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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 26, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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 of Each Class on which Registered
- ------------------------------------------------- -----------------------------
Common Stock ($.10 par value), including related New York Stock Exchange
preferred stock purchase rights
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
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. [ ]
The aggregate market value of voting stock held by nonaffiliates of the
registrant was $3,653,084,526 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 February 27, 1998. 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 certain 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.
As of February 27, 1998, there were 53,525,048 shares of common stock of the
registrant outstanding.
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 its
fiscal year ended December 26, 1997. Portions of the registrant's definitive
proxy statement for its annual meeting of stockholders to be held on May 21,
1998 are incorporated by reference into Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
Storage Technology Corporation and its subsidiaries ("StorageTek(R)" or the
"Company") design, manufacture, market and maintain information storage systems
and network products. The Company's principal product lines include tape and
robotic storage subsystems (Nearline(R)), random access storage subsystems
(online) and network products. Nearline products include magnetic tape storage
devices and automated tape libraries. Online products include rotating magnetic
disk devices that utilize fault-tolerant array technology (RAID). Network
products include connectivity and security products. StorageTek maintains a
worldwide customer service organization to install, maintain and service its own
and third-party equipment. StorageTek also offers consulting services with a
focus on information storage systems management and solution integration
services. StorageTek's products are used by customers that include large
corporations, governmental agencies, and educational, financial, medical and
scientific institutions located worldwide.
StorageTek operates in one principal industry segment. StorageTek conducts its
business through a number of business groups that are focused on dynamic
markets. These groups include: the Enterprise Business Group, which develops and
markets Nearline and online products that are designed for the mainframe and
network-attached storage market, and network security and channel extension
products; the Multiplatform Systems Business Group, which develops and markets
products for the client/server market; and, the Solutions Business Group, which
provides maintenance and consulting services in information storage management
and solutions integration. The Company believes this organizational structure
allows it to efficiently focus on developing and selling information storage
products and solutions. The Company continually evaluates its organizational
structure and at any time may create or discontinue business groups to meet
changing customer demands and emerging technologies.
In 1997, the Company reorganized its sales and support field operations in North
America. In Europe, the Company is implementing a Pan-European sales and service
model. These new structures are designed to align the sales and support
functions with the Company's business group model that focuses on specific
market segments. The Company is also focusing activities on expanding its
indirect distribution channels through OEM and value-added reseller
arrangements, such as the Company's worldwide, non-exclusive OEM agreement with
International Business Machines Corporation (IBM) for mainframe online products.
StorageTek's business model is focused on delivering information storage
solutions for the mainframe and client/server marketplaces. The Company's
strategy includes: identifying new storage solutions; developing or acquiring
access to technologies that address the identified solutions through research
and development activities or the development of strategic relationships; and
delivering these solutions through the most effective distribution channels. To
this end, the Company continues to establish strategic alliances and
partnerships with other manufacturers, developers, distributors
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and suppliers. As a result of these relationships, it is possible for other
companies to be at various times collaborators, competitors and customers in
different markets.
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 ASSUMPTIONS, ANTICIPATIONS, EXPECTATIONS AND FORECASTS CONTAINED IN THE
FOLLOWING DESCRIPTION REGARDING THE COMPANY'S FUTURE PRODUCT AND BUSINESS PLANS,
FINANCIAL RESULTS, PERFORMANCE AND EVENTS ARE FORWARD-LOOKING STATEMENTS. THE
COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY BECAUSE OF A NUMBER OF RISKS AND
UNCERTAINTIES, SOME OF THESE RISKS ARE 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," AND ELSEWHERE IN THIS
FORM 10-K.
STATEMENTS MADE HEREIN ARE ACCURATE ONLY AS OF THE DATE OF FILING OF THIS FORM
10-K WITH THE SECURITIES AND EXCHANGE COMMISSION AND MAY ONLY BE RELIED UPON AS
OF THAT DATE. THE COMPANY DISCLAIMS ANY OBLIGATION TO UPDATE INFORMATION OR
FORECASTS CONTAINED HEREIN, EXCEPT AS MAY OTHERWISE BE REQUIRED BY LAW.
PRINCIPAL PRODUCTS
Product sales, including software license fees, accounted for approximately 72%
of total revenue in 1997, while maintenance revenue accounted for the balance.
The following table presents revenue by product line, which includes both
product sales and maintenance revenue:
REVENUE BY PRODUCT LINE
- ---------------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDED DECEMBER
1997 1996 1995
--------------------- --------------------- ---------------------
$ million % $ million % $ million %
---------- ---- ---------- ----- ---------- -----
Nearline products $1,382.7 64.5 $1,328.2 65.1 $1,197.7 62.1
Online products 519.6 24.2 429.3 21.1 375.9 19.5
Network and other products 242.4 11.3 282.1 13.8 355.9 18.4
-------- ----- -------- ----- -------- -----
Total Revenue $2,144.7 100.0 $2,039.6 100.0 $1,929.5 100.0
======== ===== ======== ===== ======== =====
- -----------------------------------------------------------------------------------------------------------------
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 14 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, of this Form 10-K.
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NEARLINE PRODUCTS
StorageTek's Nearline products include its Automated Cartridge System (ACS)
library and associated tape cartridge storage products. The Company's current
library products include the PowderHorn(R)9310, which became available in the
second quarter of 1993, and the first generation 4410 ACS library, which has
been available since 1988. The Company also offers the TimberWolf(TM)automated
tape library product family that is designed to provide high-capacity, low cost
storage solutions for the client/server environment. The first TimberWolf
library product became available in the second quarter of 1996.
The Company's tape cartridge storage products include: the TimberLine(R)
9490-M44, which has been available since October 1997; the TimberLine 9490, a
high-performance 36-track cartridge subsystem, which became available in the
fourth quarter of 1994; the Twin Peaks 4890 36-track cartridge subsystem, a
cartridge subsystem designed for the client/server market, which has been
available since the second quarter of 1996; the RedWood(R) SD-3, a high-capacity
cartridge subsystem, which became available in the first quarter of 1995; the
Silverton 4490, 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 designed
to expand the range of applications for and enhance the performance of its
Nearline products.
The Company is currently developing new Nearline products and enhancements. In
October 1997, the Company announced a new data storage management solution,
Virtual Storage Manager (VSM(TM)), a mainframe tape subsystem designed to
improve performance, cartridge utilization and storage management. VSM is
currently in the engineering validation testing phase and is currently targeted
to become available in the second half of 1998. The Company is also developing a
number of other tape products, all of which are in the design, preliminary
engineering or engineering validation testing phase and for which no
availability dates have been announced. 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 online products consist of direct access storage device (DASD)
products targeted at the mainframe and client/server markets. The
characteristics of these products differ principally in information storage
capacity, transfer rate, access time, attachment protocol and cost. In 1996 and
1997, the Company entered into worldwide, non-exclusive OEM agreements with IBM.
Under the 1997 OEM agreement, which replaced the parties' 1996 agreement, the
Company develops and manufactures for IBM mainframe online storage products. IBM
currently serves as the primary distribution channel for the Company's mainframe
online storage products. Approximately 19% of the Company's total revenue during
1997 was derived from sales of mainframe online products to IBM and the Company
currently anticipates that it will derive a significant portion of its revenue
in
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1998 from product sales to IBM. The Company's strategic plans include the
development of other distribution channels for its mainframe online products.
However, there can be no assurances that the Company will continue to supply
products to IBM at current levels or that it will be successful in developing
other distribution channels. A reduction in the level of purchases by IBM could
have a significant adverse effect on the Company's operating results. See Part
II, Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Risk Factors That May Affect Future Results -
Dependence on IBM," of this Form 10-K for a discussion of certain risks that may
affect the Company's relationship with IBM and future results.
StorageTek introduced the OPENstorage(TM)Disk subsystem product family in the
third quarter of 1996, which is designed for multiplatform environments and
utilizes online disk storage array architecture. The OPENstorage product family
is sold through both direct and indirect sales channels.
StorageTek is currently developing a number of online products for the mainframe
and client/server markets. Under the OEM arrangement with IBM, the Company is
developing new online technology, some of which will be owned by IBM, and IBM
has granted the Company both royalty-bearing and royalty-free licenses to use
such technology. The Company expects to supplement the OPENstorage Disk product
family with additional client/server disk products designed to provide an
integrated solution and increase storage management functionality. These
products are currently in the design or preliminary engineering phase of
development and no availability dates have been announced.
NETWORK AND OTHER PRODUCTS
The Company's network product offerings include connectivity and security
solutions for high-performance, enterprise-wide information networks. In 1997,
the Company formed the Solutions Business Group. Through the Solutions Business
Group, the Company provides consulting services primarily in information storage
management and solution integration services. The Solutions Business Group is
also working with leading software vendors to provide storage solutions to
customers in applications such as document management, scientific applications,
check imaging, broadcasting and video solutions, and medical imaging.
