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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 29, 1995
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______ to _______
COMMISSION FILE NUMBER 1-7534
STORAGE TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 84-0593263
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2270 South 88th Street, Louisville, Colorado 80028-4309
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including area code: (303) 673-5151
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title on which Registered
- ------------------------------------------------------------------------------
Common Stock ($.10 par value), New York Stock Exchange
including related preferred
stock purchase rights
8% Convertible Subordinated New York Stock Exchange
Debentures due 2015
7% Convertible Subordinated New York Stock Exchange
Debentures due 2008
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
(Title of Class)
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. [X] YES [ ] NO
As of March 4, 1995, there were 53,316,255 shares of common stock of the
registrant outstanding. The aggregate market value of voting stock held by
nonaffiliates of the registrant was $1,319,682,809 based on the last
reported sale price of the common stock of the registrant on the New York
Stock Exchange's consolidated transactions reporting system on March 4,
1996. For purposes of this disclosure, shares of common stock held by
persons who hold more than 5% of the outstanding common stock and common
stock held by executive officers and directors of the registrant have been
excluded in that such persons may be deemed to be "affiliates" as that term
is defined under the rules and regulations promulgated under the Securities
Act of 1933. This determination is not necessarily conclusive for other
purposes.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to
Regulation 14A under the Securities Exchange Act of 1934 within 120 days of
the end of its fiscal year ended December 29, 1995. Portions of the
registrant's definitive proxy statement for its annual meeting of
stockholders to be held on May 30, 1996 are incorporated by reference into
Part III of this Form 10-K.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
PAGE
Page 2
PART I
ITEM 1. BUSINESS
GENERAL
- -------
Storage Technology Corporation and its subsidiaries ("StorageTek" or the
"Company") design, manufacture, market and service high-performance
information storage and retrieval subsystems and networking products. The
Company's three principal product lines are serial access storage subsystems
(Nearline(R)), random access storage subsystems (online) and networking
products. Nearline products include magnetic tape storage devices and
automated library systems. Online products consist of rotating magnetic
disk devices, including products that utilize fault-tolerant array
technology (RAID), and solid-state direct access storage devices (DASD).
Networking products include routers, switches, channel extenders and
security encryption devices. The Company has commenced activities designed
to expand its professional services business emphasis in the future, in
part, through increased emphasis on new marketing channels (see "MARKETING,
DISTRIBUTION AND SERVICES," below). StorageTek maintains a worldwide
customer service organization to install, maintain and service its own and
third-party equipment.
StorageTek operates in one principal industry segment and sells its products
to end-user customers, value-added resellers and original equipment
manufacturers (OEMs) of computer systems. The Company directly markets its
products worldwide through offices located in major metropolitan areas of
the United States, Canada, Europe, Australia, Japan, Mexico, New Zealand and
Brazil, as well as through distributors in Africa, Asia, Europe and other
countries in South America. In 1995, international revenue accounted for
approximately 41% of the Company's total revenue.
StorageTek's objective is to be the preferred provider of information
storage and retrieval solutions for enterprise computer systems and
networks. The Company's strategy for achieving this objective includes:
continuing to make significant investments in research and development;
expanding hardware product offerings and distribution channels to provide
solutions that address changing customer requirements; investing in new
technologies and businesses that complement its business and product
offerings; and continuing to reduce cycle time and maintain production
quality. To this end, the Company has established and will continue to
establish alliances with other manufacturers, distributors and suppliers.
As a result of these alliances, it is possible for other companies to be at
various times collaborators, competitors and customers in different markets.
On March 7, 1995, the Company acquired Network Systems Corporation (Network
Systems). The transaction was accounted for as a pooling of interests and,
as a result, certain financial information has been restated. For a
discussion of the acquisition, see Note 2, Business Combinations -- Network
Systems Corporation, of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, of this
Form 10-K. During the second quarter and third quarter of 1995, the Company
substantially reduced the scope of its midrange business with the sale of
its midrange lease assets and substantially all of its midrange service
business, and the closing of its StorageTek Distributed Systems Division
operations. See Note 3 of NOTES TO
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CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K for further
information. During the fourth quarter of 1995, the Company announced that
it was implementing actions designed to restructure its business operations,
and had incurred restructuring charges and other one-time charges of $180.9
million. The restructuring charges, totalling $167.2 million, cover the
cost of work force reductions, facility closings and consolidations, and
asset writedowns. For a discussion of the restructuring charges, see
"RESTRUCTURING PLAN", below, and Note 16 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, of this Form 10-K. On February 9, 1996, the Company announced
that it intends to sell its lease assets and enter into a worldwide lease
financing alliance during the first quarter of 1996. For a discussion, see
Note 19, Subsequent Events -- Sale of Lease Assets, of NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS. As part of its 1995 restructuring plan, the Company
entered into a letter of intent on February 28, 1996, to sell its 500,000
square foot research and manufacturing facility in Longmont, Colorado.
Storage Technology Corporation was incorporated in Delaware in 1969. Its
principal executive offices are located at 2270 South 88th Street,
Louisville, Colorado 80028-0001, telephone (303) 673-5151.
THE STATEMENTS IN THE FOLLOWING DESCRIPTION THAT REGARD THE COMPANY'S FUTURE
PRODUCT AND BUSINESS PLANS, FINANCIAL RESULTS, PERFORMANCE AND EVENTS ARE
FORWARD-LOOKING STATEMENTS AND ARE BASED ON CURRENT EXPECTATIONS. ACTUAL
RESULTS MAY DIFFER MATERIALLY DUE TO A NUMBER OF RISKS AND UNCERTAINTIES,
INCLUDING THE RISKS DETAILED IN PART II, ITEM 7, "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--RISK FACTORS
THAT MAY AFFECT FUTURE RESULTS," OF THIS FORM 10-K.
PRINCIPAL PRODUCTS
- ------------------
StorageTek has three principal product lines: Nearline products (serial
access subsystems, including magnetic tape storage devices and automated
library systems); online products (random access subsystems, including
rotating and solid-state DASD) and networking products.
Product sales, including related software revenue, accounted for
approximately 70% of total revenue in 1995, while service and rental income
accounted for the balance. The following table presents revenue by product
line, which includes product sales, service and rental and software revenue.
This information has been restated to reflect the Company's acquisition of
Network Systems Corporation in March 1995, which was accounted for as a
pooling of interests:
PAGE
Page 4
REVENUE BY PRODUCT LINE
FISCAL YEAR ENDED DECEMBER
------------------------------------------------------
1995 1994 1993
---------------- --------------- ----------------
$ million % $ million % $ million %
---------------- ---------------- ----------------
Nearline Products $1,197.7 62.1 $1,033.0 55.2 $ 875.5 54.1
Online Products 375.9 19.5 254.2 13.6 126.0 7.8
Networking Products 208.9 10.8 249.8 13.3 213.3 13.2
Midrange and Other
Products 147.0 7.6 334.4 17.9 402.9 24.9
---------------- ---------------- ----------------
Total $1,929.5 100.0 $1,871.4 100.0 $1,617.7 100.0
================ ================ ================
During 1995, the Company introduced RedWood SD-3 (RedWood(TM)), a high-capacity
tape drive, and the Arctic Fox 9800 (Arctic Fox) and Kodiak 9890 Scaleable
Storage Facility (Kodiak(TM)) online products. On March 7, 1995, the Company
completed a merger with Network Systems. The acquisition of Network Systems
provided the Company with significant new networking products. Network
Systems products currently include the BorderGuard(TM), Security Router(TM), the
Enterprise Routing Switch (ERS(TM)) and Central Archive Management (CAM(TM)).
The ERS has been developed in conjunction with Northern Telecom, Inc. The
Company anticipates that an increasing portion of its future revenue will
come from these products, enhancements to these products and other new
products currently under development. There can be no assurance, however,
that these products will provide significant revenue contribution, or that
new products will be developed in a timely manner, address technological
advances, gain market acceptance or withstand aggressive pricing practices
in the marketplace.
Additional information concerning revenue from each of the Company's product
lines is found in Part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and geographic information
is found in Part IV, Item 14, Note 17 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, of this Form 10-K.
NEARLINE PRODUCTS
- -----------------
StorageTek's current line of Nearline subsystems includes its Automated
Cartridge System (ACS) library and associated magnetic tape cartridge
storage products. The Company's current library products include: the
PowderHorn 9310 (PowderHorn(R)), the Company's second-generation ACS
library, which became available in the second quarter of 1993; the Company's
first generation 4410 ACS library, which has been available since 1988; and
WolfCreek 9360 (WolfCreek(R)), a smaller, high-performance lower-cost
library, which became available in the fourth quarter of 1993. The
Company's tape cartridge products include: the Timberline 9490
(Timberline(R)), a high-performance 36-track cartridge subsystem, available
since the fourth quarter of 1994; the high capacity (up to 50 gigabytes per
cartridge) RedWood, which currently provides Small Computer System Interface
(SCSI) support, available since the first quarter of 1995; the Silverton
PAGE
Page 5
4490 (Silverton), a 36-track cartridge subsystem, which became available
in the third quarter of 1993; and the 4480 18-track cartridge subsystem,
which has been available since 1987. The Company also develops and licenses
software programs designed to expand the range of applications for its ACS
libraries.
The Company recently completed the development of the 9710 library, a
reduced cost, smaller capacity library designed for the midrange
marketplace, and the Twin Peaks 4890 36-track cartridge subsystem (Twin
Peaks), which is also designed for the midrange marketplace. Both the 9710
library and Twin Peaks are currently in limited availability production. In
addition, the Company is developing other new library and tape products, all
of which are in the preliminary engineering phase and for which no firm
availability dates have been set. See Part II, Item 7, "Management's
Discussion And Analysis of Financial Condition and Results of Operations,"
of this Form 10-K, which is incorporated by reference into Item 1 of Part I,
for a discussion of operating results and certain risks associated with the
development and introduction of new products that may affect future results.
ONLINE PRODUCTS
- ---------------
StorageTek's current OnlinePlus(TM) product line consists of a number of online
random access DASD products, featuring RAID rotating magnetic disk
subsystems and solid-state disk (SSD) subsystems. The characteristics of
these products differ principally in information storage capacity, transfer
rate, access time and cost. The Company's Iceberg 9200 Virtual Storage
Facility (Iceberg(R)) is a key part of the Company's online strategy.
