks inherent in this complex process, including rapid technological
change, the Corporation's ability to access components and related technical
information from other companies and the requirement that the Corporation bring
to market in a timely fashion new products and services which meet customers'
changing needs.
- -- Historically, the Corporation has generated a disproportionate amount of its
operating revenues toward the end of each quarter, making precise prediction of
revenues and earnings particularly difficult and resulting in risk of variance
of actual results from those forecast at any time. In addition, the
Corporation's operating results historically have varied from fiscal period to
fiscal period; accordingly, the Corporation's financial results in any
particular fiscal period are not necessarily indicative of results for future
periods.
- -- The Corporation offers a broad variety of products and services to customers
around the world. Changes in the mix of products and services comprising
revenues could cause actual operating results to vary from those expected.
- -- The Corporation's success is partly dependent on its ability to successfully
predict and adjust production capacity to meet demand, which is partly dependent
upon the ability of external suppliers to deliver components at reasonable
prices and in a timely manner; capacity or supply constraints, or unexpected
increases or decreases in the prices of components, could adversely affect
future operating results.
- --While the Corporation believes that the materials required for its
manufacturing operations are presently available in quantities sufficient to
meet demand, the failure of a significant supplier to deliver certain components
or technical information on a timely basis or in sufficient quantities could
adversely affect the Corporation's future results of operations.
- -- The Corporation operates in a highly competitive environment which includes
significant competitive pricing pressures and intense competition for skilled
employees. Particular business segments may from time to time experience
unanticipated intense competitive pressure, possibly causing operating results
to vary from those expected.
- --The Corporation offers its products and services directly and through indirect
distribution channels. Changes in the financial condition of, or the
Corporation's relationship with, distributors and other indirect channel
partners, as well as fluctuations in end-user sales by indirect sales channel
partners, could cause actual operating results to vary from those expected.
- -- The Corporation does business worldwide in over 100 countries. Global and/or
regional economic factors and potential changes in laws and regulations
affecting the Corporation's business, including without limitation, currency
fluctuations, changes in
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monetary policy and tariffs, and federal, state and international laws
regulating the environment, could impact the Corporation's financial condition
or future results of operations.
- -- Certain of the Corporation's internal computer systems are not Year 2000
ready (i.e., such systems use only two digits to represent the year in date data
fields and, consequently, may not accurately distinguish between the 20th and
21st centuries or may not function properly at the turn of the century). The
Corporation has been taking actions intended to either correct such systems or
replace them with Year 2000 ready systems. The Corporation expects to implement
successfully the systems and programming changes necessary to address Year 2000
issues and does not believe that the cost of such actions will have a material
effect on the Corporation's results of operations or financial condition. There
can be no assurance, however, that there will not be a delay in, or increased
costs associated with, the implementation of such changes, and the Corporation's
inability to implement such changes could have an adverse effect on future
results of operations.
- -- As the Corporation continues to implement its strategic plan and respond to
external market conditions, there can be no assurance that additional
restructuring actions will not be required. With regard to completion of planned
restructuring actions, there can be no assurance that the estimated cost of such
actions will not change.
- -- The market price of the Corporation's securities could be subject to
fluctuations in response to quarter to quarter variations in operating results,
changes in analysts' earnings estimates, market conditions in the information
technology industry, as well as general economic conditions and other factors
external to the Corporation.
- -- The Corporation and Compaq Computer Corporation have announced the completion
of a definitive merger agreement. This announcement could have an impact on the
Corporation's ability to market its products and services to its customers,
possibly causing operating results to vary from those expected.
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PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES.
On February 12, 1998, the Corporation filed a Current Report on Form 8-K
reporting that effective February 3, 1998, it had amended the Rights
Agreement dated as of December 11, 1989 between the Corporation and First
Chicago Trust Company of New York to render the Rights (as defined in the
Rights Agreement) related to the Corporation's common stock inapplicable to
the Agreement and Plan of Merger dated as of January 25, 1998 between the
Corporation and Compaq Computer Corporation and the transactions
contemplated thereby. The Corporation's amendment to the Rights Agreement
is incorporated by reference in this Form 10-Q as Exhibit 4 below.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
4. Amendment, dated as of February 3, 1998, to the Rights Agreement,
originally dated as of December 11, 1989, between Digital
Equipment Corporation and First Chicago Trust Company of New York
(filed as Exhibit 4 to the Corporation's Current Report on
Form 8-K filed on February 12, 1998 and incorporated herein by
reference).
10(a). Digital Equipment Corporation 1968 Employee Stock Purchase Plan,
as amended.
10(b). Digital Equipment Corporation 1981 International Employee Stock
Purchase Plan, as amended.
10(c). Retirement Arrangement for Non-Employee Directors, as amended.
10(d). Deferred Compensation Plan for Non-Employee Directors, as amended.
10(e). Deferred Compensation Plan for Executives, as amended.
10(f). Digital Equipment Corporation Key Employee Severance Plan,
effective as of March 19, 1998 (filed as Exhibit 10.1 to the
registrant's Current Report on Form 8-K filed on May 6, 1998 and
incorporated herein by reference).
10(g) Severance Agreement, dated as of March 19, 1998, by and between
Digital Equipment Corporation and Robert B. Palmer (filed as
Exhibit 10.2 to the
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Corporation's Current Report on Form 8-K filed on May 6, 1998 and
incorporated herein by reference).
10(h) Amended and Restated Agreement and Plan of Merger dated as of
January 25, 1998, among Compaq Computer Corporation, the
registrant and Compaq Merger, Inc. (filed as Exhibit 2 to the
Registration Statement on Form S-4/Proxy Statement of Compaq
Computer Corporation and the Corporation filed on May 6, 1998 and
incorporated herein by reference).
10(i) Asset Purchase Agreement dated as of March 6, 1998, by and between
Digital Equipment Corporation and Intel Corporation. Confidential
Treatment request as to certain portions of the Agreement (filed
as Exhibit 2 to the Corporation's Current Report on Form 8-K/A
filed on May 5, 1998 and incorporated herein by reference).
27. Financial Data Schedule
(b) Reports on Form 8-K.
- On January 29, 1998, the Corporation filed a Current Report on
Form 8-K reporting that on January 25, 1998 it and Compaq Computer
Corporation entered into an Agreement and Plan of Merger.
- On February 12, 1998, the Corporation filed a Current Report on
Form 8-K reporting that effective February 3, 1998, it had amended
the Rights Agreement dated as of December 11, 1989 between the
Corporation and First Chicago Trust Company of New York to render
the Rights (as defined in the Rights Agreement) inapplicable to
the Agreement and Plan of Merger dated as of January 25, 1998
between the Corporation and Compaq Computer Corporation and the
transactions contemplated thereby.
- On March 20, 1998, the Corporation filed a Current Report on
Form 8-K reporting that on March 6, 1998, the Corporation and
Intel Corporation ("Intel") entered into an Asset Purchase
Agreement relating to the sale by the Corporation of certain
assets used in its semiconductor manufacturing operations to
Intel.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DIGITAL EQUIPMENT CORPORATION
(Registrant)
By: /s/ Vincent J. Mullarkey
----------------------------------------
Vincent J. Mullarkey
Senior Vice President, Finance and Chief
Financial Officer
(Duly Authorized Officer and Principal
Financial Officer)
May 6, 1998
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