MARKETING AND DISTRIBUTION; SERVICES
StorageTek is committed to a worldwide marketing and product maintenance
strategy. StorageTek sells its products and services to customers through a
combination of direct and indirect channels. StorageTek's direct sales and
maintenance force operates in offices located in major metropolitan areas in the
United States, Europe, Canada, Australia, Japan, Mexico, New Zealand, Singapore,
Malaysia and Brazil. Direct sales revenue accounted for approximately 60% of the
Company's total product sales revenue in 1997. The Company also sells its
products in certain international markets through independent distributors,
sometimes in tandem with direct sales operations, located in Africa, Asia,
Europe and South America. In 1997, the Company reorganized its sales and support
field operations in North America, and in Europe the Company is implementing a
Pan-Europe model. See Part II, Item 7, "Management's Discussion and
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Analysis of Financial Condition and Results of Operations -- Risk Factors That
May Affect Future Results - New Products, Markets and Distribution Channels" of
this Form 10-K for a discussion of certain risks associated with the
reorganization.
Indirect channels include: Original equipment manufacturers (OEMs), system
vendors that integrate the Company's products with other hardware and software
and provide independent marketing, service and support programs to their
customers; value-added resellers (VARs) and value-added dealers (VADs); and
independent distributors, who primarily serve markets in which StorageTek does
not have a direct presence. The indirect distribution channel accounted for
approximately 40% of the Company's total product sales revenue in 1997.
Significant OEM partnerships include the Company's relationships with IBM for
mainframe online products, NCR with respect to the TimberWolf 9710 ACS library
and Hewlett-Packard for a number of the TimberWolf products. The Company's
marketing activities include advertising in business and computer publications,
direct mailings and participating in trade shows. Further expansion of the
Company's direct and indirect sales channels is very important to achieving
significant market penetration for current and future products and the Company's
long-term success. Sales to IBM under the OEM agreement accounted for
approximately 19% of the Company's total revenue in 1997. A significant
reduction or delay in sales to IBM or other OEM customers or other major
end-user customers could adversely affect the Company's operating results.
Revenue from outside the United States accounted for approximately 34% of total
revenue in 1997, and 41% in each of 1996 and 1995. In each of these three fiscal
periods, over two-thirds of the Company's revenue originating outside the United
States was derived from Europe, with most of the remaining balance coming from
Japan, Australia and Canada. The Company is subject to various risks associated
with conducting business outside the United States. The Company believes that
its current international diversification will lessen the impact of adverse
economic changes in single regions. However, in the past, weak economic
conditions in Europe have negatively affected the Company's results. There can
be no assurances that an economic crisis in a particular geographic region will
not adversely affect the Company's operations and financial results. See Part
II, Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - International Operations and Market Risk
Management/Foreign Currency Exchange Risk," and Note 13 of NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS of this Form 10-K for a discussion of risk factors
associated with the Company's international business.
In 1997, maintenance revenue accounted for 28% of total revenue, compared to 27%
in 1996 and 30% in 1995. The Company generally warrants the performance of
products for a specified period of time, after which it services those products
under maintenance agreements for a fee. In response to continuing competitive
pressures, many of the Company's products include extended warranty periods.
Extending warranty periods may reduce future maintenance revenue and profit
margins.
The Company's primary distribution channel for mainframe online products is
currently the OEM channel, and the Company is increasing its OEM partnership
activities for other products. The increased reliance upon OEM relationships may
negatively affect
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future maintenance revenue, as OEM customers generally maintain their own
products. The Company expanded its maintenance services business model during
1997 to include providing customers full-shop maintenance services for
StorageTek equipment and equipment manufactured by other vendors.
As of December 26, 1997, the order backlog was approximately $27 million,
compared to approximately $43 million as of December 27, 1996. In 1997,
approximately 63% of the backlog amount was attributable to the Company's
library and tape products, as compared to 53% in 1996. In addition to these
backlog amounts, the Company also had approximately $51 million of inventory
held by customers on evaluation as of December 26, 1997, compared to
approximately $90 million as of December 27, 1996. Backlog amounts are
calculated on an "if sold" basis and include orders from end-users, OEMs, VARs,
VADs and distributors for products that StorageTek expects to deliver during the
following 12 months. Units held by customers on evaluation or covered by letters
of intent are not included in backlog amounts. Unfilled orders and orders with
respect to inventory held by customers on evaluation may be canceled by the
customer. Accordingly, backlog levels are not a reliable indicator of future
results, and there can be no assurance that orders in backlog or inventory held
by customers on evaluation will ultimately be recognized as revenue.
MANUFACTURING AND MATERIALS
The Company's primary manufacturing facilities are located in Puerto Rico,
Colorado, Minnesota, and France. The Company's manufacturing facilities are
currently in compliance with the ISO 9001 or 9002 international quality
standards.
StorageTek manufactures certain key components for its products. In addition, a
substantial portion of the Company's production costs is related to the purchase
of subassemblies, parts and components for its products from outside vendors
located within and outside the United States. The balance of the Company's
production costs relates 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. In particular, a key component of the
Company's tape drive heads is supplied by Sumitomo Corporation on a sole source
basis. The Company is also dependent on IBM for disk drives used in the
mainframe online products supplied to IBM under the OEM agreement. Dependence
upon single or limited source vendors involves a number of risks, including the
possibility of a shortage of key components, longer lead times, and reduced
control over production and delivery schedules.
The Company has long-term supply contracts with certain vendors and suppliers;
the remaining parts and components are obtained by delivering purchase orders to
vendors specifying the required 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 - Sole
Source Suppliers," of this Form 10-K for a discussion of factors that may affect
the Company's ability to obtain materials from sole source suppliers, which
information is incorporated by reference into Part I, Item 1 of this Form 10-K.
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COMPETITION
The markets for the Company's products and services are intensely competitive
and are subject to continuous, rapid technological change, frequent product
performance improvements, short product life cycles and price reductions. The
Company competes primarily on the basis of technology, performance, quality,
reliability, price, distribution and customer service. The Company believes that
its ability to compete depends on a number of factors, both within and outside
of its control, including the price and cost 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 United States. The Company expects that both the markets for its
products and services, and its competitors within such markets, will continue to
change in response to shifting customer storage requirements. In addition, stiff
competition has resulted in price reductions in the past and the Company expects
this trend to continue. As a result, the Company currently anticipates that it
will continue to adjust the price of many of its products and services in the
future.
In the mainframe information storage system market, the Company's competitors
include IBM, EMC, Fujitsu, and Hitachi. Competition in the client/server market
comes from the Company's traditional rivals, in addition to companies focused on
the client/server industry, such as Sun Microsystems, Compaq and
Hewlett-Packard. A number of the Company's competitors have significantly
greater market presence and financial resource than StorageTek.
In order to increase the rate of revenue growth and profitability, the Company
is focusing significant resources on product offerings for the client/server
market. Competition in the client/server market is aggressive and is based
primarily upon performance, quality, system scalability, price, service and name
recognition. The client/server market includes a broad spectrum of customers
including customers outside of the Company's traditional customer base. Many of
the Company's potential customers in the client/server market purchase their
storage requirements as part of a packaged server and storage product, which may
provide a competitive advantage to the Company's rivals. The Company expects to
address this issue by providing superior storage solutions and services that
operate across multiple computer platforms and by establishing distribution
relationships with these competitors.
In the consulting services and solutions integration market, the Company
competes against a number of large companies with an established presence in
this industry, including a number of equipment manufacturers with a larger
installed base of customers. From time to time, in connection with specific
projects, the Company partners with established companies in this market. The
Company's ability to compete in the consulting services and solutions
integration market is dependent upon its ability to attract and retain highly
skilled employees and the quality and price competitiveness of the Company's
solutions.
The quality and reliability of the Company's products and ongoing support for
its products are key elements of the Company's competitive strategy. The
Company's customer support organization operates worldwide and includes field
service engineers, and product support and administrative support personnel. The
customer support
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organization installs, maintains and services equipment manufactured by the
Company, as well as equipment manufactured by third parties. The Company
provides local customer support services from its offices located in major
metropolitan cities, with spare parts stored at regional locations. The Company
also has established several competency centers in the United States and Europe
to provide concept/design and engineering services to customers. StorageTek
believes that its installed base of products under maintenance agreements and
the expertise of the Company's customer service engineers are valuable assets of
the Company and believes they will be important competitive elements of the
Company's business in the future.
NEW PRODUCT DEVELOPMENT
StorageTek invests substantial resources to develop new products and product
enhancements. In 1997, 1996 and 1995, the Company recognized research and
development costs of approximately $210 million, $176 million and $187 million,
respectively. In order 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. For example, in 1995 the Company
acquired a network company. In 1996 and 1997, the Company entered into OEM
agreements with IBM under which IBM agreed to finance certain research and
development activities conducted by the Company associated with future
development and enhancements to mainframe online products. The Company's
research and development costs in 1998 will be affected by the level of funding
received from IBM, and other partners for new products. The Company anticipates
that its research and development costs will increase during 1998 as it focuses
on developing new mainframe products and products designed for the client/server
market.
As of December 26, 1997, approximately 1,350 employees were engaged on a
full-time basis in engineering and product development activities, primarily at
several facilities located in the United States, including Colorado and
Minnesota, and at facilities located in France and Australia. For further
discussion of risk factors concerning product development, see Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors that May Affect Future Results - New Products,
Markets and Distribution Channels," of this Form 10-K.