Iceberg, available since the second quarter of 1994, is an advanced RAID
subsystem for the IBM and IBM-compatible mainframe environment. Iceberg
Extended Facilities Product and Iceberg Extended Operator Facility are
software products designed to enhance the capabilities of Iceberg, and have
been available since the second half of 1994. The Company's online products
also include Arctic Fox, a high-performance solid-state device, and Kodiak,
a high-performance, high-capacity online product. Both Arctic Fox and
Kodiak became available in 1995. These online products are expected to
serve as an increasing source of revenue for the Company in 1996. See Part
II, Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations," of this Form 10-K for a discussion of operating
results and certain risks that may affect future results.
NETWORKING PRODUCTS
- -------------------
The Company's network product offerings were significantly expanded through
the acquisition of Network Systems, which was completed on March 7, 1995.
Currently, the Company's network products include: unlimited distance
channel extension and CPU networking devices, which have been available
since 1976; the CAM product, a software application designed to provide
backup and recovery to a variety of network client systems, available since
the first half of 1995; interconnect controllers that connect LANs to
mainframes, available since 1991; multiprotocol bridge routers for LAN, WAN
and MAN connections, available since 1988; intelligent port switching hubs,
available since 1993; the ERS, available since the first half of 1995; and
the Security Router and BorderGuard products lines, which became available in
1995. The Company currently is developing new products designed to support
network attached storage for the client-server environment.
PAGE
Page 6
MIDRANGE AND OTHER PRODUCTS
- ---------------------------
In the second and third quarters of 1995, the Company substantially reduced
the scope of its midrange business with the sale of its midrange lease
assets and substantially all of its midrange service business and the
closing of its StorageTek Distributed Systems Division operations. The
Company continues to offer library, tape and networking products that are
designed for the midrange computer market. For a discussion of the sale of
the midrange assets and service business, see Note 3 of NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K.
MARKETING, DISTRIBUTION AND SERVICES
- ------------------------------------
StorageTek is committed to a worldwide marketing and product maintenance
strategy. StorageTek has established a network of sales and service offices
located in major metropolitan areas in the United States, Canada, Europe,
Australia, Japan, Mexico, New Zealand and Brazil to market its products, in
addition to its corporate headquarters in Louisville, Colorado. The Company
also sells its products through international distributors in Africa, Asia,
Europe and in other countries in South America. In 1995, international
revenue accounted for 41% of total revenue, compared to 39% in 1994, and 38%
in 1993. Because of its focus on worldwide operations, the Company is
subject to the risks of conducting business outside the United States. See
Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors that May Affect Future
Results -- International Sales and Operations," of this Form 10-K for a
discussion of factors associated with the Company's international business.
As of December 29, 1995, the order backlog was approximately $57 million,
compared to approximately $60 million as of December 30, 1994.
Approximately 37% in 1995 and 85% in 1994 of the backlog amount is
attributable to the Company's library and tape products. In addition to
these backlog amounts, the Company also had approximately $88 million of
equipment shipped awaiting revenue recognition as of December 29, 1995,
compared to approximately $94 million as of December 30, 1994. Backlog
amounts are calculated on an "if sold" basis and include orders from
end-users, OEM customers and distributors for products that StorageTek
expects to deliver during the following 12 months. Units being evaluated or
covered by letters of intent or awaiting customer acceptance are not
included in backlog amounts. Unfilled orders and orders with respect to
equipment shipped awaiting revenue recognition may be canceled by the
customer. Accordingly, there can be no assurance that orders in the
Company's backlog or equipment shipped awaiting revenue recognition amounts
will ultimately be recognized as revenue.
In 1996, the Company intends to expand the distribution of certain products
through original equipment manufacturers, value-added distributors and
telephone sales. The Company believes that increased use of these
distribution channels will be important to achieving cost improvements and
gaining market penetration for its lower end products. The Company also has
consolidated its professional service groups and intends to expand its
service offerings in 1996 with five major categories of service to be
provided, including: data center, educational, media management, network
management and system services. Historically, the Company has not generated
a
PAGE
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significant portion of its revenue from these sources, and there can be no
assurance that the Company's efforts to expand its distribution channels and
service offerings will be successful.
The installed service base of products and the expertise of the Company's
customer service engineers are considered to be valuable assets of the
Company. These assets are expected to continue to be important competitive
elements of the Company's business. The Company has a worldwide customer
support organization to install, maintain and service StorageTek equipment,
as well as the equipment of others. The Company generally warrants the
performance of products for a specified period of time, after which it
services those products under maintenance agreements. In response to
competitive pressures, many of the products include extended warranty
periods. Such extended warranties may adversely affect profit margins. In
1995, service and rental revenue accounted for 30% of total revenue,
compared to 31% in 1994 and 35% in 1993.
MANUFACTURING AND MATERIALS
- ---------------------------
The Company currently operates manufacturing facilities in Colorado,
Minnesota, Puerto Rico, Florida, France and England. A significant portion
of the Company's European requirements for Timberline are manufactured at
its Toulouse, France, facility. In connection with the restructuring
activities announced in the fourth quarter of 1995, the Company expects to
cease manufacturing operations in Florida in the second half of 1996, and
also has announced plans to sell its manufacturing operations in England in
July 1996, see "RESTRUCTURING PLAN", below. Currently, all the Company's
manufacturing facilities are in compliance with the ISO 9001 international
quality standard.
While the Company manufactures several significant subassemblies, the
substantial majority of its production costs are subassemblies, parts and
components purchased from outside vendors. The balance of the Company's
production costs relate to in-house assembly and testing. Certain of the
parts and components included in the Company's products are obtained from a
single source or a limited group of suppliers. The Company has long-term
supply contracts with certain vendors and suppliers; the remaining parts and
components are obtained by delivering purchase orders specifying the
particular components. These vendors are not obligated to supply products
for an extended period at specific quantities and prices. See Part II, Item
7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations - Risk Factors that May Affect Future Results," of this Form
10-K for a discussion of factors that may affect the Company's ability to
obtain materials, which information is incorporated by reference into Part
I, Item 1 of this Form 10-K.
COMPETITION
- -----------
The Company competes with a number of large multinational companies that
have substantially greater resources, including, IBM, Fujitsu Limited and
Hitachi Ltd., as well as similarly sized companies, including Amdahl Corp.
and EMC Corp.
The markets for the Company's products are highly competitive and are
characterized by rapid technological change and intense price competition.
The Company believes that its ability to compete successfully depends on a
number of factors, both within and outside of its control,
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including the quality, performance, and price of the Company's and its
competitors' products, the timing and success of new product introductions
by the Company and its competitors, and general economic conditions within
and outside the U.S. In the network products arena, the Company faces
strong competition in several key product areas, including hubs, switches,
Asynchronous Transfer Mode (ATM) routers and channel extension products,
from a number of companies with significant market share and financial
resources. Further, because of the significance of IBM in mainframe
operating environments, many of the Company's products are designed to be
compatible with certain IBM operating systems and many of its products
function like IBM equipment. As a result, the Company's business in the
past has been, and in the future may be, adversely affected by a number of
factors outside the control of the Company, including among others,
modifications in the design or configuration of IBM computer systems, the
announcement and introduction of new products by IBM, as well as the
announcement of competing products by IBM and other competitors, and
reductions in the pricing of such comparable systems, equipment or service.
The Company is adapting its product offerings for the client-server, and
intensifying its activities in this arena in response to the migration
toward shared data storage. The Company anticipates that its ability to
compete in the client-server systems market will depend on a number of
factors within and outside its control, including the timely introduction
and performance of products for the client-server market introduced by the
Company and its competitors. For further discussion of competitive
conditions, see Part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors that May
Affect Future Results," of this Form 10-K.
NEW PRODUCT DEVELOPMENT
- -----------------------
The Company currently invests substantial resources in its product
development efforts in order to maintain and enhance the competitiveness of
its products. In 1995, 1994 and 1993, the Company devoted approximately
10%, 11%, and 12%, respectively, of its revenue to develop new products and
enhance the performance of existing products. In an attempt to expand the
Company's access to new technologies and reduce the amount of time necessary
to bring new products to the market, the Company in the past has acquired
other companies and has entered into joint development and other similar
relationships with other companies. For example, the Company acquired
Amperif Corporation in 1993 and Network Systems in 1995.
The Company spent approximately $187 million on research and product
development activities in 1995, as compared to approximately $206 million in
1994 and approximately $191 million in 1993. Current research and
development projects include: the development of enhancements for Iceberg
and Kodiak; the completion of development activities related to RedWood and
other Nearline tape products; the development of networking product
enhancements. As of December 29, 1995, approximately 1,500 employees were
engaged on a full-time basis in engineering and product development
activities.
In the future, there can be no assurance that new products and product
enhancements will be successfully developed or developed in a timely manner,
or if introduced, that the products will achieve market acceptance. The
Company has experienced delays from time to time in completing development
activities and introducing new products and product enhancements and there
can be no assurance that the Company will not encounter delays in the
future. For further discussion of factors concerning product development,
see Part II, Item 7, "Management's
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Discussion and Analysis of Financial Condition and Results of Operations --
Risk Factors that May Affect Future Results," of this Form 10-K.
INTELLECTUAL PROPERTY
- ---------------------
StorageTek's ability to compete is affected by its ability to protect its
proprietary information. StorageTek protects its intellectual property
rights through a combination of patents, trademarks, copyrights,
confidentiality procedures, trade secret laws and licensing arrangements.
The Company's policy is to apply for patents, or other appropriate
proprietary or statutory protection, when it develops new or improved
technology that is important to its business. StorageTek currently holds
over 270 U.S. patents, as well as foreign counterparts to many of these
patents in relevant markets, covering various aspects of its products. Four
of these patents expire in 1996 and the remainder will expire from 1997
through 2015. The Company also has pending approximately 130 U.S. patent
applications, including approximately 22 that have been allowed and are
expected to be formally issued soon, as well as pending foreign counterparts
to many of these applications. StorageTek also has licenses to use patents
held by others. StorageTek owns, has license rights to, and/or has applied
to register, over 40 trademarks, as well as copyrights. Taken as a whole,
these assets are material to StorageTek's business. However, no individual
patent, trademark, license or other item of proprietary information is
singularly material to StorageTek's business.
The Company operates in an industry characterized by vigorous pursuit and
protection of intellectual property rights, which has resulted in
significant and sometimes protracted and expensive litigation. From time to
time, StorageTek has commenced actions against other companies to protect or
enforce its intellectual property rights. Similarly, StorageTek from time
to time has been notified that it may be infringing certain patent or other
intellectual property rights of others. Although licenses or royalty
agreements are generally offered in such situations, there can be no
assurance that litigation will not be commenced in the future regarding
patents, copyrights, trademarks or trade secrets or that any license,
royalty or other rights can be obtained on acceptable terms, or at all.