PATENTS AND LICENSES
StorageTek's ability to compete is affected by its ability to protect its
proprietary information. StorageTek protects its proprietary 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, in both
the United States and selected foreign countries to establish its proprietary
rights in new or improved technology. StorageTek currently holds over 377 United
States patents, as well as foreign counterparts to
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many of these patents in selected countries, covering various aspects of its
products. These patents will expire from 1998 through 2015. The Company also has
pending approximately 108 United States patent applications, including 6 that
have been allowed and are expected to be formally issued soon, as well as
pending foreign counterparts to many of these applications. In addition,
StorageTek has licenses to use patents held by others. For example, under the
OEM agreement between IBM and the Company, IBM has granted StorageTek both
royalty-bearing and royalty-free licenses to use technology developed under the
agreement. StorageTek owns, has license rights to, and/or has applied to
register over 70 trademarks in the United States and foreign jurisdictions.
Taken as a whole, these assets are material to the Company's business. However,
no individual patent, trademark, license or other item of proprietary
information is singularly material to the Company's business.
The Company has ongoing legal proceedings relating to certain of its patents.
For a discussion of certain legal proceedings relating to the Company's patents,
see Part I, Item 3, "Legal Proceedings" of this Form 10-K. For a discussion of
certain risk factors concerning proprietary information see Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors that May Affect Future Results - Patents and
Licenses," of this Form 10-K.
ENVIRONMENT
Compliance by the Company with the 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
effect on the Company. The Company did not have any material expenditures for
environmental control facilities in 1997. The Company does not currently have
pending and has not budgeted any material estimated expenditures for
environmental control facilities during 1998. However, potential liability under
environmental legislation is ongoing, regardless of whether or not the Company
has complied with existing governmental guidelines.
Government regulation of the environment and related compliance costs has
increased in recent years. The Company cannot predict the nature or scope of
future environmental laws or regulations, how they will be administered, or
whether compliance will require substantial expenditures. Based upon currently
available information, the Company does not expect future compliance with
existing environmental regulations will have a material effect on the financial
results and operations of the Company.
RESTRUCTURING PLAN
During the fourth quarter of 1995, the Company recorded a restructuring charge
of $167.2 million related to the adoption of a formal action plan for
restructuring several businesses. The restructuring was adopted in an effort to
establish a more cost-efficient business structure in response to competition.
Elements of the Company's restructuring plan included focusing on core
businesses, outsourcing non-strategic activities, rearchitecting its
distribution processes and channels, and accelerating the integration of Network
Systems Corporation. See Part II, Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Restructuring and Other
Charges," and Part IV, Item 14, Note 7 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, of this Form 10-K, for additional information concerning the 1995
Restructuring Plan.
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YEAR 2000
The Company's product lines include information storage systems and network
products which store, retrieve and transmit data. In order to properly process
data, the Company's products must manage and manipulate data that includes both
20th and 21st century dates (Year 2000 Compliant). The Company believes its
current products are Year 2000 Compliant provided they have been upgraded to
include all recommended engineering changes. There can be no assurance that the
Company's current products will be Year 2000 Compliant. In addition, the Company
does not currently intend to develop modifications to certain of its older
products to make them Year 2000 Compliant and plans to notify the affected
maintenance customers of this plan. The Company's inability to effectively
manage the year 2000 risks associated with its current and older product lines
could have material adverse effects, including increased warranty costs,
customer satisfaction issues and potential lawsuits.
The Company is currently in the process of replacing many of its internal
business and financial information systems. These systems are being replaced by
new systems which are believed to be Year 2000 Compliant. The Company is also
identifying and implementing changes to other information systems which are not
being replaced in order to make them Year 2000 Compliant. The Company
anticipates that the installation of its new information systems and changes to
its remaining information systems in order to make them Year 2000 Compliant will
be completed by the first half of 1999. The Company currently does not expect
that the year 2000 will cause operational problems or result in the Company
incurring material costs incremental to the cost of the information systems
projects currently underway. Delays in implementing these internal information
systems or a failure to fully identify all year 2000 dependencies in the
Company's internal information systems could have material adverse consequences,
including delays in the delivery or sale of the Company's products, or cause the
Company to incur increased costs.
EMPLOYEES
The Company employed approximately 8,300 persons on a full-time basis worldwide
as of December 26, 1997. The Company's future success is dependent, in part, on
its ability to continue to attract, retain and motivate skilled personnel.
OTHER MATTERS
The Company's results historically have experienced seasonality, with increased
sales revenue in the fourth quarter compared to other quarters because of
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 1998
and that revenue during the fourth quarter will be higher than any other
quarter.
During 1997, OEM sales to IBM accounted for approximately 19% of the Company's
total revenue and, at year-end, approximately 26% of the Company's outstanding
account receivable balance was due from IBM. No other single customer accounted
for 10% or more of the Company's total revenue in 1997.
No material portion of the Company's business is subject to contract termination
at the
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election of the United States 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 5 Description of the Company's debt, financing arrangements
and leasing obligations.
Note 9 Description of the Company's common stock repurchase
programs.
Note 13 Description of the Company's financial instruments and
off-balance-sheet risks - concentrations of credit risks.
Note 14 Information on the geographic operations of the Company's
single business segment. See also Part II, Item 7,
"Management's Discussion and Analysis of Financial
Condition and Results of Operations -- International
Operations and Market Risk Management/Foreign Currency
Exchange Risk," for further discussion of the risks
associated with the Company's 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 practices,
restructuring plans and risk factors that may affect future results.
ITEM 2. PROPERTIES
StorageTek conducts its operations worldwide and occupies both leased and owned
facilities. At the present time, such facilities are adequate for the Company's
purposes.
Colorado. StorageTek occupies facilities in 16 separate buildings in Boulder
County, Colorado, comprising approximately 1.9 million square feet. The Company
owns facilities with approximately 1.6 million square feet; the remaining space
is leased. These facilities include StorageTek's executive offices, as well as
manufacturing, research and development, and spare parts storage facilities.
Substantially all of the Boulder County space is fully utilized.
Other United States Properties. StorageTek owns approximately 199,000 square
feet of manufacturing facilities in the Palm Bay/Melbourne, Florida, area. A
majority of this space is leased to a third party. The Company owns 200,000
square feet of manufacturing, research and development, and administrative
facilities in the Minneapolis, Minnesota area, which are approximately 85%
utilized. The Company occupies manufacturing facilities in Puerto Rico, of which
approximately 78,000 square feet are owned and 50,000 square feet are leased.
The facilities in Puerto Rico are approximately 95% utilized. The Company also
leases office and customer facilities throughout the United States at
approximately 136 locations comprising approximately
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725,000 square feet.
International Properties. StorageTek leases approximately 200,000 square feet of
engineering, manufacturing and marketing facilities in Toulouse, France, which
are approximately 60% utilized. In addition, StorageTek leases facilities at
locations throughout the world, primarily for sales and customer support
activities, spare parts storage, and limited research and product development
activities. The Company maintains offices in 15 locations in Canada comprising
92,000 square feet, an office in Latin America comprising 7,000 square feet,
over 70 offices in Europe comprising approximately 453,000 square feet, and 12
offices in the Asia/Pacific region comprising approximately 93,000 square feet.
Many of the Company's leases throughout the world contain renewal rights,
cancellation rights and rights of first refusal on contiguous expansion space.
ITEM 3. LEGAL PROCEEDINGS
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. Stuff
appealed the dismissal to the Colorado Court of Appeals. In April 1996, the
trial court stayed discovery on the Company's counterclaim for breach of the
covenant not to sue pending resolution of the appeal. In March 1997, the Court
of Appeals reversed the District Court's judgment and remanded the case to the
District Court for further proceedings. In December 1997, the Colorado Supreme
Court rejected the Company's petition seeking a reversal of this decision. A new
trial date has not been set.
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 to
either 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
November 20, 1997, a jury determined in favor of the Company and awarded it
approximately $68 million in damages. Array and Tandem were awarded
approximately $8 million for amounts owed by StorageTek for inventory purchases.
On January 13, 1998, the parties filed a motion for dismissal to settle all
outstanding claims.
On June 29, 1995, Odetics, Inc. (Odetics) 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 "pass-through" 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's fees and costs. In
February 1996, a jury found that the Company's products did not infringe the 151
Patent. Odetics appealed and in June 1997, the U.S. Court of Appeals for the
Federal Circuit reversed the District Court's ruling and remanded
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the case back to the District Court for further proceedings. A new trial is
scheduled to commence in March 1998.
On December 8, 1995, Odetics 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 also infringes the 151 Patent. The complaint seeks
injunctive relief, treble damages in an unspecified amount, and an award of
attorney's fees and costs. This case has been stayed pending the outcome of the
case filed by Odetics on June 29, 1995, which is described above.
On July 30, 1996, the Company received Civil Investigative Demands (CIDs) from
the U.S. Department of Justice Antitrust Division concerning the OEM agreement
with IBM for mainframe online storage subsystems. The Company received
additional CIDs in 1996 and 1997. The CIDs requested production of documents and
testimony in connection with a review of the agreement for compliance with the
Sherman Act. On December 18, 1997, the DOJ filed a complaint and a proposed
settlement with the U.S. District Court for the District of Columbia. The
proposed settlement is set forth in a proposed consent decree, which will be
effective upon approval by the Court. The Court is expected to issue a ruling in
March 1998.