StorageTek is currently engaged in certain proceedings relating to its
intellectual property and alleged patent infringement. See Part I, Item 3,
"Legal Proceedings" of this Form 10-K. For a discussion of factors
concerning intellectual property see Part II, Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Risk Factors that May Affect Future Results," of this Form 10-K.
ENVIRONMENT
- -----------
Compliance by StorageTek with provisions of federal, state and local laws
regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, has not had a material
adverse affect on StorageTek. For 1995, StorageTek did not have any
material expenditures for environmental control facilities. To date in
1996, StorageTek does not have pending and has not budgeted any material
estimated expenditures for environmental control facilities. However,
potential liability under environmental legislation is ongoing, regardless
of whether or not StorageTek has complied with existing governmental
guidelines.
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Government regulation of the environment and related compliance costs have
increased in recent years. StorageTek cannot predict the nature or scope of
future environmental laws or regulations or how they will be administered or
whether compliance will require substantial expenditures. Based upon
currently available information, StorageTek does not expect that future
compliance with environmental regulations will have a material affect on
StorageTek.
RESTRUCTURING PLAN
- ------------------
In the fourth quarter of 1995, the Company disclosed that it was evaluating
its current operations and manner of conducting business and was
implementing actions designed to restructure its business operations. On
January 25, 1996, the Company disclosed that during the fourth quarter of
1995, it incurred restructuring charges of $167.2 million, to cover the cost
of work force reductions of approximately 1,700 employees, facility closings
and consolidations affecting its facilities located in Colorado, and other
facilities located both within and outside the U.S., and asset writedowns.
This restructuring was adopted in an effort to establish a more competitive
cost structure in response to slower revenue growth and increasing price
competition particularly in the online marketplace. In connection with the
restructuring, the Company plans to focus on core businesses and outsource
non-strategic activities, re-architect its distribution processes within and
outside the U.S., and accelerate the integration of its Network Systems
unit. Additional information concerning the 1995 restructuring plan is
found in Part II, Item 7, "Management's Discussion and Analysis of Financial
Results and Operations, " and Part IV, Item 14, Note 16 of NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K.
OTHER MATTERS
- -------------
The Company employed approximately 10,000 persons on a full-time basis
worldwide as of December 29, 1995.
The Company does not consider its business to be highly seasonal, although
it historically has experienced increased sales revenue in the fourth
quarter compared to other quarters due to customers' tendencies to make
purchase decisions near the end of the calendar year. There can be no
assurance that this historical trend will continue in 1996 and that fourth
quarter results will be higher than any other quarter.
For the year ended December 29, 1995, no single customer accounted for 10%
or more of the Company's consolidated total revenue.
No material portion of the Company's business is subject to contract
termination at the election of the U.S. government.
Reference is made to the following NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS set forth in Part IV, Item 14, of this Form 10-K for certain
additional information, which information is incorporated by reference
herein:
Note 2 Description of the Company's business combinations with
Network Systems Corporation, Bytex Corporation, Amperif
Corporation and Bus-Tech, Inc.
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Note 3 Description of the Company's sale of its midrange lease
assets in June 1995, and substantially all of its midrange service
business in September 1995.
Note 16 Description of the Company's restructuring and other charges
in 1995 and prior years.
Note 17 Information on the geographic operations of the Company's
single business segment, which has been restated in connection
with the Network Systems Corporation merger on March 7, 1995. See
also Part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- International
Operations and Hedging Activities" and "Risk Factors that May
Affect Future Results -- International Sales and Operations" for
further discussion of the risks attendant to foreign operations.
Reference is also made to Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," of this Form
10-K, for information regarding liquidity, including working capital,
restructuring plans and risk factors that may affect future results.
ITEM 2. PROPERTIES
StorageTek occupies facilities in 15 separate buildings in Boulder County,
Colorado, comprising approximately 2.5 million square feet. Of these,
approximately 2.2 million square feet are owned by StorageTek and the
remaining space is leased. Currently, substantially all of this space is
occupied. These facilities include StorageTek's executive offices, as well
as manufacturing, research and development, and spare parts storage
facilities.
StorageTek owns approximately 199,000 square feet of manufacturing
facilities in the Palm Bay/Melbourne, Florida, area, and approximately
200,000 square feet of manufacturing, research and development, and
administrative facilities in the Minneapolis, Minnesota, area. These
facilities are approximately 50% and 100% utilized, respectively.
StorageTek occupies approximately 180,000 square feet of leased engineering,
manufacturing and marketing facilities in Toulouse, France; 128,000 square
feet of manufacturing facilities in Puerto Rico, of which approximately
78,000 square feet is owned and 50,000 square feet is leased; and
approximately 38,000 square feet of leased manufacturing facilities in
England. The facilities in France, Puerto Rico and England are
approximately 55%, 80% and 100% utilized, respectively.
StorageTek also leases facilities at approximately 348 locations throughout
the world, primarily for sales, customer services, and spare parts storage,
as well as for limited research and product development purposes.
Approximately 237 of these leased field offices are located in North
America, with combined office and warehouse facilities totaling
approximately 1,275,000 square feet in the United States and 100,000 square
feet in Canada. As part of the restructuring activities in the fourth
quarter of 1995, a number of the leased field office facilities have been
fully or partially vacated and the Company is currently in the process of
consolidating a number of facilities into other StorageTek facilities. The
Company maintains approximately 95 field offices
PAGE
Page 12
in Europe comprising approximately 540,000 square feet, and 15 offices in
the Asia/Pacific region comprising approximately 75,000 square feet.
As part of the 1995 restructuring plan, the Company is in the process of
consolidating its foreign field offices and entered into a letter of intent
on February 28, 1996, to sell its 500,000 square foot research and
manufacturing facility in Longmont, Colorado. Many of the Company's leases
throughout the world contain renewal rights, cancellation rights and rights
of first refusal on contiguous expansion space. At the present time, such
facilities are adequate for the Company's purposes.
ITEM 3. LEGAL PROCEEDINGS
In the second quarter of 1992, seven purported class actions were filed in
the U.S. District Court for the District of Colorado against the Company and
certain of its officers and directors. These actions were subsequently
consolidated into a single action, and a consolidated amended complaint was
filed on July 7, 1992, seeking an unspecified amount of damages. The
complaint alleged that the defendants failed to properly disclose the status
of development of a new product and the Company's business prospects. The
complaint further alleged that the individual defendants sold shares of the
Company's common stock based on material inside information, in violation of
federal securities and common law. The court certified a class consisting
(with certain exceptions) of those who purchased StorageTek's common stock
and related securities from December 23, 1991, to August 7, 1992. A
shareholder derivative action was also filed in the second quarter of 1992
based on substantially similar factual allegations was consolidated with the
class action. On July 27, 1995, the Company and the plaintiffs in the
shareholder class action and derivative litigation announced an agreement to
settle the litigation. The settlement provided that, without admitting any
wrongdoing, the Company would pay $30,680,000 for its portion of the
settlement. The Company's insurance policies paid $24,320,000 as part of
the total settlement of $55,000,000. As a result of the settlement, a
one-time charge of $30,680,000 was recognized during the third quarter of
1995. The court gave final approval to the settlement in December 1995.
On June 10, 1993, the Company filed suit against EMC Corp. in U.S. District
Court for the District of Colorado. The suit currently alleges infringement
by EMC Corp. of a patent pertaining to the Company's disk storage
technology. The complaint seeks an injunction prohibiting further
infringement, treble damages in an unspecified amount, and an award of
attorney fees and costs. EMC Corp. filed an answer and counterclaim on
July 20, 1993, alleging, among other things, patent misuse by StorageTek and
seeking the invalidation of the Company's patents, damages in an unspecified
amount and an award of attorney fees, costs and interest. The case is in
the discovery phase.
On September 23, 1994, EMC Corp. filed suit in U.S. District Court in
Wilmington, Delaware, alleging infringement of a patent pertaining to disk
storage technology. The complaint seeks an injunction, treble damages in an
unspecified amount and an award of attorney fees and costs. On December 22,
1994, the Company filed a counterclaim for infringement of one of its
patents and, in November 1995, added a second patent to its counterclaim.
The case is in the discovery phase. A trial date has been set for May 1996.
PAGE
Page 13
In January 1994, Stuff Technology Partners II, a Colorado Limited
Partnership (Stuff), filed suit in Boulder County, Colorado, District Court
against the Company and certain subsidiaries. The suit alleged that the
Company breached a 1990 settlement agreement that had resolved earlier
litigation between the parties. The suit sought injunctive relief and
damages in the amount of $2,400,000,000. On December 28, 1995, the court
dismissed the complaint. The Company is currently proceeding with a
counterclaim against Stuff for breach of its covenant not to sue, which was
part of the 1990 settlement agreement.
On January 21, 1994, Bell Atlantic Business Systems Services, Inc. (BABSS)
filed suit in Federal District Court for the Northern District of
California, alleging that a number of the Company's service business
policies were illegal, including price increases and parts and maintenance
software availability. On January 4, 1996, the parties settled this suit.
The settlement of this litigation did not involve any admission of wrongdoing
by the Company, and had no material affect on the Company's financial
position or results of operations.
On February 15, 1994, the Company filed suit in Boulder County, Colorado,
District Court against Array Technology Corporation (Array) and Tandem
Computers Incorporated (Tandem). The suit asked that the court order Array
and Tandem either to support certain disk drives purchased from them or
provide the Company with technical data necessary for StorageTek to provide
such customer support. In March 1994, Array and Tandem filed their answer
and also filed counterclaims against the Company alleging breach of contract
and claiming damages. On June 10, 1994, the court ordered Array and Tandem
to continue to provide support for these products and to maintain, in an
independent escrow account, the materials necessary to enable the Company to
support the products in the event Array and Tandem failed to provide such
services. On May 30, 1995, the Company filed an amended complaint seeking
damages. The case is in the discovery phase. A trial date has been set for
November 1996.
On June 29, 1995, Odetics, Inc. filed a patent infringement suit in the U.S.
District Court for the Eastern District of Virginia against the Company and
two of its customers alleging that the "passthrough" port in certain of the
Company's tape library products infringed U.S. Patent No. 4,779,151 (the
"151 Patent"). The complaint asked the court to impose injunctive relief,
treble damages in an unspecified amount, and an award of attorney fees and
costs. A trial commenced on January 22, 1996, and on February 1, 1996, a
jury found that the Company's products did not infringe the 151 Patent. A
notice of appeal to the U.S. Court of Appeals for the Federal Circuit is due
March 29, 1996. A notice of appeal to the U.S. Court of Appeals for the
Federal Circuit was filed by Odetics, Inc. on March 8, 1996.
On December 8, 1995, Odetics, Inc. filed a second patent infringement suit
in the U.S. District Court for the Eastern District of Virginia against the
Company. The complaint alleges that the "cartridge access port" in certain
of the Company's tape library products infringe the 151 Patent. The
complaint seeks injunctive relief, treble damages in an unspecified amount,
and an award of attorney fees and costs. This case has been stayed pending
the outcome of any appeal to the U.S. Court of Appeals for the Federal Circuit
with respect to the case filed by Odetics, Inc. in June 1995.
In addition, the Company is involved in various other less significant legal
proceedings. The Company believes it has adequate legal defenses with
respect to each of the suits cited above and intends to vigorously defend
against these actions. However, it is reasonably possible that
PAGE
Page 14
these cases could result in outcomes unfavorable to the Company. While the
Company currently believes that the amount of the ultimate potential loss
would not be material to the Company's financial position, the outcome of
litigation is inherently difficult to predict. In the event of an adverse
outcome, the ultimate potential loss could have a material affect on the
Company's financial position or reported results of operations in a
particular quarter. An adverse decision, particularly in patent litigation,
could require material changes in production processes and products or
result in the Company's inability to ship products or components found to
have violated third-party patent rights.
Information concerning certain of these legal proceedings is also contained
in Note 14 of NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS identified in
Part IV, Item 14, of this Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of StorageTek security holders during the
fourth quarter of the fiscal year ended December 29, 1995.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following persons were serving as executive officers of the Company
as of March 11, 1996.
NAME POSITION WITH COMPANY AGE
- --------------------------------------------------------------------
Ryal R. Poppa Chairman of the Board, 62
President and Chief
Executive Officer
David E. Weiss Executive Vice President 51
and Chief Operating Officer
Lowell Thomas Gooch Executive Vice President 51
and General Manager of
Network Systems
John V. Williams Executive Vice President of 52
Worldwide Field Operations
David E. Lacey Corporate Vice President 49
and Interim Chief Financial
Officer
W. Russell Wayman Corporate Vice President, 51
General Counsel and
Secretary
Mr. Poppa became Chairman of the Board, Chief Executive Officer and a
director of the Company in January 1985, and President of the Company in
January 1988. He is also a director of SemiTool Inc.
Mr. Weiss was appointed Chief Operating Officer on March 10, 1995. Mr.
Weiss served as Executive Vice President of Systems Development from January
1993 to March 1995. He was a Senior Vice President of Marketing and Program
Management Process from June 1992 to January 1993 and Corporate Vice
President of Market Planning from August 1991 to June 1992.
PAGE
Page 15
From March 1991 through August 1991, he was a staff vice president reporting
to the Chief Executive Officer.
On November 20, 1995, Mr. Gooch was appointed as Executive Vice President
and General Manager of the Company's Network Systems Corporation unit. From
January 1989 to November 1995, Mr. Gooch was Executive Vice President of
Operations of the Company. Mr. Gooch has been employed by the Company in
various capacities since 1972.
Mr. Williams was appointed Executive Vice President of Worldwide Field
Operations on January 1, 1995. Prior to that time, he served as Senior
Corporate Vice President, Americas, from August 1993 through December 1994.
He was Corporate Vice President from February 1992 through August 1993 and
Vice President of North America from September 1990 through February 1992.
Mr. Lacey was appointed Interim Chief Financial Officer on February 1, 1995,
in addition to his position as Corporate Vice President. Mr. Lacey became a
Corporate Vice President in December 1990. He served as Corporate
Controller of the Company from October 1989 to February 1995.
Mr. Wayman has served as Corporate Vice President since March 1991, General
Counsel since January 1990 and Corporate Secretary of the Company since
February 1990.
PAGE
Page 16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The common stock of Storage Technology Corporation is traded on the New York
Stock Exchange under the symbol STK. The table below reflects the high and
low closing sales prices of the common stock on the New York Stock Exchange
composite tape as reported by The Wall Street Journal for 1995 and 1994. On
December 29, 1995, there were 17,431 record holders of common stock of
StorageTek.
1995 High Low
----------------------------------------------------
First Quarter $32.625 $18.625
Second Quarter 26.750 17.875
Third Quarter 29.500 23.750
Fourth Quarter 27.625 22.250
1994 High Low
----------------------------------------------------
First Quarter $40.625 $31.250
Second Quarter 34.125 25.125
Third Quarter 39.000 28.750
Fourth Quarter 31.000 26.625
Dividends
- ---------
StorageTek has never paid cash dividends on its common stock. The Company
currently plans to continue to retain future earnings for use in its
business. Furthermore, the Company's existing multicurrency credit
agreement and 9.53% Senior Secured Notes contain certain restrictions that
limit the payment of cash dividends based primarily upon the Company's
consolidated net income. As of December 29, 1995, under the terms of the
multicurrency credit agreement, the Company did not have sufficient
cumulative consolidated net income to permit the payment of cash dividends
on its common stock.
PAGE
Page 17
ITEM 6.SELECTED FINANCIAL DATA
The following data, insofar as it relates to the three fiscal years 1993
through 1995 (except for the 1993 Balance Sheet Data), has been derived from
the consolidated financial statements appearing elsewhere herein, including
the Consolidated Balance Sheet as of December 29, 1995, and December 30,
1994, and the related Consolidated Statement of Operations for each of the
three years in the period ended December 29, 1995, and notes thereto. The
data, insofar as it relates to the Balance Sheet Data as of December 31,
1993, December 25, 1992, and December 27, 1991, and the Statement of
Operations Data for the fiscal years 1992 and 1991, has been derived from
the historical financial statements of the Company for such periods,
restated as appropriate to reflect mergers accounted for as poolings of
interests.
The following table data (in thousands of dollars, except per share amounts)
should be read in conjunction with the consolidated financial statements and
notes thereto.
YEAR ENDED DECEMBER
-----------------------------------------------------------------------
1995 1994 1993 1992 1991
-----------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA
Revenue $1,929,485 $1,871,350 $1,617,691 $1,774,325 $1,807,541
Cost of revenue 1,217,622 1,186,942 1,072,784 1,179,756 1,197,798
--------- --------- --------- --------- ---------
Gross profit 711,863 684,408 544,907 594,569 609,743
Research and product development costs 187,275 206,083 191,048 177,699 144,686
Marketing, general, administrative and
other income and expense, net 445,889 425,490 393,991 388,496 363,356
Restructuring and other charges (Note 16) 212,207 8,000 90,414 60,310(a) 9,078(b)
--------- --------- --------- --------- ---------
Operating profit (loss) (133,508) 44,835 (130,546) (31,936) 92,623
Interest income 43,325 46,935 62,438 75,885 80,339
Interest expense (34,347) (40,832) (43,853) (49,991) (53,398)
--------- --------- --------- --------- ---------
Income (loss) before income taxes
and accounting change (124,530) 50,938 (111,961) (6,042) 119,564
Provision for income taxes (17,800) (18,900) (9,500) (27,200) (21,200)
--------- --------- --------- --------- ---------
Income (loss) before cumulative effect
of accounting change (142,330) 32,038 (121,461) (33,242) 98,364
Cumulative effect of accounting
change (Note 10) 40,000
--------- --------- --------- --------- ---------
Net income (loss) $ (142,330) $ 32,038 $ (81,461) $ (33,242) $ 98,364
========= ========= ========= ========= =========
Earnings (loss) per common share:
Income (loss) before cumulative effect
of accounting change $ (2.91) $ 0.38 $ (2.59) $ (0.66) $ 1.99
Net income (loss) (2.91) 0.38 (1.80) (0.66) 1.99
BALANCE SHEET DATA
Working capital $ 425,351 $ 501,065 $ 492,576 $ 402,876 $ 503,052
Total assets 1,888,629 2,144,458 2,064,851 2,011,007 2,055,897
Long-term debt 363,963 356,887 362,718 370,988 375,847
Stockholders' equity 962,833 1,265,285 1,215,877 1,138,927 1,157,681
(a) In 1992, the Company recognized restructuring charges of $60,310,000.
(b) In 1991, the Company recognized merger expenses of $9,078,000.
PAGE
Page 18
ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements in the following discussions regarding the Company's
future product and business plans, financial results, performance and events
are forward-looking statements and are based on current expectations.
Actual results may differ materially due to a number of risks and
uncertainties, including the risks detailed below in "RISK FACTORS THAT MAY
AFFECT FUTURE RESULTS."
GENERAL
- -------
The Company reported a net loss for the year ended December 29, 1995, of
$142.3 million on revenue of $1.93 billion, compared to net income for the
year ended December 30, 1994, of $32.0 million on revenue of $1.87 billion
and a net loss for the year ended December 31, 1993, of $81.5 million on
revenue of $1.62 billion. The Company's results include restructuring and
other charges of $212.2 million in 1995, $8.0 million in 1994, and $90.4
million in 1993. A $40.0 million benefit was also recognized in 1993 from
the cumulative effect of a change in the method of accounting for income
taxes.
As more fully discussed in Note 2 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, the Company, through a wholly owned subsidiary, completed a
merger with Network Systems Corporation (Network Systems) on March 7, 1995.
The merger was accounted for as a pooling of interests and, accordingly, the
consolidated financial statements were restated for all periods prior to the
merger to include the operations of Network Systems, adjusted to conform
with StorageTek's accounting policies and presentation.
Revenue increased 3% in 1995 compared to 1994, primarily due to incremental
sales revenue from the TimberLine 9490 (TimberLine(R)) 36-track cartridge
subsystem and the Iceberg 9200 Virtual Storage Facility (Iceberg(R)). These
increases were largely offset by a significant decline in revenue from
midrange products, as well as lesser declines in revenue from older
generation library and tape products and networking products. The
significant decline in revenue from midrange products was primarily due to
the sale of substantially all of the Company's midrange lease assets and
midrange service business in the second and third quarter of 1995,
respectively. As anticipated, revenue from older generation Nearline(R)
products, including the 4480 18-track tape cartridge subsystem, Silverton
4490 36-track tape cartridge subsystem (Silverton), and 4410 Automated
Cartridge System (ACS) library, decreased in 1995. The decline in revenue
from networking products reflects slower than expected market acceptance of
the Enterprise Routing Switch (ERS(TM)) and other new internetworking products,
coupled with declines in older mainframe channel extension networking
products. While revenue from Iceberg increased 73% for 1995 compared to
1994, the rate of growth fell short of the Company's expectations primarily
due to continued price competition in the online marketplace, and slower
than expected market acceptance.