On October 3, 1995, certain former employees of the Company filed suit in the
U.S. District Court for the District of Colorado against the Company. The
amended suit alleges violations of the Age Discrimination in Employment Act
(ADEA) and the Employee Retirement Income Security Act (ERISA) between the
period of April 13, 1993, and December 31, 1996. On November 26, 1997, the Court
granted the plaintiffs' request to proceed as a collective action on the ADEA
claims and denied the plaintiffs' request to proceed as a class on the ERISA
claims. The plaintiffs seek, among other things, compensatory damages in an
unspecified amount, including the value of back pay and benefits; reinstatement
as employees or alternatively the value of future earnings and benefits; and
exemplary or liquidated damages. The Company has filed an answer denying both
the ADEA and ERISA claims. This case is in the discovery phase.
The Company believes it has adequate legal defenses with respect to each of the
actions cited above and intends to vigorously defend against these actions.
However, it is reasonably possible that these actions could result in outcomes
unfavorable to the Company. The Company is also involved in various other less
significant legal actions. 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 these actions is inherently difficult to predict. In
the event of an adverse outcome, the ultimate potential loss could have a
material adverse effect on the Company's financial position or reported results
of operations in a particular quarter. An unfavorable 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 these legal proceedings is also contained in Note 8 of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS included in Part IV, Item 14, of this
Form 10-K.
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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 26, 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following persons were serving as executive officers of the Company as of
March 6, 1998.
NAME POSITION WITH COMPANY AGE
- ----------------------------------------------------------------------------------------------------------
David E. Weiss.............. Chairman of the Board, President and Chief 53
Executive Officer
David E. Lacey.............. Executive Vice President and Chief Financial Officer 51
Victor Perez................ Executive Vice President, Enterprise Operations 47
Gary Francis................ Vice President and General Manager, Enterprise 50
Nearline Business Group
Sylvia Summers.............. Vice President and General Manager, 45
Multiplatform Systems Business Group
Thomas G. Arnold............ Vice President and Corporate Controller 36
Mr. Weiss has served as Chairman of the Board, President and Chief Executive
Officer since May 23, 1996. He served as Chief Operating Officer of the Company
from March 1995 to May 1996, Executive Vice President of Systems Development
from January 1993 to March 1995, 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. Mr. Weiss joined the Company
in February 1991 as Staff Vice President.
Mr. Lacey was appointed Executive Vice President and Chief Financial Officer on
May 23, 1996. From February 1995 to May 1996, Mr. Lacey served as Interim Chief
Financial Officer and Corporate Vice President. Mr. Lacey was appointed a
Corporate Vice President in December 1990 and served as Corporate Controller of
the Company from October 1989 to February 1995. Mr. Lacey has been employed by
the Company in various other capacities since 1985.
Mr. Perez was appointed Executive Vice President in October 1997. From June 1996
to November 1997, he served as Corporate Vice President and General Manager,
Enterprise DASD and International Manufacturing. From November 1995 to June
1996, Mr. Perez served as Corporate Vice President World Wide Manufacturing. Mr.
Perez was appointed Corporate Vice President in November 1994 and has been
employed by the Company in various other capacities since 1979.
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Mr. Francis was appointed as Vice President and General Manager of Nearline
Business Group in February 1997. From September 1993 to February 1997, Mr.
Francis served as Vice President of the Nearline Line of Business and from
August 1992 to September 1993 served as Director of Strategic Planning. Mr.
Francis has been employed by the Company in various other capacities since 1976.
Ms. Summers was appointed Vice President and General Manager, Multiplatform
Business Group in May 1997. Prior to joining StorageTek, Ms. Summers was with
Bull Corporation, Paris, France, where she served as Vice President, Storage
Business Group from April 1996 to April 1997, and Vice President Software
Solutions from February 1994 to April 1997.
Mr. Arnold was appointed Vice President and Corporate Controller in April 1997.
From November 1995 to April 1997, he served as Director of Worldwide
Consolidation and Reporting. Mr. Arnold served as Manager of External Reporting
from April 1991 to November 1995. Mr. Arnold has been employed by the Company in
various other capacities since 1989.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY 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 during each fiscal quarter
of 1997 and 1996. On December 26, 1997, there were 13,151 record holders of
common stock of StorageTek.
1997 High Low
------------------------------------------------------------------
First Quarter $53.875 $37.250
Second Quarter 46.125 34.000
Third Quarter 54.000 45.125
Fourth Quarter 66.375 48.000
1996 High Low
------------------------------------------------------------------
First Quarter $31.250 $22.375
Second Quarter 42.875 24.375
Third Quarter 40.000 31.875
Fourth Quarter 51.000 38.000
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.
The Company's existing $350 million credit agreement contains provisions
restricting the payment of cash dividends.
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ITEM 6. SELECTED FINANCIAL DATA
The following data, insofar as it relates to the three fiscal years 1995 through
1997 (except for the 1995 Balance Sheet Data), has been derived from the
consolidated financial statements appearing elsewhere herein, including the
Consolidated Balance Sheet as of December 26, 1997, and December 27, 1996, and
the related Consolidated Statement of Operations for each of the three years in
the period ended December 26, 1997, and notes thereto. The data, insofar as it
relates to the Balance Sheet Data as of December 29, 1995, December 30, 1994,
and December 31, 1993, and the Statement of Operations Data for the fiscal years
1994 and 1993, 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
--------------------------------------------------------------------------------
1997 1996 1995 1994 1993
--------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA
Revenue $ 2,144,656 $ 2,039,550 $ 1,929,485 $ 1,871,350 $ 1,617,691
Cost of revenue 1,171,530 1,192,777 1,217,622 1,186,942 1,072,784
----------- ----------- ----------- ----------- -----------
Gross profit 973,126 846,773 711,863 684,408 544,907
Research and product development costs 209,526 176,422 187,275 206,083 191,048
Marketing, general, administrative and
other income and expense, net 472,839 444,870 445,889 425,490 393,991
Restructuring and other charges (Note 7) 212,207 8,000(b) 90,414(c)
----------- ----------- ----------- ----------- -----------
Operating profit (loss) 290,761 225,481 (133,508) 44,835 (130,546)
Interest income, net 25,356 1,211 8,978 6,103 18,585
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes,
accounting change and extra-
ordinary item 316,117 226,692 (124,530) 50,938 (111,961)
Provision for income taxes (84,300) (55,900) (17,800) (18,900) (9,500)
----------- ----------- ----------- ----------- -----------
Income (loss) before accounting
change and extraordinary item 231,817 170,792 (142,330) 32,038 (121,461)
Cumulative effect of accounting change 40,000
Extraordinary gain, net of taxes 9,535
----------- ----------- ----------- ----------- -----------
Net income (loss) $ 231,817 $ 180,327 $ (142,330) $ 32,038 $ (81,461)
=========== =========== =========== =========== ===========
Basic earnings (loss) per common share: (a)
Income (loss) before accounting
change and extraordinary item $ 3.86 $ 3.04 $ (2.91) $ 0.39 $ (2.59)
Net income (loss) 3.86 3.21 (2.91) 0.39 (1.80)
Diluted earnings (loss) per common share: (a)
Income (loss) before accounting
change and extraordinary item $ 3.79 $ 2.86 $ (2.91) $ 0.38 $ (2.59)
Net income (loss) 3.79 3.01 (2.91) 0.38 (1.80)
BALANCE SHEET DATA
Working capital $ 661,206 $ 724,171 $ 425,351 $ 501,065 $ 492,576
Total assets 1,740,017 1,884,276 1,888,629 2,144,458 2,064,851
Total debt 22,391 155,257 449,222 464,690 469,490
Stockholders' equity 1,112,503 1,180,983 962,833 1,265,285 1,215,877
- ----------------
(a) Earnings per share data has been restated for 1996 and prior years to
conform with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share."
(b) In 1994, the Company recognized restructuring charges of $8,000,000.
(c) In 1993, the Company recognized restructuring charges of $77,832,000;
acquired research and development expenses of $7,060,000; and merger
expenses of $5,522,000.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
ALL ASSUMPTIONS, ANTICIPATIONS, EXPECTATIONS AND FORECASTS CONTAINED IN THE
FOLLOWING DISCUSSION REGARDING THE COMPANY'S PRODUCT AND BUSINESS PLANS,
FINANCIAL RESULTS, PERFORMANCE AND EVENTS ARE FORWARD-LOOKING STATEMENTS. THE
COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY BECAUSE OF A NUMBER OF RISKS AND
UNCERTAINTIES, SOME OF THESE RISKS ARE DETAILED BELOW IN "RISK FACTORS THAT MAY
AFFECT FUTURE RESULTS" AND ELSEWHERE IN THIS FORM-10K.
STATEMENTS MADE HEREIN ARE ACCURATE ONLY AS OF THE DATE OF FILING THIS FORM 10-K
WITH THE SECURITIES AND EXCHANGE COMMISSION AND MAY ONLY BE RELIED UPON AS OF
THAT DATE. THE COMPANY DISCLAIMS ANY OBLIGATION TO UPDATE INFORMATION ON
FORECASTS CONTAINED HEREIN, EXCEPT AS MAY BE OTHERWISE REQUIRED BY LAW.
GENERAL
The Company reported net income for the year ended December 26, 1997, of $231.8
million on revenue of $2.14 billion, compared to net income for the year ended
December 27, 1996, of $180.3 million on revenue of $2.04 billion and a net loss
for the year ended December 29, 1995, of $142.3 million on revenue of $1.93
billion. The Company's results include an extraordinary gain on sale of lease
assets of $9.5 million in 1996, and restructuring and other charges of $212.2
million in 1995.
Revenue increased 5% in 1997 compared to 1996. The increase in revenue in 1997
is primarily because of increased sales of client/server tape and disk products,
mainframe online products, and increased consulting services revenue. Mainframe
Nearline product sales generated by the Company's applications initiative more
than offset decreased sales of earlier generation Nearline products and price
declines associated with the TimberLine(R)9490. Revenue associated with network
products declined in 1997. Revenue during 1997 was reduced by unfavorable
foreign currency exchange rate movements, particularly in Europe. The overall
gross profit margin increased during 1997, principally because of increased
manufacturing volumes of online products.
Revenue increased 6% in 1996 compared to 1995, primarily because of increased
sales revenue from mainframe Nearline products, mainframe online products,
client/server tape libraries, and application sales. Revenue from older
generation Nearline products decreased during 1996 as compared to 1995. Revenue
from network and other products also declined in 1996 as compared to 1995,
primarily because of the continued decline in revenue from a number of older
network products, the sale of a non-strategic network business during the third
quarter of 1996, and the sale of substantially all of the Company's midrange
lease assets and midrange service business in 1995.
The Company's future revenue and operating results are significantly dependent
upon the continued demand for mainframe Nearline and online products in their
traditional markets; expanding the market for and increasing sales of mainframe
Nearline products and products for the client/server environment through the
successful development and introduction of new products and applications;
expanding marketing and distribution channels; and successfully establishing the
Company's consulting services business. For discussion of these and other risk
factors, see "Risk Factors That May Affect Future Results" below.
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The Company's cash balances decreased $132.1 million during 1997. Net cash flows
generated from operations of $446.7 million were more than offset by the
repurchase of 9.2 million shares of the Company's common stock at a cost of
$485.0 million, investments in property, plant and equipment of $65.9 million,
and short-term investments of $48.1 million. The Company's cash balances
increased $123.9 million during 1996. Net cash flows generated from operations
in 1996 of $464.7 million include cash received from the sale of substantially
all of the Company's lease assets. Cash from operating activities during 1996
was partially utilized by the repurchase of 4.5 million shares of the Company's
common stock for $195.5 million, net repayments of debt of $100.0 million and
net investments in property, plant and equipment of $68.9 million.
The following table, stated as a percentage of total revenue, presents
Consolidated Statement of Operations information and revenue by product line,
which includes both product sales and maintenance revenue.
Year Ended December
1997 1996 1995
-----------------------------------------------
Revenue:
Nearline products 64.5% 65.1% 62.1%
Online products 24.2 21.1 19.5
Network and other products 11.3 13.8 18.4
------ ------ ------
Total revenue 100.0 100.0 100.0
Cost of revenue 54.6 58.5 63.1
------ ------ ------
Gross profit 45.4 41.5 36.9
Research and product development costs 9.8 8.6 9.7
Marketing, general, administrative and other
income and expense, net 22.0 21.8 23.1
Restructuring and other charges 11.0
------ ------ ------
Operating profit (loss) 13.6 11.1 (6.9)
Interest income, net 1.1 0.4
------ ------ ------
Income (loss) before income taxes and
extraordinary item 14.7 11.1 (6.5)
Provision for income taxes (3.9) (2.7) (0.9)
------ ------ ------
Income (loss) before extraordinary item 10.8 8.4 (7.4)
Extraordinary gain, net of income taxes 0.4
------ ------ ------
Net income (loss) 10.8% 8.8% (7.4)%
====== ====== ======
REVENUE
NEARLINE PRODUCTS
Revenue from Nearline products increased 4% in 1997 compared to 1996, primarily
because of increased sales of TimberWolf, a line of smaller-scale tape libraries
designed for client/server attachment; and sales of RedWood SD-3, a high
capacity cartridge subsystem. The Company's initiative to develop new
applications for its Nearline products was a significant contributor to the
increase in RedWood sales in 1997. The Company's new applications include
document management, scientific applications, check imaging, broadcasting and
video solutions, and medical imaging. Unit sales of the TimberLine, a 36-track
cartridge subsystem, increased in 1997, as compared to 1996, but sales revenue
decreased as a result of a decline in the average selling price of these
products. Sales of the PowderHorn 9310, an automated
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cartridge system library, and earlier generation Nearline products also
decreased in 1997 as compared to 1996. Nearline revenue was unfavorably affected
by foreign currency exchange rate movements during 1997.
Revenue from Nearline products increased 11% in 1996 compared to 1995, primarily
because of increased sales revenue from TimberLine. RedWood, PowderHorn and
TimberWolf also contributed to increased revenue during 1996. Revenue from
earlier generation Nearline products decreased in 1996 as compared to 1995.
The Company anticipates a slow growth rate in the market for mainframe tape
products as customers continue to transition to the client/server environment.
Future revenue growth for Nearline products is dependent upon successfully
developing and introducing new Nearline products, the continued success of the
Company's applications development initiative and expanding the indirect
distribution channels for the Company's client/server products through
agreements such as the original equipment manufacturer (OEM) agreement with
Hewlett-Packard announced in the fourth quarter of 1997. In October 1997, the
Company announced the Virtual Storage Manager (VSM), a mainframe data storage
management solution designed to improve performance, cartridge utilization, and
overall storage management. Failure to timely develop and introduce VSM and
other new Nearline products and features currently under development may
negatively impact the Company's results and long-term success. There can be no
assurance that the Company will continue to expand the Nearline market through
its application development efforts or that it will continue to be successful in
expanding the indirect distribution channels for its client/server Nearline
products.
ONLINE PRODUCTS
Revenue from online products increased 21% in 1997 as compared to 1996 because
of increased sales of mainframe online products under the OEM agreement with IBM
and increased sales of products in the Company's OPENstorage Disk subsystem
family for the client/server market.
Revenue from online products increased 14% in 1996 as compared to 1995. This
increase in revenue was primarily because of increased sales volume of mainframe
online products under the OEM agreement with IBM in the second half of 1996,
coupled with end-user sales of mainframe online products in the first half of
1996. These increases were partially offset by a decrease in revenue
contribution from earlier generation online products.
Approximately 19% of the Company's total revenue during 1997 was derived from a
worldwide non-exclusive OEM agreement under which the Company develops and
manufactures mainframe online storage products for IBM. In December 1997, the
Company entered into a new OEM agreement with IBM which expires in December
2000. IBM is not subject to any long-term volume purchase commitments; however,
IBM does receive volume-purchase discounts under this new agreement. IBM may
elect to terminate the agreement for convenience or for cause, or upon certain
instances of change in control or the occurrence of certain other conditions.
The Company may elect to terminate the agreement for cause. There can be no
assurance that the Company will continue to realize benefits associated with the
agreement. See "Risk Factors That May Affect Future Results - Dependence on
IBM," for further discussion of the risks associated with the OEM agreement.
The Company made significant investments during 1997 associated with its
entrance into the client/server disk market. Success in the client/server disk
market is critical to the Company's
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plans to grow revenue in the future. The Company plans to enhance its current
product line in 1998 with new products which provide the customer with an
integrated solution and increase storage management functionality. In addition
to successfully managing the risks associated with introducing these new
products, the Company must continue to establish new cost-effective, high-volume
distribution channels for these products. There can be no assurance that the
Company will be successful in its client/server disk initiative.
NETWORK AND OTHER PRODUCTS
Revenue from network and other products decreased 14% in 1997, as compared to
1996, primarily because of continued declines in sales from network products.
This decrease was partially offset by an increase in consulting services
revenue.
Revenue from network and other products decreased 21% in 1996 compared to 1995.
This decrease was primarily because of the decline in revenue from network
products, the sale of a non-strategic network business and the sale of the
midrange lease assets and the midrange service business.
GROSS PROFIT
Overall gross profit margins increased to 45% in 1997, as compared to 42% in
1996 and 37% in 1995. The increase in 1997 was primarily because of increased
manufacturing volumes of mainframe online products. The increase in 1996 was
primarily because of cost savings achieved in connection with the Company's 1995
restructuring and increased manufacturing volumes.
Gross profit on product sales increased to 46% in 1997, as compared to 39% in
1996, principally as a result of increased manufacturing volumes of mainframe
online products, increased sales of higher-margin software products and cost
reductions associated with the manufacturing process. Product sales margins in
1997 also benefited from a change in the classification of advanced
manufacturing costs of approximately $34.7 million, which are included within
research and product development costs in the 1997 Consolidated Statement of
Operations. Gross profit on product sales increased to 39% in 1996, as compared
to 37% in 1995, primarily as a result of cost savings achieved in connection
with the Company's 1995 restructuring, increased manufacturing volumes and lower
purchase costs associated with components for online and Nearline products.
Product sales margins in 1996 also benefited from reduced sales revenue
contribution from lower-margin midrange products as a result of the sale of this
business.