Revenue increased 16% in 1994 compared to 1993, primarily due to increased
sales of Silverton, Iceberg, and the PowderHorn 9310 (PowderHorn(R)), an ACS
library. Sales of the Company's first-generation 4410 ACS library and 4480
18-track tape cartridge system declined in 1994, as did sales of midrange
products.
PAGE
Page 19
Improvements in revenue and operating results during 1996 are significantly
dependent upon successfully addressing development and distribution issues
associated with the Company's networking products, as well as the effective
implementation of significant business restructuring activities initiated
during the fourth quarter of 1995 in all parts of the Company's business.
Risk factors that may affect future results also include the continuing
success of TimberLine, Iceberg, Silverton and PowderHorn; successfully
gaining market acceptance for the RedWood SD-3 (RedWood(TM)) and the Kodiak
9890 Scalable Storage Facility (Kodiak(TM)); the successful introduction of
planned technological improvements to these products; intense competition
and pricing pressure in the online marketplace; and the introduction of new
products by competitors; among others. See "RISK FACTORS THAT MAY AFFECT
FUTURE RESULTS," below.
The Company's cash balances increased $36.4 million during 1995 as cash
generated from operations of $306.0 was partially offset by net repayments
of debt of $201.9 million, and investments in property, plant and equipment
of $58.0 million. The Company's cash balances decreased $52.9 million
during 1994 primarily as a result of significant investments associated with
new products and increased $124.9 million during 1993 primarily as a result
of proceeds from a preferred stock offering.
The following table, stated as a percentage of total revenue, presents
consolidated statement of operations information and revenue by product
line, which includes product sales, service and rental, and software
revenue.
Year Ended December
-------------------------------------
1995 1994 1993
-------------------------------------
Revenue:
Nearline Products 62.1% 55.2% 54.1%
Online Products 19.5 13.6 7.8
Networking Products 10.8 13.3 13.2
Midrange and Other Products 7.6 17.9 24.9
---- ---- ----
Total revenue 100.0 100.0 100.0
Cost of revenue 63.1 63.4 66.3
---- ---- ----
Gross profit 36.9 36.6 33.7
Research and product development costs 9.7 11.0 11.8
Marketing, general, administrative
and other income and expense, net 23.1 22.8 24.4
Restructuring and other charges 11.0 0.4 5.6
---- ---- ----
Operating profit (loss) (6.9) 2.4 (8.1)
Interest income (expense), net 0.4 0.3 1.2
---- ---- ----
Income (loss) before income
taxes and cumulative effect
of accounting change (6.5) 2.7 (6.9)
Provision for income taxes (0.9) (1.0) (0.6)
---- ---- ----
Income (loss) before cumulative
effect of accounting change (7.4) 1.7 (7.5)
Cumulative effect on prior years of
change in method of accounting for
income taxes 2.5
---- ---- ----
Net income (loss) (7.4)% 1.7% (5.0)%
==== ==== ====
PAGE
Page 20
REVENUE
- -------
NEARLINE PRODUCTS
Revenue from Nearline products increased 16% in 1995 compared to 1994,
primarily due to incremental sales of TimberLine, which became available in
the fourth quarter of 1994. Revenue from PowderHorn also increased in 1995
compared to 1994. As anticipated, revenue from the 4480 18-track tape
cartridge subsystem and Silverton, which represent earlier generation tape
subsystems, declined in 1995. Revenue from the first generation 4410 ACS
library also declined slightly in 1995. RedWood, a high-capacity tape
drive, was introduced in the first quarter of 1995; however, the Company
received no significant revenue contribution from RedWood in 1995.
Revenue from Nearline products increased 18% in 1994 compared to 1993,
primarily due to increased sales of PowderHorn and Silverton. The Company
also recognized incremental sales from TimberLine during the fourth quarter
of 1994. Sales of the 4410 ACS library and 4480 18-track cartridge
subsystem declined during 1994.
Incremental sales associated with TimberLine and RedWood are expected to
offset future declines in revenue from earlier generation Nearline products.
RedWood currently provides Small Computer System Interface (SCSI) support
for multiple computing platforms. Future revenue contribution from RedWood
is significantly dependent upon the Company's ability to deliver a version
of the product which allows for the use of higher capacity tape cartridges.
While the Company believes issues associated with the design and manufacture
of higher capacity tape cartridges for RedWood were resolved during the
fourth quarter of 1995, there can be no assurance that all RedWood
development issues have been successfully addressed or that the product will
gain market acceptance in the future.
ONLINE PRODUCTS
Revenue from online products increased 48% in 1995 compared to 1994,
primarily due to incremental sales of Iceberg, which became available during
the second quarter of 1994. While Iceberg sales revenue increased during
1995, the rate of revenue growth fell short of the Company's expectations,
primarily due to the rapid rate of price erosion in the online marketplace,
and slower than expected customer acceptance of Iceberg. The Company
announced the commencement of initial shipments of Kodiak in the third
quarter of 1995; however, the Company received no significant revenue
contribution from Kodiak in 1995.
Revenue from online products increased 102% in 1994 compared to 1993, due to
incremental sales of Iceberg. Iceberg sales fell short of the Company's
expectations in 1994, primarily as a result of lower than anticipated unit
sales volume, smaller configuration sizes, price competition, as well as
longer than anticipated customer evaluation and acceptance periods.
Future revenue contribution from online products is significantly dependent
upon successfully increasing production volumes of Kodiak without
significant engineering, design or manufacturing difficulties, as well as
the timely introduction of additional functions and features for both
Iceberg and Kodiak in the highly competitive online marketplace. While the
Company believes the introduction and production schedules for these
additional functions and features are achievable, there can be no assurance
that the schedules will be met, or that these
PAGE
Page 21
functions and features will result in additional market acceptance for Iceberg
and Kodiak. Future revenue contribution from online products is also
significantly dependent upon the rate of future price declines in the
marketplace. While worldwide demand for online storage capacity in the
enterprise marketplace increased significantly in 1995, this increase was
largely offset by declines in the price per megabyte for storage.
NETWORKING PRODUCTS
Revenue from networking products decreased 16% in 1995 compared to 1994.
This decrease reflects anticipated declines in older mainframe channel
extension networking products, coupled with slower than expected market
acceptance of ERS and other internetworking products which support
communication between networks. Revenue and operating results associated
with networking products were adversely affected by difficulties encountered
with the integration of Network Systems, and delays in the development of
Asynchronous Transfer Mode (ATM) support for ERS.
Revenue from networking products increased 17% in 1994 compared to 1993, due
to incremental revenue contribution from purchase acquisitions made during
1993 by Network Systems.
As part of its restructuring, the Company initiated efforts during the
fourth quarter of 1995 to accelerate the integration of Network Systems,
increase focus on core networking products for the information storage and
retrieval marketplace, discontinue the development of future network hub
products, modify the distribution structure for networking products, and
reduce operating expenses. Improvements in revenue and operating results
with respect to networking products are significantly dependent upon the
successful implementation of these restructuring actions, the introduction
of ATM support for ERS, and the introduction of enhancements for other
networking products. The development of ATM support for ERS is completely
dependent upon the success of the Company's joint development agreement with
Northern Telecom, Inc. The Company does not anticipate ATM support for ERS
will become available until 1997. There can be no assurance that the
Company's joint development agreement with Northern Telecom, Inc. will be
successful, or that the Company's networking product line will generate any
significant future profits.
MIDRANGE AND OTHER PRODUCTS
Revenue from midrange and other products decreased 56% in 1995 compared to
1994. This decline is primarily the result of the Company's sale of its net
investment in sales-type leases associated with its midrange business during
the second quarter of 1995 and the sale of substantially all of the midrange
service business during the third quarter of 1995. No material gain or loss
resulted from the sale of the midrange lease assets as the gain on the lease
asset sale was largely offset by transaction and integration costs. A one-
time gain of approximately $8.8 million was recognized in connection with
the sale of the midrange service business. As a result of the sale of the
midrange lease assets and midrange service business, revenue from the
midrange product line is expected to be significantly reduced in future
periods.
Revenue from midrange subsystems and other products decreased 17% in 1994
compared to 1993. Midrange revenue and operating results during 1994 were
adversely affected by a steep price erosion in the midrange online
marketplace. A restructuring plan adopted by the
PAGE
Page 22
Company in the third quarter of 1993 resulted in further reductions in
midrange revenue as the Company redirected its marketing efforts to a segment
of the midrange marketplace.
GROSS PROFIT
- ------------
Gross profit on product sales of 37% in 1995 was unchanged, compared to
1994. Gross profit improvements were obtained from product cost
improvements, principally from Iceberg, and cost savings associated with the
increased manufacturing volumes during 1995 for online and Nearline
products. Product sales margins also benefited from reduced sales revenue
contribution from lower margin midrange products as a result of the sale of
the midrange lease assets. These improvements were offset by the
continuation of price declines in the online marketplace, and a significant
decrease in margin contribution from networking products.
Gross profit on product sales increased to 37% in 1994, compared to 33% in
1993, primarily as a result of a favorable product mix which included
increased revenue contribution from higher margin products sold during 1994,
such as Iceberg, Silverton, and PowderHorn; and reduced revenue contribution
from lower margin midrange products.
Gross profit on service and rental revenue was unchanged at 36% in 1995, as
compared to 1994. Gross profit on service and rental revenue increased
slightly to 36% in 1994, compared to 35% in 1993.
The Company's ability to sustain or improve product sales margins during
1996 is significantly dependent upon the rate of the price declines in the
online marketplace, achieving satisfactory manufacturing volumes associated
with networking products to offset fixed costs, and achieving cost savings
associated with the manufacture of its online and networking products.
Product sales margins also may be adversely affected by inventory writedowns
as a result of more rapid than anticipated technological changes. Service
margins also may be affected in the future due to increased price
competition.
RESEARCH AND PRODUCT DEVELOPMENT
- --------------------------------
Research and product development expenditures decreased 9% in 1995 compared
to 1994, and declined as a percentage of revenue from 11.0% in 1994 to 9.7%
in 1995. While the Company continued to invest in the development of new
products and enhancements to existing products, these decreases reflect the
completion of several major product development programs in 1994 and the
implementation of cost-control measures directed at achieving targeted
expense ratios. Research and product development increased 8% in 1994
compared to 1993, primarily due to costs incurred in connection with the
continued development of TimberLine, RedWood, Iceberg and networking
products.