Gross profit on maintenance revenue decreased to 45% in 1997, as compared to 47%
in 1996. The decline is principally attributable to reduced margins associated
with the Company's consulting services business. Gross profit on maintenance
revenue increased to 47% in 1996, as compared to 36% in 1995. This increase is
primarily because of continued cost savings associated with the 1995
restructuring and reduced maintenance revenue contribution from lower-margin
midrange services as a result of the sale of the midrange service business in
1995.
The market for most of the Company's products is subject to intense price
competition. The Company anticipates it will continue to experience price
competition as it expands into the client/server storage market. The Company's
ability to sustain or improve product sales margins is significantly dependent
upon continued success in reducing manufacturing costs in
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all of its product lines. The Company anticipates that the product sales margins
for its mainframe online products may decline because of volume-purchase
discounts under the terms of the OEM agreement with IBM. Product sales margins
also may be affected by inventory reserves and writedowns resulting from rapid
technological changes and delays in gaining market acceptance for new products.
Maintenance margins may be adversely affected in the future as a result of
increased competition and lower margins associated with mainframe products and
the Company's consulting services business.
RESEARCH AND PRODUCT DEVELOPMENT
Research and product development expenditures increased 19% in 1997, as compared
to 1996. Research and product development costs for 1997 include incremental
costs of approximately $34.7 million because of a change in the classification
of costs associated with certain advanced manufacturing activities that were
previously included within cost of sales in the 1996 Consolidated Statement of
Operations. After considering this reclassification, research and product
development costs were relatively unchanged in 1997, as compared to 1996.
Increased investments during 1997 in developing new client/server tape and disk
products, and new mainframe Nearline products were offset by the receipt of
additional funding from IBM for certain research and development activities on
mainframe online products under the terms of the OEM agreement. Research and
product development expenditures decreased 6% in 1996, as compared to 1995,
primarily as a result of research and development funding from IBM. The
Company's research and development costs in 1998 will be affected by the level
of funding received from IBM and other partners for the development of new
products. The Company anticipates that its research and development costs will
increase during 1998 as it focuses on developing new mainframe products and
products designed for the client/server market.
MARKETING, GENERAL, ADMINISTRATIVE AND OTHER
Marketing, general, administrative and other income and expense (MG&A) increased
6% in 1997, as compared to 1996. The increase is primarily because of spending
on internal business and financial information systems, employee profit-sharing
and bonus expenses associated with increased earnings levels, and marketing
expenses associated with the Company's client/server storage initiative. The
increase was partially offset by gains realized on the sale of accounts
receivable of $33.8 million in 1997. MG&A remained relatively unchanged in 1996,
as compared to 1995, as cost savings associated with the 1995 restructuring were
partially offset by increased marketing expenses.
Gains and losses associated with foreign currency transactions and translation
adjustments, net of associated hedging results, are included in MG&A and
aggregated a net gain of $0.5 million for 1997, compared to net losses of $0.5
million in 1996 and $4.3 million in 1995. See "INTERNATIONAL OPERATIONS" and
"MARKET RISK MANAGEMENT / FOREIGN CURRENCY EXCHANGE RISK," below, for further
discussion of the foreign exchange risks associated with the Company's
international operations and the related foreign currency hedging activities.
INTEREST INCOME AND EXPENSE
Interest income increased 10% in 1997, as compared to 1996, primarily as a
result of an increase in cash available for investment. Interest expense
decreased 82% in 1997, as compared to 1996, primarily because of the redemption
of all of the Company's outstanding convertible debentures. Interest income
decreased 37% and interest expense decreased 24%
24
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in 1996, as compared to 1995, primarily because of the Company's sale of its
lease financing business.
The Company anticipates its net interest income will decline during 1998
primarily as a result of the Company's plan to use some of its cash to complete
the repurchase of up to $800 million of its common stock. See "Liquidity and
Capital Resources - Working Capital," for further discussion of the Company's
stock repurchase plan.
INCOME TAXES
Statement of Financial Accounting Standards (SFAS) No. 109 requires that
deferred income tax assets be recognized to the extent realization of such
assets is more likely than not. Based on the currently available information,
management has determined that the Company will more likely than not realize
$140.0 million of deferred income tax assets as of December 26, 1997. The
Company's valuation allowance of approximately $22.5 million as of December 26,
1997, was established based upon the consideration of a variety of factors,
including the Company's earnings history, the number of years the Company's
operating loss and tax credits can be carried forward, the existence of taxable
temporary differences, near-term expectations, and the highly competitive nature
of the high-technology marketplace.
The Company anticipates that the effective tax rate will exceed the U.S. federal
income tax rate of 35% in 1998 as the Company has recognized substantially all
of its remaining net deductible temporary differences, tax credit carryforwards
and net operating loss carryforwards in the United States.
RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges for the year ended December 29, 1995, consisted
of the following (in thousands of dollars):
Restructuring charges $167,175
Litigation settlement 30,680
Merger and consolidation charges 14,352
--------
$212,207
========
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The following table summarizes the activity in the Company's restructuring
reserves (in thousands of dollars):
Employee Asset Lease Other
Severance Writedowns Abandonments Exit Costs Total
-----------------------------------------------------------
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
Cash payments (26,837) (2,907) (9,414) (39,158)
Reclassifications 301 (154) 1,222 1,369
--------- -------- -------- -------- -----------
Balances, December 27, 1996 16,152 0 15,477 1,980 33,609
Cash payments (6,718) (1,550) (577) (8,845)
Reclassifications 5,560 (1,858) (1,174) 2,528
--------- -------- -------- -------- -----------
Balances, December 26, 1997 $ 14,994 $ 0 $ 12,069 $ 229 $ 27,292
========= ======== ======== ======== ===========
RESTRUCTURINGS
During the fourth quarter of 1995, the Company recorded a restructuring charge
of $167.2 million in connection with the adoption of a formal action plan for
restructuring its enterprise and network businesses. The restructuring was
adopted in an effort to establish a more cost-efficient business structure in
response to competition. Elements of the Company's restructuring plan included
focusing on core businesses and outsourcing non-strategic activities,
rearchitecting its distribution processes and channels, and accelerating the
integration of Network Systems Corporation, which was acquired in March 1995.
Reclassifications were made in 1997 and 1996 to reflect revised estimates of the
various components of the restructuring. Reclassifications had no effect on the
Consolidated Statement of Operations.
The remaining restructuring reserves relate principally to the Company's plans
to further integrate its sales administration organization and rearchitect its
distribution processes in the United States and Europe. While the majority of
these remaining accruals are expected to result in future cash outflows, these
outflows are not expected to have a material effect on the Company's liquidity.
The Company believes that its restructuring programs have eliminated certain
non-essential functions and excess costs. There can be no assurance, however,
that the Company's restructuring activities will be successful or sufficient to
allow the Company to continue to generate improved operating results in future
periods. It is possible that changes in the Company's business or in its
industry may necessitate restructuring charges in the future.
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LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL
The Company's cash balances decreased $132.1 million from December 27, 1996, to
December 26, 1997. Cash generated from operations of $446.7 million during 1997
was more than offset by the cash used to repurchase 9.2 million of the Company's
common shares. Net purchases of property, plant and equipment of $65.9 million
and an increase in short-term investments of $48.1 million also contributed to
the decrease in cash balances during 1997. In October 1997, the Company
announced a plan to repurchase up to $800 million of its common stock through
open market purchases and privately negotiated transactions. In connection with
the plan announced in October 1997, the Company repurchased and retired 8.0
million shares of its common stock during 1997 pursuant to a privately
negotiated transaction, resulting in an initial cash outflow of $431.3 million.
The final purchase price of the common stock is subject to adjustment based on
the trading price of the common stock during a defined period. Any price
adjustment will be reflected as an adjustment to capital in excess of par value
on the Consolidated Statement of Changes in Stockholders' Equity. Repurchases of
common stock associated with the plan announced in October 1997 are expected to
be completed by the end of 1998. In February 1997, the Company announced a
program to repurchase up to 1.5 million shares of common stock on an annual
basis. As of December 26, 1997, the Company had repurchased 1.2 million shares
of common stock under this program, resulting in a total cash outflow of $53.7
million.
The Company's cash balances increased $123.9 million from December 29, 1995, to
December 27, 1996. The increase in cash balances in 1996 primarily resulted from
cash generated from operations of $464.7 million, which was offset by net
repayments of debt of $100.0 million, the repurchase of 4.5 million shares of
common stock for a purchase price of approximately $195.5 million, investments
in property, plant and equipment of $68.9 million and an increase of short-term
investments of $29.2 million. Net cash from operating activities during 1996
includes cash received from the sale of lease assets and cash payments
associated with the 1995 restructuring.
The current ratio decreased to 2.1 as of December 26, 1997, from 2.4 as of
December 27, 1996, primarily because of an increase in accounts payable and
accrued liabilities. Accounts receivable increased from $554.2 million as of
December 27, 1996, to $628.0 million as of December 26, 1997, primarily as a
result of increased sales revenue and a receivable from IBM which was collected
in January 1998. Inventories decreased from $288.6 million as of December 27,
1996, to $205.5 million as of December 26, 1997, principally as a result of a
reduction in raw materials and benefits associated with a recently implemented
finished goods inventory delivery process.
AVAILABLE FINANCING LINES
In 1997, the Company replaced its $150 million unsecured credit agreement with a
$350 million unsecured credit agreement which expires in October 2001 (the
Revolver). The credit limit available under the Revolver will be reduced by
$12.5 million on the last day of each calendar quarter beginning December 31,
1998. The interest rates under the Revolver depend on the type of advance
selected. The basic advance rate is no less than the London Interbank Offered
Rate (LIBOR) plus 0.75% (6.75% as of December 26, 1997). Under the Revolver, the
Company is required to comply with certain financial and other covenants,
including restrictions on the payment of cash dividends on its common stock. As
of December 26, 1997, the
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Company had issued letters of credit for approximately $25.4 million and had
approximately $324.6 million of available credit under the Revolver.
The Company has a financing agreement with a bank which provides for the sale of
promissory notes in the principal amount of up to $140 million at any one time.
The agreement, which expires in July 1999, provides for commitments by the bank
to purchase promissory notes denominated in a number of foreign currencies. The
notes must be repaid only to the extent of future revenue of the Company and
obligations under the agreement are not cancelable by the Company or the bank.
Transaction gains and losses related to the notes are deferred and recognized as
an adjustment to the revenue supporting the note repayment. The promissory
notes, together with accrued interest, are payable in U.S. dollars within 40
days from the date of issuance and bear interest at rates no less than the LIBOR
rate plus 0.35% (6.35% as of December 26, 1997). Under the terms of the
agreement, the Company is required to comply with certain covenants which
include the maintenance of a collateral account, including cash and qualifying
investments, in an amount of no less than the outstanding promissory notes. As
of December 26, 1997, the Company had no outstanding borrowings and had
committed to borrowings between January 1998 and December 1998 in the cumulative
principal amount of approximately $198.3 million.
The Company had a financing agreement with a bank which provided for the sale of
certain U.S. and foreign based accounts receivable on a recourse basis which
expired on January 31, 1998. This agreement allowed for receivable sales of up
to $40 million at any one time with the Company's obligations under the
agreement secured by a letter of credit for the amount of the receivables sold.
The selling price of the receivables was partially determined based upon foreign
currency exchange rates, and any gains or losses on the sales were recognized
within MG&A in the Consolidated Statement of Operations at the time the
receivables were sold. During 1997, the Company sold approximately $308.1
million of receivables in connection with this agreement. As of December 26,
1997, the outstanding balance associated with receivables sold on a recourse
basis, but not collected, was approximately $24.8 million. As of December 26,
1997, the Company had committed to receivable sales of approximately $39.9
million. Gains and losses associated with receivable sales did not have a
material effect on the Company's reported financial results after taking into
consideration other transactions associated with the Company's international
operations.
The Company intends to continue to commit substantial 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 believes it has adequate working capital and financing
capabilities to meet its anticipated operating and capital requirements for the
next 12 months. Over the longer term, the Company may choose to fund these
activities through the issuance of additional equity or debt financing. 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.
TOTAL DEBT-TO-TOTAL CAPITALIZATION
The Company's total debt-to-total capitalization ratio decreased from 12% as of
December 27, 1996, to 2% as of December 26, 1997 as a result of the conversion
of the Company's convertible debentures in 1997.
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INTERNATIONAL OPERATIONS
During 1997, 1996 and 1995, approximately 34%, 41% and 41%, respectively, of
the Company's revenue was generated by its international operations. The
decrease in 1997 is principally because of the OEM sales of mainframe online
products to IBM, which occurred domestically in 1997. The Company's 1997
international operating income includes $40.0 million of expense associated with
the transfer of technology to a wholly-owned subsidiary in anticipation of a
future off-shore manufacturing operation. The Company expects that a significant
portion of revenue will be generated from international operations in the
future. The majority of the Company's international operations involves
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 operating and financial results can be
materially affected by fluctuations in foreign currency exchange rates. In an
attempt to mitigate the impact of foreign currency fluctuations, the Company
employs a hedging program which utilizes foreign currency options and forward
exchange contracts. See "MARKET RISK MANAGEMENT / FOREIGN CURRENCY EXCHANGE
RISK," below.
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 weak economic
conditions in Europe. The Company does not currently anticipate that the
economic crisis in Asia will have a material adverse effect on the Company's
future financial results. The Company is subject to the risks of conducting
business outside the United States, including 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. There
can be no assurances that one or more of the foregoing factors will not have a
material adverse effect on the Company's business or financial results in the
future.
MARKET RISK MANAGEMENT / FOREIGN CURRENCY EXCHANGE RISK
The market risk inherent in the Company's financial instruments relates
primarily to changes in foreign currency exchange rates. To mitigate the impact
of foreign currency fluctuations, the Company seeks opportunities to reduce
exposures through financing activities and utilizes foreign currency options and
forward exchange contracts to further reduce any remaining exposures. All
foreign currency options and forward exchange contracts are authorized and
executed pursuant to the Company's policies. Foreign currency options and
forward exchange contracts that are designated as and qualify as hedging
transactions are subject to hedge accounting treatment. The Company does not
hold or issue financial instruments, foreign currency options or forward
exchange contracts for trading purposes. See Note 13 to the NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS for further discussion of the Company's
financial instruments and off-balance-sheet risks.
The Company has a financing agreement with a bank which provides for commitments
by the bank to purchase promissory notes denominated in a number of foreign
currencies. Transaction gains and losses related to the notes are deferred and
recognized as an adjustment to the revenue supporting the note repayment. See
"Available Financing Lines" above for further discussions of the financing
agreement.
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The Company periodically 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 associated with the options are
deferred and recognized as an adjustment to the associated revenue at the same
time as the underlying anticipated transactions. To the extent that an option
which qualified for hedge accounting is terminated or ceases to be effective as
a hedge, any deferred gains and losses up to that point continue to be deferred
and are recognized as an adjustment to the associated 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 anticipated monetary assets and liabilities held in foreign
currencies and anticipated revenues from its international operations. The
carrying amounts of these forward foreign exchange contracts equal their fair
value as the contracts are adjusted at each balance sheet date for changes in
exchange rates. Gains and losses on the forward contracts used to hedge monetary
assets and liabilities are recognized as incurred within MG&A on the
Consolidated Statement of Operations as adjustments to the foreign exchange
gains and losses on the translation of net monetary assets. Gains and losses on
the forward contracts used to hedge anticipated revenue are recognized as
incurred as an adjustment to revenue.
A hypothetical 10% adverse movement in foreign exchange rates applied to the
Company's foreign currency exchange rate sensitive instruments held as of
December 26, 1997, would result in a hypothetical loss of approximately $26.6
million. This hypothetical loss does not take into consideration the Company's
underlying international operations. The Company anticipates that any
hypothetical loss associated with the Company's foreign currency exchange rate
sensitive instruments would be offset by gains associated with its underlying
international operations.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
NEW PRODUCTS, MARKETS AND DISTRIBUTION CHANNELS
The Company's results of operations and competitive strength depend upon its
ability to successfully develop, manufacture and market innovative new products
and product enhancements. Short product life cycles are inherent to the
high-technology market. The Company must devote significant resources to
research and product development projects and effectively manage the risks
inherent in new product transitions. Developing new technology and products is
complex and involves uncertainties. Delays in product development,
manufacturing, or in customer purchasing decisions can make product transitions
difficult. In addition, product transitions make the process of production and
inventory planning more difficult as the Company must accurately anticipate
product mix and configuration demands, and accurately forecast inventory levels.
The Company has experienced product development delays in the past that
adversely affected the Company's financial results and competitive position.
There can be no assurances that the Company will be able to successfully manage
the development and introduction of new products and product enhancements in the
future.
The Company historically has generated a significant portion of its revenue and
operating profits from mainframe products. The rate of growth in the mainframe
market has slowed as a result of customers shifting their storage requirements
from the mainframe to the client/server environment. The Company's future
financial results are significantly dependent upon successfully introducing new
products for the client/server environment. The Company
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currently is making significant investments in research and development
activities focused on new products for the client/server markets currently
planned for introduction in 1998. The Company must also establish new
cost-effective, high-volume distribution channels for these products. There can
be no assurances that the Company will be successful in these activities.
The Company also has implemented an applications development initiative, which
is intended to develop new applications for its products. The new applications
initiative was successful in developing new markets for the Company's mainframe
Nearline products during 1997. However, there can be no assurances that the
Company's client/server products and applications development activities will
result in increased revenue and profitability during 1998.
In the fourth quarter of 1997, the Company reorganized its sales and support
field operations in North America. In Europe, the Company is implementing a
Pan-European sales and service model. These new structures are designed to align
the sales and support functions with the Company's business group model that
focuses on specific market segments. The Company believes the reorganization
will allow it to more effectively deliver information storage solutions to its
customers and achieve cost-savings. The reorganization may cause temporary
disruptions in sales and support field operations and may adversely affect the
Company's revenue and operating results.
The Company's greater dependence on indirect distribution channels, such as OEMs
and value-added resellers, will make production and inventory planning more
complex. In the event an indirect partner establishes a new relationship with a
competitor or experiences financial difficulties, the Company's operating and
financial results may be adversely affected. See "Dependence on IBM," below, for
a discussion of issues associated with the Company's distribution channels for
its mainframe online products.