MARKETING, GENERAL, ADMINISTRATIVE AND OTHER
- --------------------------------------------
Marketing, general, administrative and other income and expense (MG&A and
Other) increased 5% in 1995 compared to 1994 and remained relatively
unchanged as a percent of revenue at 23% for both 1995 and 1994. The
increase in MG&A and Other in 1995 is due primarily to increased marketing
expenses resulting from higher sales volumes, and a charge of $13.7 million
incurred as a result of activities indirectly related to the Company's 1995
restructuring. Also included within MG&A and Other for 1995 is a one-time
gain of $8.8 million realized on the
PAGE
Page 23
sale of substantially all of the Company's midrange service business. Gains
and losses associated with foreign currency transactions and translation
adjustments, net of associated hedging results, are included in MG&A and Other
and aggregated a net loss of $4.3 million for 1995, compared to a net loss of
$1.2 million in 1994.
MG&A and Other increased 8% in 1994 compared to 1993, primarily due to an
increase in operating expenses as a result of higher sales volumes and costs
incurred in connection with the introduction of new products. These
increases were partially offset by lower marketing expenses related to the
midrange business and reduced foreign currency losses in 1994, compared to
1993. Gains and losses associated with foreign currency transactions and
translation adjustments, net of associated hedging results, aggregated a net
loss of $1.2 million for 1994, compared to a net loss of $9.0 million in
1993.
See "INTERNATIONAL OPERATIONS AND HEDGING ACTIVITIES," below, for further
discussion of the foreign exchange risks associated with the Company's
international operations and the related foreign currency hedging
activities.
RESTRUCTURING AND OTHER CHARGES
- -------------------------------
Restructuring and other charges consist of the following (in thousands of
dollars):
Year Ended
----------------------------------------------------
December 29, December 30, December 31,
1995 1994 1993
----------------------------------------------------
Restructuring charges $167,175 $8,000 $77,832
Litigation settlement 30,680
Merger and consolidation
charges 14,352 5,522
Acquired research and
development 7,060
------- ----- ------
$212,207 $8,000 $90,414
======= ===== ======
See Note 14 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for a discussion
of the $30.7 million charge associated with the settlement of litigation in
1995. See Note 2 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for a
discussion of the $14.4 million charge associated with the merger with
Network Systems in 1995 and the $5.5 million charge associated with the
merger with Amperif Corporation in 1993. See Note 2 of NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, also, for a discussion of the $7.1
million charge incurred in connection with Network Systems' acquisition of
Bytex Corporation in 1993.
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The following table summarizes the activity in the Company's restructuring
reserves during the last three years (in thousands of dollars):
Employee Asset Lease Other
Severance Writedowns Abandonments Exit Costs Total
-------------------------------------------------------------------------
Balances, December 25, 1992 $ 2,794 $ 2,536 $ 4,866 $ 10,196
Restructuring charges 12,636 $ 59,178 3,490 2,528 77,832
Cash payments (7,955) (769) (3,598) (12,322)
Asset writedowns (59,178) (59,178)
Reclassifications to other
restructuring charges (1,236) (1,236)
------ ------- ------ ------ -------
Balances, December 31, 1993 6,239 0 5,257 3,796 15,292
Restructuring charges 3,000 2,200 2,300 500 8,000
Cash payments (6,203) (1,775) (684) (8,662)
Asset writedowns (2,200) (2,200)
------ ------- ------ ------ -------
Balances, December 30, 1994 3,036 0 5,782 3,612 12,430
Restructuring charges 49,265 91,609 16,660 9,641 167,175
Cash payments (9,613) (3,904) (3,081) (16,598)
Asset writedowns (91,609) (91,609)
------ ------- ------ ------ -------
Balances, December 29, 1995 $42,688 $ 0 $18,538 $10,172 $ 71,398
====== ======= ====== ====== =======
1995 RESTRUCTURING
As more fully discussed in Note 16 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, during the fourth quarter of 1995, the Company recorded a
restructuring charge of $167.2 million related to the adoption by the
Company of a formal action plan for restructuring its enterprise and
networking businesses. The restructuring was adopted in an effort to
establish a more competitive cost structure in response to slower revenue
growth and increasing price competition, particularly in the online
marketplace. In connection with the restructuring, the Company plans to
focus on core businesses and outsource non-strategic activities, rearchitect
its distribution processes and accelerate the integration of Network
Systems, which was acquired in March 1995.
The majority of the Company's restructuring actions were either completed in
the fourth quarter of 1995 or are expected to be completed during 1996. As
of December 29, 1995, the remaining accrual associated with this
restructuring was approximately $67.6 million. This accrual consisted of
estimated future employee severance obligations of approximately $42.5
million; estimated future rent obligations associated with excess lease
space of approximately $16.0 million; and accruals for other exit costs
associated with the restructuring of approximately $9.1 million. While the
majority of these remaining accruals are expected to result in future cash
outflows, these outflows are not expected to have a material affect on the
Company's liquidity.
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The 1995 restructuring is expected to yield expense reductions on an annual
basis through the elimination of recurring costs as follows (in thousands of
dollars):
Employee cost savings $ 90,000
Depreciation and amortization savings 20,000
Lease abandonments and other cost savings 15,000
-------
Total estimated annual savings $125,000
=======
The Company does not expect to realize the full benefit of the expense
reductions until the second half of 1997 when all associated restructuring
activities are expected to be completed. While the Company is currently
evaluating various outsourcing and automation projects in order to gain
further improvements in operating efficiencies, the Company does not
anticipate that any material incremental costs have been or will be incurred
as part of the restructuring which would offset the anticipated expense
reductions described above.
The Company believes that its restructuring programs over the past several
years have eliminated certain non-essential functions and excess costs.
Based on current short and long-term forecasts, the Company believes that
such cost reductions will benefit future operations. While the Company does
not currently foresee any significant additional restructuring charges in
the near future, the successful implementation of the action plans
associated with the Company's 1995 restructuring during 1996 and 1997 is
critical to achieving improved operating results in future periods. There
can be no assurance that the anticipated expense reductions will be
achieved, or that the Company's restructuring activities will otherwise be
successful or sufficient to allow the Company to generate improved operating
results in future periods. It is possible that changes in the Company's
business or in its industry may necessitate future restructuring charges,
which may be significant.
1994 RESTRUCTURING
As more fully discussed in Note 16 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, during the fourth quarter of 1994, Network Systems recorded a
restructuring charge of $8.0 million in connection with an expense reduction
plan.
As of December 29, 1995, substantially all actions associated with the 1994
restructuring have been completed and the remaining accrual associated with
this restructuring of approximately $0.5 million related principally to
future rent obligations associated with excess lease space. No material
cash outflows are anticipated to result from this restructuring in the
future.
1993 RESTRUCTURINGS
As more fully discussed in Note 16 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, during the third quarter of 1993, StorageTek recorded a
restructuring charge of $69.2 million and, during the fourth quarter of
1993, Network Systems recorded a restructuring charge of $8.6 million for an
aggregate 1993 restructuring charge of $77.8 million for the combined
companies.
As of December 29, 1995, substantially all actions associated with the 1993
restructurings have been completed and the remaining accrual associated with
these restructurings of
PAGE
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approximately $3.3 million related principally to future rent obligations
associated with excess lease space. No material cash outflows are anticipated
to result from these restructurings in the future.
INTEREST INCOME AND EXPENSE
- ---------------------------
Interest income decreased 8% in 1995 compared to 1994, primarily due to a
reduction in the Company's net investment in sales-type lease balance.
Despite an increase in market interest rates, interest income decreased 25%
during 1994 compared to 1993, due to a reduction in net investment in sales-
type leases and a decrease in the Company's cash balances available for
investment.
Interest expense decreased 16% in 1995 compared to 1994, due primarily to a
reduction of nonrecourse borrowings and other long-term debt in the second
half of 1995. Interest expense decreased 7% in 1994 compared to 1993,
primarily as a result of reduced levels of nonrecourse borrowings in the
first half of 1994.
The reductions in the balances of net investment in sales-type leases and
nonrecourse borrowings during 1995 reflect the sale of the Company's
midrange lease assets and the repayment of the associated lease borrowings
during 1995. As further discussed in Note 9 of NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS, on December 15, 1995, the Company exercised its right
to exchange 7% convertible subordinated debentures for all of its
outstanding shares of preferred stock. As a result of the exchange,
interest expense will increase and the obligation to pay preferred stock
dividends will be eliminated. As more fully discussed in Note 19 of NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS, the Company announced on February 9,
1996, that it intends to sell substantially all of its net investment in
sales-type leases. In connection with this sale, the Company intends to
repay its outstanding nonrecourse borrowings and 9.53% Senior Secured Notes.
The completion of this proposed transaction would result in further
reductions in interest income and expense during 1996.
INCOME TAXES
- ------------
As further discussed in Note 10 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, effective as of the beginning of the fiscal year 1993, the
Company was required to change its method of accounting for income taxes
from Statement of Financial Accounting Standards (SFAS) No. 96 to SFAS No.
109. A one-time benefit of $40 million was recognized in the first quarter
of 1993 as a result of the adoption of the new income tax accounting
standard on a prospective basis. The adoption of SFAS No. 109 had no cash
flow impact.
SFAS No. 109 requires that deferred income tax assets be recognized to the
extent realization of such assets is more likely than not. The Company
evaluates a variety of factors in determining the amount of the deferred
income tax assets to be recognized pursuant to SFAS No. 109, including the
number of years the Company's operating losses and tax credits can be
carried forward, the existence of taxable temporary differences, the
Company's earnings history, and the Company's near-term earnings
expectations. Based on the currently available information, management has
determined that the Company will more likely than not realize $74.9 million
of net deferred income tax assets as of December 29, 1995.
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The Company's provision for income taxes relates primarily to U.S. state
taxes and taxable earnings associated with its international operations in
certain foreign countries. The Company's effective tax rate can be subject
to significant fluctuations due to dynamics associated with the mix of its
U.S. and international taxable earnings. See Note 10 of NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS for information with respect to the
current status of the Internal Revenue Service examinations.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
WORKING CAPITAL
The Company's cash balances increased $36.4 million and short-term
investments decreased $5.5 million from December 30, 1994, to December 29,
1995. The increase in cash during 1995 primarily resulted from cash
generated from operations of $306.0 million; offset by net repayments of
debt of $201.9 million and investments in property, plant and equipment of
$58.0 million. Net cash provided by operations was $306.0 million for 1995
compared to $75.2 million for 1994 and $84.0 million for 1993. Net cash
provided by operations for 1995 includes cash generated from the sale of
midrange lease assets and midrange service business of approximately $193.0
million and refunds from the Internal Revenue Service of $17.8 million,
offset by a one-time payment associated with the settlement of shareholder
litigation of approximately $30.7 million. The net repayment of debt for
1995 of $201.9 million was primarily due to the repayment of borrowings
associated with the sale of midrange lease assets.
The decrease of $52.9 million in cash balances during 1994 primarily
resulted from investments in equipment held for sale or lease of $93.3
million, and in property, plant and equipment of $120.1 million; offset by
income tax refunds received by Network Systems of $23.9 million. The
increase of $124.9 million in cash balances during 1993 reflects the net
proceeds of $166.5 million from the preferred stock offering, coupled with
the net cash generated by operating activities of $84.0 million, partially
offset by investments in property, plant and equipment of $83.4 million, and
net repayments of debt of $24.5 million.
The current ratio decreased to 1.8 as of December 29, 1995, from 2.0 as of
December 30, 1994. Accounts receivable increased from $353.5 million as of
December 30, 1994, to $396.5 million as of December 29, 1995, primarily due
to an increase in end-user sales in relation to sales-type leases.
Inventories decreased from $261.7 million as of December 30, 1994, to $214.6
million as of December 29, 1995, principally as a result of the sale of
substantially all of the Company's midrange business, as well as strong year-
end demand for Nearline products in 1995.
AVAILABLE FINANCING LINES
The Company has a $200 million secured multicurrency credit agreement with a
group of U.S. and international banks (the Revolver) which expires on March
29, 1996. The interest rates available under the Revolver depend on the
type of advance selected; however, the primary advance rate is the agent
bank's prime lending rate (8.5% at December 29, 1995). The total amount
available under the Revolver is limited to a monthly borrowing base
determined as a percentage of the Company's eligible accounts receivable,
lease assets (primarily net investments in sales-type leases not previously
utilized for other secured borrowings), and equipment awaiting revenue
recognition. To obtain funds under the Revolver, the Company is
PAGE
Page 28
required to comply with certain financial and other covenants, including
restrictions on the payment of cash dividends on its common stock. As of
December 29, 1995, the Company had no outstanding advances under the Revolver
and had approximately $116 million of available credit under the Revolver.
The Company expects to negotiate a new multicurrency credit agreement prior to
the expiration of the Revolver on March 29, 1996. There can be no
assurances, however, that the Company will be able to complete a new credit
agreement on terms acceptable to the Company.
The Company has historically provided lease financing to its customers and,
to the extent not funded with nonrecourse or other borrowings, utilized its
lease assets as a source of liquidity. As more fully discussed in Note 19
of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, the Company announced on
February 9, 1996, that it intends to sell its net investment in sales-type
leases and enter into a worldwide lease financing alliance. The Company
expects to close the proposed transaction by the end of the first quarter of
1996, and anticipates an extraordinary gain if the transaction is completed.
In connection with the sale of its net investment in sales-type leases, the
Company intends to repay its outstanding nonrecourse borrowings and its
9.53% Senior Secured Notes. The completion of this transaction is expected
to provide a significant one-time source of cash at the time of closing;
however, the Company would no longer have lease assets as a source of
liquidity on a going forward basis.
As more fully discussed in Note 19 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, on January 29, 1996, the Company entered into a one-year
agreement with a bank which provides for the sale of certain U.S. and
foreign based accounts receivable on a recourse basis. This agreement
allows for receivable sales of up to $40 million at any one time and
StorageTek's obligations under the agreement will be secured by a letter of
credit for the amount of the receivables sold. The selling price of the
receivables will be partially determined based upon foreign currency
exchange rates and any gains or losses on the sales will be recognized
within MG&A and Other in the Consolidated Statement of Operations at the
time the receivables are sold. As of February 23, 1996, the Company had
committed to future cumulative sales of approximately $206 million. Gains
and losses associated with the receivable sales are not expected to have a
material affect on the Company's reported financial results after taking
into consideration other transactions associated with the Company's
international operations.
After consideration of the factors noted above which potentially affect the
Company's future liquidity, the Company believes it has adequate working
capital and financing capabilities to meet its anticipated operating and
capital requirements for the next 12 months, including new product
offerings. Over the longer term, the Company intends to continue to commit
substantial amounts of its resources to research and development projects
and may, from time to time, as market and business conditions warrant,
invest in or acquire complementary businesses, products or technologies.
The Company may seek to fund these activities or possible transactions
through the issuance of additional equity or debt. The issuance of equity
or convertible debt securities could result in dilution to the Company's
stockholders. There can be no assurance that such additional financing, if
required, can be completed on terms acceptable to the Company.
PAGE
Page 29
LONG-TERM DEBT-TO-TOTAL CAPITALIZATION
The Company's long-term debt-to-total capitalization ratio increased to 27%
as of December 29, 1995, from 22% as of December 30, 1994. This increase
resulted from the exchange of $171.2 million of 7% convertible subordinated
debentures for all of the Company's outstanding preferred stock on December
15, 1995, and reductions in stockholders' equity resulting from the
restructuring and other charges of $212.2 million incurred during 1995.
REPAYMENT OBLIGATIONS AND CONVERSION FEATURES
Pursuant to the indenture related to the Company's 8% Convertible
Subordinated Debentures due 2015 (8% Convertible Debentures), the Company is
required to make semiannual interest payments on the $145.6 million
principal amount of the 8% Convertible Debentures outstanding. The 8%
Convertible Debentures are convertible at the option of the holder into
common stock at a price of $35.25 per share. The 8% Convertible Debentures
are currently redeemable at the option of the Company at a premium of 4.0%,
and are redeemable at decreasing premiums through May 30, 2000. The Company
is required to make annual principal payments of $8 million, plus accrued
interest, into a sinking fund beginning May 31, 2000, to provide for the
retirement of 75% of the 8% Convertible Debentures prior to their maturity
on May 31, 2015. 8% Convertible Debentures purchased by the Company in the
open market and 8% Convertible Debentures converted to common stock may be
applied to the sinking fund requirements. As of December 29, 1995, the
Company held 8% Convertible Debentures in the principal amount of $14.4
million available for sinking fund payments.
In connection with the Company's 9.53% Senior Secured Notes due August 31,
1996 (the Notes), the Company is required to make semiannual interest
payments on the $55 million principal amount outstanding. All principal
amounts are due and payable on August 31, 1996. The Notes are redeemable at
the option of the Company, in whole or in part, at a premium which is
determined based on current interest rates and the time remaining until
maturity. As further discussed in Note 19 of the NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS, the Company intends to prepay the Notes in March 1996
in connection with the sale of its net investment in sales-type leases.
On December 15, 1995, the Company exercised its right to exchange 7%
Convertible Subordinated Debentures due 2008 (7% Convertible Debentures) for
all of its outstanding shares of $3.50 Convertible Exchangeable Preferred
Stock, $.01 par value (Preferred Stock). The Preferred Stock was exchanged
at a rate of $50 principal amount of 7% Convertible Debentures for each
share of Preferred Stock. The exchange resulted in the Company issuing 7%
Convertible Debentures in the aggregate principal amount of $171.2 million.
Pursuant to the indenture related to the Company's 7% Convertible
Debentures, the Company is required to make semiannual interest payments on
the $171.2 million principal amount of the 7% Convertible Debentures
outstanding. The first interest payment is due March 15, 1996, for the
three-month period from the date of the exchange. The 7% Convertible
Debentures are unsecured, subordinated obligations of the Company and are
currently convertible into common stock at a price of $23.50 per share. The
7% Convertible Debentures are pari parsu with the Company's 8% Convertible
Debentures. The 7% Convertible Debentures are redeemable for cash at any
time on and after March 15, 1996, in whole or in part, at the option of the
Company, initially at a premium of 4.9%, and are redeemable at decreasing
premiums thereafter through
PAGE
Page 30
March 15, 2003. The Company is required to make annual payments into a
sinking fund beginning March 15, 2003, in the amount of $17.1 million to
provide for the retirement of 50% of the 7% Convertible Debentures prior to
their maturity on March 15, 2008. 7% Convertible Debentures purchased by
the Company in the open market and 7% Convertible Debentures converted to
common stock may be applied to the sinking fund requirements. As of
December 29, 1995, the Company held no 7% Convertible Debentures available
for sinking fund payments.
INTERNATIONAL OPERATIONS AND HEDGING ACTIVITIES
- -----------------------------------------------
In 1995, approximately 41% of the Company's revenue was generated by its
international operations. The majority of the Company's international
operations involve transactions denominated in the local currencies of
countries within Western Europe, principally Germany, France and the United
Kingdom; Japan; Canada and Australia. An increase in the exchange value of
the U.S. dollar reduces the value of revenue and profits generated by the
Company's international operations. As a result, the Company's operations
and financial results can be materially affected by changes in foreign
currency exchange rates.
In an attempt to mitigate the impact of foreign currency fluctuations, the
Company employs a hedging program which takes into account operating and
financing activities to reduce exposures and utilizes foreign currency
options and forward exchange contracts. The Company utilizes foreign
currency options, generally with maturities of less than one year, to hedge
a portion of its exposure to exchange-rate fluctuations in connection with
anticipated revenue from its international operations. Gains and losses on
the options are deferred and recognized as an adjustment to the hedged
revenue. The Company also utilizes forward exchange contracts, generally
with maturities of less than two months, to hedge its exposure to exchange-
rate fluctuations in connection with net monetary assets held in foreign
currencies. The forward contracts are marked-to-market each month with any
gains or losses recognized within MG&A and Other as an adjustment to the
foreign exchange gains and losses on the translation of net monetary assets.
See Note 15 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for additional
information with respect to the Company's foreign currency hedging
activities, including an assessment of the market and credit risks
associated with these activities. See "RISK FACTORS THAT MAY AFFECT FUTURE
RESULTS - INTERNATIONAL SALES AND OPERATIONS," below, for further discussion
of other factors which may affect the Company's international operations.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
- -------------------------------------------
NEW PRODUCTS AND TECHNOLOGICAL CHANGE
The Company believes that the successful and timely development of new
products, software applications and enhancements will play a key role in
determining its results of operations and competitive strength in the
future. During the past several years, the Company has introduced many key
products including Iceberg, Kodiak, TimberLine, RedWood, and PowderHorn, and
has plans to introduce new products and enhancements that it believes will
be key to its financial strength and competitiveness. In the past, the
Company has encountered defects which have delayed the introduction of new
products and product enhancements, and the manufacture of existing products.
These delays have, from time to time, adversely affected the Company's
financial results and competitive position in the market. There can be no
assurances that the
PAGE
Page 31
Company will not encounter product delays in the future, or that despite
intensive testing by the Company, flaws in design or production will not
occur, which could result in the Company experiencing a rate of failure in
its products that delay the sale of its products, trigger substantial repair
or replacement costs, excessive warranty claims and damage to the Company's
reputation and have a material adverse affect upon the Company's financial
results.
The market for the Company's products is characterized by rapid
technological advances which necessitate frequent product introductions and
enhancements, and can result in unpredictable product transitions,
significant price erosion, and shortened product life cycles. To be
successful in this market, the Company must make significant investments in
research and product development and introduce competitive new products and
enhancements to existing products on a timely basis. Delays associated with
development and introduction of new products have resulted, from time to
time, in the Company incurring significant accounting charges to reflect the
impaired values of associated business acquisitions, inventory, and other
product-line specific assets. There can be no assurance that new products
developed by the Company will be accepted in the marketplace. Moreover,
certain components of the Company's products operate near the present limits
of electronic and physical performance capabilities and are designed and
manufactured with relatively small tolerances.
DEPENDENCE ON IBM SYSTEMS
Many of the Company's products are designed to be compatible with certain
IBM operating systems and many of its products function like IBM equipment
due to the significance of the IBM computer operating environments. Future
revenue from products and services is therefore dependent on the
marketplace's continued widespread acceptance of and IBM's continued support
of these products. While the Company believes that customers will continue
to use, and IBM will continue to support, these operating systems and
products, there can be no assurances of such continued use and support. A
significant shift away from the mainframe environment or modifications in
the design or configuration of IBM computers may have a material adverse
affect on the Company's business. The Company is adapting its product
offerings to address the client-server market through the development of
network attached storage products; however, most of these products are only
in the engineering phase of development. There can be no assurances that
the Company will be successful in timely developing and marketing products
to address the rapidly expanding client-server market.
INTENSE COMPETITION; PRICING PRESSURES
The Company competes with a number of large multinational companies that
have substantially greater resources than the Company's, including IBM,
Fujitsu Ltd., and Hitachi, Ltd., as well as similarly sized companies,
including Amdahl Corporation and EMC Corporation. Industry estimates
currently show that while demand for online storage capacity in the
enterprise marketplace is expected to increase in 1996, price erosion is
expected to more than offset this growth in demand. Competition could be
affected by cooperative alliances and relationships with competitors and
prospective customers that may emerge and rapidly acquire market share,
which may have a material adverse affect on the Company's business and
financial results.
The Company competes with a number of networking companies that have a
greater presence in the networking marketplace, including 3Com, Cisco
Systems, Inc., Cabletron Systems, Inc. and Bay Networks, Inc. The
operating results of the Company's networking product line did not meet its
expectations in 1995 due to difficulties encountered with the integration of
Network Systems, and delays in the development of ATM support for ERS. The
development of ATM support for
PAGE
Page 32
ERS is completely dependent upon the success of the Company's joint
development agreement with Northern Telecom, Inc. The Company does not
anticipate ATM support for ERS will become available until 1997. There
can be no assurance that the Company's joint development agreement with
Northern Telecom, Inc. will be successful, or that the Company's networking
product line will generate any significant future profits. The Company's
inability to successfully and timely develop and introduce new network
products and product enhancements, expand its market penetration through
new distribution channels and improve the margins on its network products
through effective cost controls could have a material adverse affect on
the Company's future business and financial results.
The Company is adapting its product offerings for, and intensifying its
activities in, the client-server arena in response to the migration toward
shared data storage. The Company anticipates that its ability to compete in
the client-server systems market will depend on a number of factors within
and outside its control, including the timely introduction and performance
of products for the client-server market introduced by the Company and its
competitors.
INTELLECTUAL PROPERTY
The Company's competitive strength is affected by its ability to protect its
proprietary information. StorageTek protects its intellectual property
rights through a combination of patents, trademarks, copyrights,
confidentiality procedures, trade secret laws and licensing arrangements.
The Company's policy is to apply for patents, or other appropriate
proprietary or statutory protection when it develops new or improved
technology that is important to its business. Such protection, however, may
not preclude competitors from developing products similar to the Company's
products. In addition, competitors may attempt to restrict the Company's
ability to compete by advancing various intellectual property law theories
which could, if enforced by the courts, restrict the Company's ability to
develop and manufacture interoperable products. Also, the laws of certain
foreign countries do not protect the Company's intellectual property rights
to the same extent as the laws of the United States. The Company also
relies on certain technology that is licensed from others. The Company is
unable to predict whether these license arrangements can be renewed on terms
acceptable to the Company. The Company's intellectual property rights are
material to the Company's business. The failure to successfully protect its
intellectual property rights or obtain licenses from others as needed could
have a material adverse affect on the Company's business and financial
results.
The high technology industry is characterized by vigorous pursuit and
protection of intellectual property rights or positions, which in some
instances has resulted in significant litigation and is often protracted and
expensive. Litigation by or against the Company could result in significant
expense and divert the efforts of the Company's technical and management
personnel, whether or not such litigation results in any determination
unfavorable to the Company. In the event of an adverse result in any such
litigation, the Company could be required to pay substantial damages, cease
the manufacture, use and sale of infringing products, expend significant
resources to develop non-infringing technology, discontinue the use of
certain processes, enter into royalty arrangements, or obtain licenses to
the infringing technology. There can be no assurances that the Company
would be successful in such development or that such license or royalty
arrangements would be available on reasonable terms, or at all, and any such
development or license could require expenditures by the Company of
substantial time and other resources. The Company has, from time to time,
commenced actions against other companies to protect or enforce its
intellectual property rights. Similarly, the Company has, from time to
time, been notified that it may be infringing certain patent or other
intellectual property rights of others. Currently, the Company is involved
in a number of proceedings relating to its intellectual property
PAGE
Page 33
and patent infringement. See Part III, Item 3, "Legal Proceedings" and
Note 14 of NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS for additional
information with respect to the Company's legal proceedings.
INTERNATIONAL SALES AND OPERATIONS
During 1995, approximately 41% of the Company's revenue was derived from
sales in markets outside the United States, primarily in Europe. The
Company expects that international sales will continue to account for a
significant portion of its revenue for the foreseeable future. During 1995,
the Company commenced manufacturing operations in Toulouse, France and plans
to expand the volume of its production at the Toulouse facility in 1996.
The Company's international business may be affected by changes in demand
resulting from localized economic and market conditions. For example, in
the past, the Company's business has been adversely affected by recessions
in Europe. In addition, the Company is subject to the risks of conducting
business outside the United States, including fluctuations in foreign
currency exchange rates, changes in or impositions of legislative or
regulatory requirements, tariffs, quotas, difficulty in obtaining export
licenses, potentially adverse taxes, the burdens of complying with a variety
of foreign laws and other factors outside the Company's control. In
addition, the laws of certain foreign countries in which the Company's
products are or may be manufactured or sold may not protect the Company's
intellectual property rights to the same extent as the laws of the United
States. To date, the Company has not experienced any material adverse
affects on its operations as a result of the foregoing factors. There can
be no assurances, however, that one or more of the foregoing factors will
not have a material adverse affect on the Company's business or financial
results in the future.
MANUFACTURING RISKS; DEPENDENCE ON SUPPLIERS
The Company generally uses standard parts and components for its products
and believes that, in most cases, there are a number of alternative,
competent vendors for most of those parts and components. However, the
Company purchases certain important components and products from single
suppliers that the Company believes are currently the only manufacturers of
the particular components that meet the Company's qualification requirements
and other specifications. In addition, the Company manufactures some key
components, or its products include components, for which alternative
sources of supply are not readily available. In the past, certain of the
Company's suppliers have experienced occasional technical, financial or
other problems that have delayed deliveries, without significant effect on
the Company. An unanticipated failure of any sole source supplier to meet
the Company's requirements for an extended period, or an interruption of the
Company's ability to secure comparable components, could have a material
adverse affect on its revenue and results of operations. In the event a
sole source supplier was unable or unwilling to continue to supply
components, the Company would have to identify and qualify other acceptable
suppliers. This process could take an extended period and no assurance can
be given that any additional source would become available or would be able
to satisfy the Company's production requirements on a timely basis.
RESTRUCTURING PLAN
During the fourth quarter of 1995, the Company recorded a restructuring
charge of $167.2 million to cover the costs of work force reductions of
approximately 1,700 employees, facility closings and consolidations, and
asset writedowns. This restructuring was adopted in an effort to establish
a more competitive cost structure in response to slower revenue growth and
increasing price competition in the marketplace. In connection with the
restructuring, the Company plans to focus
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on core businesses and outsource non-strategic activities, rearchitect its
distribution processes and accelerate the integration of Network Systems,
which was acquired in March 1995. There can be no assurance that the Company
will achieve anticipated expense reductions, or that the Company's
restructuring activities will otherwise be successful or sufficient to allow
the Company to generate improved operating results in future periods. It is
possible that changes in the Company's business or in its industry may
necessitate future restructuring charges, which may be significant. See
Item 1, Part 1, "Restructuring Plan," "Restructuring and Other Charges,"
above, and Note 16 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for
additional information regarding the Company's restructuring plan.
EARNINGS FLUCTUATIONS
The Company's reported earnings have fluctuated significantly and may
continue to fluctuate significantly from quarter to quarter due to a variety
of factors including, among others, the effects of (i) customers' historical
tendencies to make purchase decisions near the end of the calendar year,
(ii) the timing of the announcement and availability of products and product
enhancements by the Company and its competitors, (iii) fluctuating foreign
currency exchange rates, (iv) longer than anticipated customer acceptance
periods for the Company's products, and (v) changes in the mix of products
sold.
VOLATILITY OF STOCK PRICE
The trading price of the Company's common stock has fluctuated and in the
future may fluctuate substantially in response to reported earnings,
industry conditions, new product or product development announcements by the
Company or its competitors, announced acquisitions and joint ventures by the
Company or its competitors, general market and economic conditions,
international currency fluctuations and other events or factors. Further,
the volatility of the stock markets in recent years has caused wide
fluctuations in trading prices of stocks of high technology companies
independent of their individual operating results. In the future, the
Company's reported earnings may be below the expectations of stock market
analysts and investors, and in such events, there could be an immediate and
significant adverse affect on the trading price of the Company's common
stock.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data listed in the Index to
Consolidated Financial Statements at Item 14 of this Form 10-K are
incorporated by reference into this Item 8 of Part II of this Form 10-K.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
There have been no disagreements with the Company's independent accountants
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure or any reportable events.
As described in the Company's current report on Form 8-K dated as of April
3, 1995, and amended by Forms 8-K/A dated April 7, 1995 and April 12, 1995,
at a meeting of the Company's Audit Committee held on March 16, 1995, the
Committee determined to engage the accounting firm of Price Waterhouse LLP
(Price Waterhouse) as independent accountants for all subsidiaries of the
Company for 1995, subject to approval of shareholders. The shareholders
ratified the appointment on May 24, 1995, at the Annual Meeting of
Sharehol