DEPENDENCE ON IBM
In 1997, approximately 19% of the Company's total revenue was derived from OEM
sales of mainframe online products to IBM. The Company currently anticipates
that it will derive a significant portion of its sales revenue in 1998 from
product sales to IBM. Under the worldwide, non-exclusive OEM agreement entered
into during December 1997, IBM is not subject to any long-term volume purchase
commitments, however, IBM does receive volume-purchase discounts. IBM may
terminate the agreement under certain conditions. The Company's success under
the OEM agreement is significantly dependent upon achieving certain product
development, delivery and performance milestones. The Company's success is also
dependent upon IBM continuing to successfully market the mainframe online
products, and developing and delivering to the Company disk drives for inclusion
in the products. Because of the volume-purchase discounts included in the OEM
agreement, the Company must continue to reduce costs and expenses associated
with manufacturing the products in order to achieve the expected benefits. The
OEM relationship may also cause the Company to incur additional costs associated
with unanticipated increases or decreases in manufacturing and inventory
volumes. There can be no assurances that the Company will achieve the milestones
contained in the OEM agreement or that IBM will successfully market these
products in the future.
In December 1997, the Company and IBM agreed to a settlement with the United
States Department of Justice (DOJ) concerning the Company's OEM relationship
with IBM. The terms of the settlement are contained in a proposed consent decree
which was filed with the U.S. District Court for the District of Columbia on
December 18, 1997. The proposed consent decree will be effective upon approval
by the court. The court is expected to issue a ruling in
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March 1998. Under the terms of the proposed consent decree, which will expire in
December 2002, the Company must develop new distribution channels for its online
products during 1998 or the Company will be subject to limitations on its sales
to IBM in the future. The Company's OEM agreement with IBM expires in December
2000 and IBM has indicated that it is currently developing a competitive online
product. Failure to develop new distribution channels for the Company's
mainframe online products could adversely affect the Company's ability to sell
its mainframe online products in future periods. See Note 8 of NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS for further information regarding the DOJ
investigation.
COMPETITION
The markets for the Company's products and services are intensely competitive.
In the mainframe market, the Company's traditional competitors include IBM, EMC,
Fujitsu and Hitachi. In an effort to increase the rate of revenue growth and
profitability, the Company has entered the client/server storage market.
Competition in the client/server market comes from the Company's traditional
rivals, in addition to companies focused on the client/server industry, such as
Sun Microsystems, Compaq and Hewlett-Packard. A number of the Company's
competitors have significantly greater market presence and financial resources
than the Company. In addition, many of the Company's potential customers in the
client/server market purchase their storage requirements as part of a packaged
server and storage product, which may provide a competitive advantage to the
Company's rivals. The Company expects to address this issue by providing
superior storage solutions that operate across multiple computer platforms and
by establishing distribution relationships with these competitors. There can be
no assurances that the Company will be able to successfully compete against
other companies in the mainframe and client/server market.
PATENTS AND LICENSES
The Company's patents and other proprietary rights are material assets and key
elements of the business and competitive strength. The Company protects its
proprietary information 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 in the United States and other selected
countries to establish its proprietary rights in new and improved technology.
There can be no assurances, however, that these arrangements will successfully
preclude competitors from developing products similar to the Company's products,
or that the Company's proprietary rights will not be challenged, invalidated, or
circumvented, or that these rights will provide significant competitive
advantages. The Company also relies on technology that is licensed from others,
such as IBM. The Company is unable to predict whether its licensing arrangements
can be renewed in the future on terms acceptable to the Company.
In order to protect and enforce its proprietary rights, from time to time the
Company has commenced legal actions against other companies. Similarly, other
companies have brought legal actions against the Company claiming infringement
of patent or other proprietary rights. Licenses or royalty arrangements are
generally offered in these situations. However, any litigation by or against the
Company, with or without merit, may result in significant expense and divert the
efforts of the Company's technical and management personnel. In the event of a
successful claim of infringement against the Company, 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; or discontinue the use of certain processes if the Company is unable
to enter into royalty arrangements. As a result of an
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increasingly complex and diverse competitive environment, the Company
anticipates that the volume of proprietary rights claims will grow. There can be
no assurances that litigation will not be commenced against the Company in the
future involving patents, copyrights, trademarks or trade secrets, or that the
Company will be able to obtain any licensing, royalty or other rights on
acceptable terms. The Company currently is involved in legal proceedings
involving its proprietary rights and alleging patent infringement. See Note 8 of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for additional information with
respect to these legal proceedings.
VOLATILITY OF STOCK PRICE; EARNINGS FLUCTUATIONS
The trading price of the Company's common stock has fluctuated significantly in
the past and may fluctuate significantly in the future. 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,
broad market trends unrelated to the Company's performance, changes in revenue
or earnings estimates by the investment community, global economic conditions
and foreign currency exchange rate fluctuations are among the factors that can
affect the Company's stock price. In addition, if the Company's reported
operating results are below the expectations of stock market analysts and
investors, there could be an immediate and significant adverse effect on the
trading price of the Company's common stock.
The Company's operating results have fluctuated significantly in the past and
may continue to fluctuate in the future. Fluctuations are caused by factors such
as customers' historical tendencies to make purchase decisions near the end of
the quarter, the timing of the announcement and availability of new products by
the Company and its competitors, fluctuating foreign currency exchange rates,
changes in the mix and configuration of products sold, rapid price erosion, the
purchasing patterns of the Company's OEM partners and global economic
conditions.
SOLE SOURCE 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. Certain of the Company's key
components and products are purchased 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 or for
which alternative sources of supply are not readily available. In particular, a
key component of the Company's tape drive heads is supplied by Sumitomo
Corporation on a sole source basis and the Company is dependent on IBM for disk
drives used in products manufactured for IBM under an OEM agreement. Certain of
the Company's suppliers have experienced occasional technical, financial or
other problems in the past that have delayed deliveries, but 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 in
the Company's ability to secure comparable components, could have a material
adverse effect on the Company's revenue and operating results. 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.
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RISKS ASSOCIATED WITH THE YEAR 2000
The Company's product lines include information storage systems and network
products which store, retrieve and transmit data. In order to properly process
data, the Company's products must manage and manipulate data that includes both
20th and 21st century dates (Year 2000 Compliant). The Company believes its
current products are Year 2000 Compliant provided they have been upgraded to
include all recommended engineering changes. There can be no assurance that the
Company's current products will be Year 2000 Compliant. In addition, the Company
does not currently intend to develop modifications to certain of its older
products to make them Year 2000 Compliant and plans to notify the affected
maintenance customers of this plan. The Company's inability to effectively
manage the year 2000 risks associated with its current and older product lines
could have material adverse effects, including increased warranty costs,
customer satisfaction issues and potential lawsuits.
The Company is currently in the process of replacing many of its internal
business and financial information systems. These systems are being replaced by
new systems which are believed to be Year 2000 Compliant. The Company is also
identifying and implementing changes to other information systems which are not
being replaced in order to make them Year 2000 Compliant. The Company
anticipates that the installation of its new information systems and changes to
its remaining information systems in order to make them Year 2000 Compliant will
be completed by the first half of 1999. The Company currently does not expect
that the year 2000 will cause operational problems or result in the Company
incurring material costs incremental to the cost of the information systems
projects currently underway. Delays in implementing these internal information
systems or a failure to fully identify all year 2000 dependencies in the
Company's internal information systems could have material adverse consequences,
including delays in the delivery or sale of the Company's products, or cause the
Company to incur increased costs.
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.
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.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Company's directors required by this Item is
incorporated by reference from the information set forth under the caption
"Proposal 1--Election of Directors" in the Company's definitive Proxy Statement
concerning the Annual Meeting of Stockholders to be held May 21, 1998 (the "1998
Proxy Statement"). The information concerning the Company's executive officers
required by this Item is incorporated by reference to the information set forth
under the caption "Executive Officers of the Registrant," in Part I of this
Annual Report on Form 10-K.
The information concerning compliance with Section 16(a) of the Securities
Exchange Act of 1934, as amended, required by this Item is incorporated by
reference to the information set forth under the caption "Compensation of
Executive Officers -- Section 16(a) Beneficial Ownership Reporting Compliance"
in the 1998 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
information under the captions "Compensation of Executive Officers" and
"Standard Arrangements for Compensation of Directors" in the 1998 Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information under the caption "Voting Securities of the Company -- Security
Ownership" in the 1998 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
The information required by this Item is incorporated by reference to the
information under the captions "Standard Arrangements for Compensation of
Directors" and "Compensation of Executive Officers" in the 1998 Proxy Statement.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. Financial Statements: PAGE
Consolidated Balance Sheet at December 26, 1997,
and December 27, 1996 F-1
Consolidated Statement of Operations for the
Years Ended December 26, 1997, December 27, 1996,
and December 29, 1995 F-2
Consolidated Statement of Cash Flows for the
Years Ended December 26, 1997, December 27, 1996,
and December 29, 1995 F-3
Consolidated Statement of Changes in Stockholders'
Equity for the Years Ended December 26, 1997,
December 27, 1996, and December 29, 1995 F-4
Notes to Consolidated Financial Statements F-5
Report of Independent Accountants F-26
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts and Reserves F-27
All other schedules are omitted because they are not applicable, or the required
information is included in the consolidated financial statements or notes
thereto.
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3. Exhibits: