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FORM 10-K
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 25, 1998
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, 80028-4309
Colorado (Zip Code)
(Address of principal executive offices)
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
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Common Stock ($.10 par value), including
related preferred stock purchase rights New York Stock Exchange
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 $2,557,715,628 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 26, 1999. For purposes of this
disclosure, shares of common stock held by persons who hold more than 5% of the
outstanding common stock and common stock held by executive officers and
directors of the registrant have been excluded in that such persons may be
deemed to be "affiliates" as that term is defined under the rules and
regulations promulgated under the Securities Act of 1933. This determination is
not necessarily conclusive for other purposes.
As of February 26, 1999, there were 99,928,022 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 25, 1998. Portions of the registrant's definitive
proxy statement for its annual meeting of stockholders to be held on May 20,
1999, are incorporated by reference into Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
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Storage Technology Corporation (StorageTek(R) or the Company) designs,
manufactures, markets and maintains information storage products, information
storage services and storage management software. For three decades, the Company
has provided customers with high-performance storage products. The Company
provides customers with a broad range of products, including tape, disk and
network products; storage services, including support services, integration
services, IT business consulting and technology services; and storage management
software.
The Company's business is organized into three reportable business segments:
storage products, storage services and storage management software. The Company
continually evaluates its organizational structure and, from time to time, may
determine to create, discontinue, merge or reconfigure its organizational
structure to meet changing customer demands, sales channels, and product and
services offerings.
The Company's products are used by a range of customers that include large
multinational companies, small businesses, and governmental agencies,
encompassing a wide range of industry sectors, including financial, retail,
telecommunications, airlines and services, as well as educational, scientific
and medical institutions located around the world. The Company markets its
products and services through its direct sales organization and indirect sales
channels, including original equipment manufacturer (OEM), value-added
distributor (VAD), value-added reseller (VAR) and other distribution
arrangements.
StorageTek's strategy is focused on providing information-centric solutions that
allow the customer to collect, move, store, share and protect digital
information. The Company's strategy of delivering solutions to customers which
turn data into information and information into power is founded on a virtual,
intelligent storage architecture ("VISTA") technology model, which is grounded
in a industry standard and a commitment to open storage management. The
following chart identifies the multi-layered VISTA model.
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Systems Management
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Applications
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Storage Management
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Storage Administration
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Storage Access
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Physical Storage
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The key features of the Company's VISTA model include open storage solutions
that allow the customer to mix-and-match products from a number of vendors;
intelligent storage solutions that contain embedded intelligence apart from the
server; and integrated storage solutions that provide customers with a complete,
scalable product hierarchy, storage management and services. StorageTek intends
to provide many of the components in the VISTA model, and to build partnerships
with other vendors to provide customers with total information-centric storage
solutions. To this end, StorageTek continues to establish strategic alliances
and partnerships with other manufacturers, developers, distributors and
suppliers. As a result, it is possible for other companies to be at various
times collaborators, customers and competitors in different markets.
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The Company 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 BE RELIED UPON ONLY 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
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StorageTek's business is organized into three reportable business segments:
storage products; storage services; and storage management software. The
Company's storage product offerings include tape, disk and network products.
Storage services offerings include support services for StorageTek and
third-party products, integration services, IT business consulting and
technology services. The storage management software segment sells and licenses
software products. The following table presents information about each of the
three business segments, including revenue from external customers and gross
profit. The Company does not allocate research and product development costs;
selling, general, administrative and other income and expense; interest income;
interest expense; provision for income taxes; or extraordinary items to the
segments. All of the Company's assets are retained and analyzed at the corporate
level and are not allocated to the individual segments.
REVENUE AND GROSS PROFIT BY BUSINESS SEGMENT
(IN THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER
1998 1997 1996
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Revenue
Storage products $1,520,647 $1,495,038 $1,452,871
Storage services 633,821 584,016 541,963
Storage management software 103,754 65,602 44,716
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Total revenue $2,258,222 $2,144,656 $2,039,550
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Gross profit
Storage products $ 688,050 $ 669,914 $ 567,285
Storage services 273,662 265,521 262,850
Storage management software 78,698 37,691 16,638
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Total gross profit $1,040,410 $ 973,126 $ 846,773
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Additional information concerning revenue from each of the Company's business
segments and geographic information is found in Part II, Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
in Part IV, Item 14, Note 13, of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, of
this Form 10-K, which information is incorporated by reference into this Part I,
Item 1.
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STORAGE PRODUCTS
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The Company's storage products, which accounted for 67% of total revenue in
1998, include a range of tape, disk and network products that serve as
components of the Company's VISTA model. The Company's storage products are
designed for the mainframe, client-server and evolving storage area network
(SAN) markets.
TAPE PRODUCTS
The Company's tape products historically have generated significant revenue for
the Company. The Company's tape products are engineered to provide reliable,
cost-effective storage of digital information. In December 1998, the Company
announced the availability of the 9840 product, a high-performance,
high-capacity tape drive. The 9840 tape drive is a new-generation tape drive
that is designed to provide fast data access, and support a broad range of
applications including backup and restore, hierarchial storage management (HSM),
and new applications enabled by this technology such as imaging and video
applications. The Company's other tape products include the TimberLine(R), a
high-performance 36-track cartridge subsystem, which first became available in
the fourth quarter of 1994; the Redwood(R) SD-3, a high-capacity cartridge
subsystem, which became available in 1995; the Twin Peaks 4890 36-track
cartridge subsystem, a cartridge subsystem designed for the client-server
market, which has been available since 1996; the first generation 36-track
subsystems, including Silverton, which were first introduced in 1993; and the
first generation, 4480 18-track cartridge subsystem, which was introduced in
1987.
The Company also offers the PowderHorn(R) 9310 Automated Cartridge System (ACS),
a high-performance, high-capacity cartridge library that is compatible with
large UNIX, supercomputing and mainframe systems, which became available in
1993; the TimberWolf(TM) automated tape library product family, which is
designed to provide low cost, reliable storage solutions for the client-server
market, and which first became available in 1996; and the first generation 4410
ACS library, which has been available since 1988.
The Company is currently developing new tape products and enhancements, 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 this Part I, Item 1, for a discussion of operating results and certain
risks associated with the development and introduction of new products that may
affect future results.
DISK PRODUCTS
The Company's disk product offerings include a family of disk systems that offer
a spectrum of capacity, performance, connectivity and price. The Company's disk
product offerings include Iceberg(R), which utilizes virtual disk technology,
and is currently targeted for the mainframe market. Iceberg is designed to
provide high-performance, scalability and continuous online data availability,
and first became available in 1994. The Company also offers the OPENstorage(TM)
Disk product family, which is designed for the client-server disk market. The
OPENstorage products are designed to provide high-performance,
high-availability, scalable physical storage, and first became available in the
third quarter of 1996.
Since the third quarter of 1996, Iceberg has been principally sold through a
worldwide, non-exclusive OEM agreement with International Business Machines
Corporation (IBM) as the RAMAC Virtual Array (RVA). This OEM agreement expires
in December 2000. In 1998 and 1997, approximately 20% and 19%, respectively, of
the Company's total revenue was derived from OEM sales to IBM. The Company
anticipates that IBM will remain the major distribution channel for the Iceberg
product in 1999. See "Risk Factors That May Affect Future Results -- Dependence
on IBM," for discussion of the risks associated with IBM. The OPENstorage Disk
products are distributed by the Company's direct sales force and through
indirect channels.
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The Company anticipates that in the future IBM will reduce its level of
purchases under the OEM agreement. The Company's strategy for the Iceberg
product in 1999 will focus on increasing the sales activities of its direct
sales channel, developing new distribution channels, and introducing virtual
disk products based on the Iceberg technology for the client-server market.
Under the OEM arrangement with IBM, the Company is developing new disk
technology, some of which will be owned by IBM, and IBM has granted the Company
both royalty-bearing and royalty-free licenses to use this technology. These
disk products are currently in the design, preliminary engineering or
engineering validation testing phase and for which no availability dates have
been publicly announced. There can be no assurances that the Company will be
successful in timely developing, introducing, or marketing new disk products and
enhancements, or establishing cost-effective, high-volume distribution channels
for its disk products.
NETWORK PRODUCTS
A key element of the Company's VISTA model is the sharing of information across
a network. The Company's network products are designed to provide device
interface and host interface with the physical storage and the connectivity
infrastructure necessary to enable the integration of network-based storage
management functions. The Company is dedicating significant resources to manage
the development of these key components of the VISTA model. The Company's
principal network products include the StorageNet(R) family of products, which
are designed to provide high-performance, high-speed connectivity between local
and wide-area networks and serve as the foundation of StorageTek's SAN
infrastructure. The first StorageNet products became available in 1996. The
StorageNet product group was expanded during 1997 and 1998, and now includes the
StorageNet SCSI Extender, StorageNet SCSI Multiplexer, StorageNet Fibre Channel
Hub 1000, StorageNet Fibre Channel SCSI Bridge 3100, StorageNet Fibre Channel
Switch 4000 and StorageNet Access Hub.
The Company also offers customers a range of network security products,
including hardware and software, that are designed to allow customers to
implement, maintain and monitor secured network environments. These products
include the NetSentry(R) and the family of BorderGuard(R) products.
STORAGE SERVICES
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The Company's storage services include support services, integration services,
IT business consulting and technology services. The Company provides support
services for both StorageTek products and third-party equipment around the
world, using a combination of service engineers, remote diagnostic tools, online
and telephone assistance, and partnerships with strategic third-party service
providers. In 1998, the Company's storage services revenue accounted for
approximately 28% of total revenue.
A key element of the Company's strategy is to grow the storage services beyond
the traditional product maintenance and support business. The Company has
devoted resources to expanding the services business and, in 1998, the Company
implemented a number of new service programs. These programs include, offering
multi-vendor support services, broadening the range of consulting and
integration service offerings, and developing pre-packaged solutions customized
to specific customer application needs.
The Company's consulting and integration services are designed to generate
revenue growth through professional service fees, as well as through the
reselling of third-party hardware and software solution components. These
services are directed both at the Company's traditional customers as an avenue
to expand the relationship, and at emerging, high-growth data storage markets
targeted by the Company, including document management, check imaging, medical
imaging, digital broadcasting, scientific, and geographical information systems.
Among the traditional customer base, StorageTek's new technology offerings,
including StorageTek's SAN products, are expected to provide new growth
opportunities for consulting and integration services.
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The Company's services business strategy includes providing customers with
additional pre-packaged offerings. In 1999, the Company announced an "appliance"
strategy in which mission-specific, integrated hardware and software packages
are sold as packaged units. These offerings are directed at e-mail archival, PC
backup, and multi-media archival application market spaces. These applications
address rapidly expanding data volumes in the Company's existing customer base,
and they each represent classes of data that have not traditionally been stored
on StorageTek products. These applications also provide the Company with new
product offerings for the Internet and Intranet market spaces. The Company
expects to achieve substantial competitive advantage in these high-growth
storage markets by including value-add software and integration services in the
creation of these appliances.
The Company plans to provide another category of bundled service offering in
1999 through its Storage Utility Services package. This bundled service offering
is designed to take advantage of the rapid growth of communications bandwidth
and dramatic fall in communications costs and will offer remote storage capacity
as a utility service offering. This service offering is expected to help protect
customers from the accelerating technology obsolescence cycles inherent to the
high-tech industry.
The Company believes that its storage services business is an important
strategic asset. The Company expects that the storage services business will
provide a significant opportunity for revenue growth. There can be no assurances
that the Company will be successful in its initiative to include storage
services as part of an integrated packaged solution with products and software
or achieving its services business revenue growth objectives.
In the past, the Company's product support services had been the principal
source of service revenue. The Company generally warrants its products for a
specified period of time, after which it services products for a fee under
maintenance agreements. As a result of competitive pressures, many of the
Company's products may include extended warranty periods. Extending warranty
periods may reduce future product support revenue and put downward pressure on
profit margins. The Company's product support revenue also may be adversely
affected by the Company's increasing reliance on indirect distribution channels
for its products, as some indirect distributors, provide service for the
products that they sell.
STORAGE MANAGEMENT SOFTWARE
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In January 1999, the Company realigned its organization to create a new business
unit dedicated to developing storage management software. Storage management is
a fundamental layer of the VISTA model and the Company believes that its storage
management software will be important to its competitiveness in the SAN and
server-attached markets. The Company's approach is based on delivering open,
intelligent and integrated storage solutions, which will require a comprehensive
storage management strategy. The Company intends to continue to develop software
tools and will work with other software vendors to enable it to deliver a total
solution. In 1998, storage management software accounted for approximately 5% of
total revenue.
The Company's principal storage management software include the following
products. The Virtual Storage Manager (VSM(TM)) is a software driven data
storage management solution designed to improve performance, cartridge
utilization and overall storage management using StorageTek's storage products.
VSM is engineered to support the demands created by data center consolidation,
electronic commerce, data warehousing and enterprise resource planning. VSM
first became available in December 1998 and is expected to serve as a
significant component in the Company's software strategy. SnapShot(TM) software,
which uses the virtual disk architecture of the Company's Iceberg product, is
designed to provide virtual duplication and significantly reduce CPU and channel
utilization costs associated with data movement. SnapShot allows customers to
accelerate year 2000 testing to improve decision support and business
continuance processes. The SnapShot product was first released in 1996.
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The Company offers a number of software solutions to improve the performance of
the tape and library storage products, including the Nearline(R) management
software, Nearline enablement software and tape applications software. The
Nearline management software products are designed to integrate with various
independent software products, to provide reporting, management and monitoring
functions for tape systems, and were first available in 1989. Tape application
software provides high-performance backup and recovery applications. These
products include the Expert High Performance Data Mover and Expert Library
Manager, and were first released in the third quarter 1998.
Central Archive Management (CAM) software products are designed to provide
comprehensive data backup and restore storage management functionality across
the enterprise in distributed environments. CAM was first released in 1995. The
REEL software products include a scalable family of tape-management, backup and
restore and connectivity software for networked open system environments. The
software is designed to provide customers with high performance, flexibility and
scalability in UNIX and Windows NT environments. REEL was first released in
1993.
The Company's software strategy includes partnering with other vendors and
equipment manufacturers to distribute its software products. The Company
currently distributes SnapShot primarily through an OEM agreement with IBM, but
is expanding its sales of SnapShot through the direct sales channel. Delays in
gaining significant market acceptance for VSM, and delays in introducing VSM and
SnapShot software designed for the open systems market could adversely affect
the Company's operating and financial results.
BACKLOG
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As of December 25, 1998, the storage product order backlog was approximately $42
million, compared to year-end amounts of approximately $27 million in 1997, and
$42 million in 1996. In addition to the backlog amount, as of December 25, 1998,
the Company had approximately $64 million of storage product inventory held by
customers on evaluation, compared to $51 million as of December 26, 1997, and
$90 million on December 27, 1996. The order backlog for storage management
software products on December 25, 1998 was approximately $4.5 million, and at
year-end 1997 and 1996 was $0.2 million and $1 million, respectively. See Note 1
of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of this Form 10-K for a discussion
of the Company's significant accounting policies.
Backlog amounts are calculated on an "if sold" basis and include orders from
end-users, OEMs, VADs, VARs and distributors for products that StorageTek
expects to deliver during the following 12 months. Product 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.
MARKETING AND DISTRIBUTION
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StorageTek markets its products and services globally, through a combination of
a direct sales organization and indirect sales channels. The Company now
maintains a presence in most major cities in the world. The Company operates
sales and service offices throughout the United States and Europe, as well as
Australia, Brazil, Canada, China, Japan, Malaysia, Mexico and Singapore, and
sells its products and services through independent distributors, sometimes in
tandem with direct sales and support service operations, located in Africa,
Europe, South America and New Zealand.
The Company's direct sales organization includes sales representatives, service
engineers, system engineers, system integrators, and administrative support
staff. The Company's direct sales outside the United States are generally made
by foreign sales subsidiaries. The Company's indirect channels include: OEMs,
VARs, master resellers who supply product and services to VARs, VADs, system
integrators that integrate StorageTek products with other hardware and software
and independently
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provide marketing and support services to customers, and independent
distributors, who primarily operate in geographic areas where StorageTek does
not have a direct presence. Indirect channel sales account for an increasing
portion of the Company's product sales revenue. In 1998 and 1997, the Company's
indirect distribution channel accounted for approximately 46% and 40%,
respectively, of the Company's total product and software revenue.
Expanding the distribution channels for its products, services and software is
important to the Company's long-term success. A significant indirect channel
partnership includes the Company's non-exclusive, worldwide OEM agreement with
IBM for disk products and software. The Company also has a number of OEM
partners for tape products including, among others, Bull Alliance Compagnie,
Dell Computer Corporation, Hewlett-Packard Company, NCR Corporation, Sequent
Computer Systems Inc., Siemens Nixdorf, Silicon Graphics, Inc. and Unisys
Corporation. The Company anticipates that the IBM OEM agreement will remain the
major distribution channel in 1999 for Iceberg and SnapShot. The Company plans
to devote significant resources in 1999 to expand the direct sales of Iceberg in
anticipation of reduced sales levels to IBM in the future. There can be no
assurances that the Company will be successful in developing a strong direct
channel for these products.
The operations and financial conditions of the Company's indirect sales partners
are important to the Company's success. A significant reduction or delay in
sales to a major reseller could adversely affect the Company's operating
results. The Company's reliance on its indirect sales partners may adversely
affect future support service revenue, as OEM customers and some resellers
generally provide maintenance for their own products.
Revenue from outside the United States accounted for approximately 37% of total
revenue in 1998, 34% in 1997, and 41% in 1996, which includes sales to
end-users, resellers and distributors. 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 the majority of the balance coming from Japan,
Australia and Canada. The Company is subject to various risks associated with
conducting business outside the U.S. 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 -- Risk Factors That May Affect Future Results -- Euro Conversion,"
and Note 12 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS of this Form 10-K for
a discussion of risk factors associated with the Company's international
business, which information is incorporated by reference into this Part I, Item
1.
MANUFACTURING AND MATERIALS
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The Company's primary manufacturing and assembly facilities are located in
Colorado, Puerto Rico, Minnesota and France. All of 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 vendors located
within and outside the United States. The balance of the Company's production
costs relates to in-house manufacturing, assembly and testing. In particular,
the Company manufactures its own read/write heads for the 9840 tape drive
product. The successful manufacture of such heads gives the Company a
competitive edge in that it has developed a key proprietary design and
manufacturing technologies. However, due to the sophisticated nature of the
exacting manufacturing process steps associated with tight physical, electrical
and chemical tolerances, the Company must rely on its own skilled personnel and
capital intensive resources to meet customer demand for products incorporating
its tape head technologies. Even within a cleanroom environment, minor equipment
malfunctions in any one of many manufacturing process steps due to factors such
as extraneous chemical contaminants, ambient particulate, power surges, optical
misalignments, timing or temperature variations could halt production for an
indeterminate amount of time. To help mitigate these
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risks, the Company is working to establish, staff and qualify a second tape head
manufacturing line facility located near the present manufacturing operations.
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,
Imation Corporation is a single source supplier for the 9840 tape cartridges,
and the Company is dependent upon Sumitomo Corporation for materials used in the
Company's tape drive recording heads. The Company is also dependent on IBM for
disk drives used in the Company's Iceberg product which are sold to IBM under an
OEM agreement and which the Company sells through its own direct sales channel.
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 this Part I, Item 1.
COMPETITION
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The markets for the Company's products, services and software are intensely
competitive and are subject to continuous, rapid technological change, frequent
product performance improvements, short product life cycles and aggressive
pricing. The Company competes in a number of markets that include a broad
spectrum of customers. The Company competes primarily on the basis of
technology, product availability, performance, quality, applications and
industry solutions, 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. These factors include the price and cost
of the Company's and its competitors' product offerings, the timing and success
of new products and applications, product introductions by the Company's
competitors, and general economic and business conditions within and outside the
United States. Strong competition has resulted in price reductions in the past
and the Company expects this trend to continue.
The Company expects that the markets for its products, services and software,
and its competitors within such markets, will continue to change in response to
shifting customer storage requirements and technological advances. The Company's
competitors include, among others, Compaq Computer Corporation, EMC Corporation,
Hewlett-Packard Company, Hitachi Ltd., IBM and Sun Microsystems, Inc. A number
of the Company's competitors have significantly greater market presence and
financial resources than the Company.
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 wide range 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 bundled product, which may
provide a competitive advantage to the Company's rivals. The Company expects to
address a number of these competitive factors through its SAN strategy, which
emphasizes an open, intelligent and integrated storage solution, and is capable
of operating in a range of environments, and by developing distribution
relationships with its competitors. The Company anticipates that the competition
in the SAN market will intensify in the future as its competitors aggressively
seek to position themselves to take advantage of the shift in customer demands.
The SAN market is characterized by various alliances formed to promote industry
standards and deliver tested, interoperable SAN technology. The Company is a
member of several associations, which also include
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the Company's competitors. In addition, a number of the Company's competitors in
the product, services and software markets have formed alliances with the stated
objective of developing interoperable SAN solutions. For example, 3Com
Corporation, Legato Systems, Inc. and MTI Technology Corporation have formed an
alliance to deliver tested SAN solutions. In the storage management software
market, the Company competes with vendors with which it has established
partnerships, including that of Legato Systems, Inc. and VERITAS Software
Corporation.
The Company works with third-party maintenance service providers and, in
connection with specific projects, the Company partners with established
companies to provide consulting services. The Company's ability to compete in
the services markets is dependent upon its ability to attract and retain highly
skilled technical professionals and the price, flexibility, reliability, quality
and price competitiveness of the Company's solutions.
NEW PRODUCT DEVELOPMENT
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StorageTek invests substantial resources to develop new products, software and
enhancements. In 1998, 1997 and 1996, the Company incurred research and
development costs for these product and software development activities of
approximately $235 million, $210 million and $176 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, the Company has an OEM agreement with IBM
under which IBM has financed certain research and development activities
conducted by the Company associated with mainframe disk products. In 1998 and
1997, the Company received approximately $50 million and $46 million,
respectively, of research and product development funding from third parties.
The Company anticipates that its research and development costs will increase
during 1999 as the funding from third parties is expected to decrease, and as a
result of the Company's commitment to invest resources to develop new products
and software.
As of December 25, 1998, approximately 1,500 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, which information is
incorporated by reference into the Part I, Item 1.
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 approximately
400 United States patents, as well as foreign counterparts to many of these
patents in selected countries, covering various aspects of its products. These
patents will expire from 1999 through 2017. The Company also has pending in the
United States numerous patent applications, including several that have been
allowed and are expected to be formally issued, 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. Taken as
a whole, these assets are material to the Company's business. However, no
individual patent, license or other item of proprietary information is
singularly material to the Company's business.
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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, which information is
incorporated by reference into this Part I, Item 1.
ENVIRONMENT
- -----------
Compliance 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
financial results and operations of the Company. The Company did not have any
material expenditures for environmental control facilities in 1998. The Company
does not currently have pending and has not budgeted any material estimated
expenditures for environmental control facilities during 1999. However,
potential liability under environmental legislation is ongoing, regardless of
whether or not the Company has complied with existing governmental guidelines.
The Company has received notice from the State of Florida and the United States
Environmental Protection Agency regarding a potential matter involving ground
water contamination and remediation activities at a property located in Palm
Bay/Melbourne, Florida. The Company is currently not able to predict the outcome
or potential expenditures associated with this matter but does not expect that
it will have a material adverse effect on the financial results and operations
of the Company.
Government regulation of the environment and related compliance costs have
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 expects future compliance with existing
environmental regulations will have no material effect on the financial results
and operations of the Company.
RISKS ASSOCIATED WITH THE YEAR 2000
- -----------------------------------
The Company's product lines include information storage products and software
that collect, move, share, store and protect data. In order to properly process
data, the Company's products must successfully manage and manipulate data that
includes both 20th and 21st century dates (be Year 2000 Ready). The Company has
evaluated all of its currently offered products and software and believes that
they are Year 2000 Ready, provided they have been upgraded to include all
recommended engineering changes. However, there can be no assurance that the
Company's current products and software will be Year 2000 Ready in all
environments. In addition, the Company does not currently intend to develop
modifications to certain of its older products to make them Year 2000 Ready and
is in the process of notifying the affected maintenance customers of potential
year 2000 problems with older products and software in order to raise their
awareness.
The Company is in the process of assessing its year 2000 readiness, and is
replacing many of its internal information systems. These programs, the
projected costs associated with these programs, the status of the Company's
assessment of the year 2000 readiness of its key suppliers and vendors, and
certain risks arising from the year 2000 are discussed in Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors That May Affect Future Results -- Information Systems
Transition, and -- Risks Associated with the Year 2000", of this Form 10-K,
which information is incorporated by reference into this Part I, Item 1.
EMPLOYEES
- ---------
The Company employed approximately 8,700 persons on a full-time basis worldwide
as of December 25, 1998. The Company's future success is dependent, in part, on
its ability to attract, retain and motivate highly skilled personnel.
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OTHER MATTERS
- -------------
The Company's results historically have experienced seasonality, with increased
revenue in the Company's fourth quarter compared to other quarters because
customers tend to make purchase decisions near the end of the calendar year.
There can be no assurance that this historical trend will continue in 1999 and
that revenue during the fourth quarter will be higher than any other quarter.
During 1998, sales of the Company's disk products to IBM accounted for
approximately 20% of the Company's total revenue. Approximately 15% of the
Company's outstanding accounts receivable balance on December 25, 1998, was due
from IBM. No other single customer accounted for 10% or more of the Company's
total revenue in 1998.
No material portion of the Company's business is subject to contract termination
at the 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 credit facilities, debt and lease
obligations.
Note 8 Description of the Company's common stock.
Note 12 Description of the Company's financial instruments and
off-balance-sheet risks.
Note 13 Information on the operations of business segments and in
geographic areas. 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 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 17 separate buildings in Boulder
County, Colorado, comprising approximately 2.0 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. The Company
also leases approximately 62,500 square feet of office space located nearby
Jefferson County, Colorado.
Other United States Properties. StorageTek owns approximately 200,000 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 is 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 fully utilized. The Company also leases office
and customer facilities throughout the United States at approximately 140
locations comprising approximately 850,000 square feet.
International Properties. StorageTek leases approximately 200,000 square feet of
engineering, manufacturing and marketing facilities in Toulouse, France, which
are approximately 75% utilized. In addition, StorageTek leases facilities at
locations throughout the world, primarily for sales and customer
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support activities, spare parts storage, and limited research and product
development activities. The Company maintains offices in 16 locations in Canada
comprising approximately 100,000 square feet, two offices in Latin America
comprising 8,000 square feet, over 70 offices in Europe comprising approximately
455,000 square feet, and 12 offices in the Asia/Pacific region comprising
approximately 80,000 square feet. Many of the Company's leases throughout the
world contain renewal rights, cancelation 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 $2.4
billion. On December 28, 1995, the court dismissed the complaint. Stuff appealed
the dismissal to the Colorado Court of Appeals. 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. The case is in the discovery phase.
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
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 the case back to the District
Court for further proceedings. On March 27, 1998, a second trial was held and a
jury found that a pass-through port in certain of the Company's tape library
products willfully infringed the 151 Patent and awarded actual damages to
Odetics of $70.6 million. On July 31, 1998, the Court granted the Company's
motion for judgment as a matter of law, overturning the jury's verdict, and
entered judgment in favor of the Company. On August 10, 1998, Odetics appealed
the judgment to the U.S. Court of Appeals for the Federal Circuit, and on August
26, 1998, the Company filed a cross-appeal. These appeals are pending before the
U.S. Court of Appeals. Oral arguments on the appeal are scheduled for April
1999.
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 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. On November 9, 1998, the Court granted the plaintiffs' request to
proceed as a class on the ERISA claims. Approximately 1,300 persons are eligible
members of the ERISA class, which includes approximately 400 members of the ADEA
class. The Company has appealed the Court's certification of the ERISA class.
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. The case is in the discovery phase and a trial date has been set
for October 1999.
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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 7 of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS included in Part IV, Item 14, of this
Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of StorageTek security holders during the
fourth quarter of the fiscal year ended December 25, 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following persons were serving as executive officers of the Company as of
March 5, 1999.
NAME POSITION WITH COMPANY AGE
- -------------------------------------------------------------------------------------------------------
David E. Weiss Chairman of the Board, President and Chief Executive Officer 54
Victor M. Perez Executive Vice President and Chief Operating Officer 48
Roger D. Archibald Vice President and General Manager, Enterprise Disk Business
Group 46
Thomas G. Arnold Vice President and Corporate Controller 37
Jeffrey M. Dumas Corporate Vice President and General Counsel 53
Gary D. Francis Vice President and General Manager, Enterprise Nearline
Business Group 51
Robert S. Kocol Corporate Vice President and Chief Financial Officer 42
Jean Reiczyk Corporate Vice President and General Manager, Solutions
Business Group 49
Bruce S. Taafe Vice President, International Field Operations 55
Joan M. Wrabetz Vice President and General Manager, SAN Operations 39
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. Perez was appointed to serve as Executive Vice President and Chief Operating
Officer in January 1999. Prior to this appointment, from October 1997 to January
1999, he served as Executive
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Vice President, Enterprise Operations. From June 1996 to October 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 Worldwide Manufacturing. Mr. Perez was appointed
Corporate Vice President in November 1994 and has been employed by the Company
in various other capacities since 1979.
Mr. Dumas joined the Company in August 1998, and serves as Corporate Vice
President and General Counsel. From April 1995 to August 1998, Mr. Dumas served
as Vice President and General Counsel of Symbios, Inc. He served as Group
Counsel-Work Stations Division at Silicon Graphics, Inc., a computer products
company, from 1992 to 1995.
Mr. Kocol was appointed Corporate Vice President and Chief Financial Officer in
December 1998. Prior to this appointment, from 1996 to 1998, he served as Vice
President of Financial Planning and Operations. In 1991, Mr. Kocol joined the
Company's financial group located in Colorado, as Director of Financial
Operations. He was subsequently promoted to Director of Worldwide Field
Operations Finance and Administration. Mr. Kocol has been employed by the
Company in various other capacities since 1980.
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.
Mr. Archibald joined the Company in July 1998, and serves as Vice President and
General Manager, Enterprise Disk Business Group. Prior to joining the Company in
1998, he served in various management positions at Hewlett-Packard Company, a
computer and imaging products company, most recently from 1993 to 1998, he
served as Information Storage Group, Worldwide Marketing Manager.
Mr. Francis was appointed 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 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.
Mr. Reiczyk was appointed Corporate Vice President and General Manager,
Solutions Business Group, in February 1999, and served as Vice President and
General Manager, Solutions Business Group from September 1997 to January 1999.
Prior to joining the Company, Mr. Reiczyk served as Senior Vice President and
Corporate Quality Officer at Global One, from March 1997 to September 1997. From
1994 to February 1997, he served as Vice President, Value Added Services, at
AT&T Europe, a unit of AT&T, a telecommunications company.
Mr. Taafe was appointed Vice President, International Field Operations, in 1997.
From 1995 to 1997, he served as Vice President, Asia Pacific Field Operations,
and from 1994 to 1995, he was located in the Company's United Kingdom office and
served as Vice President, International Operations.
Ms. Wrabetz joined the Company in May 1998, and serves as Vice President and
General Manager, SAN Operations. Prior to joining the Company, from 1996 to
April 1998, she served as Vice President of Tricord Systems Corp., a PC server
vendor, and from 1990 to 1995, she served as Chief Executive Officer and
President of Aggregate Computing Corp., a software company.
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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 1998 and 1997. The amounts shown reflect adjustments for the 2-for-1 stock
split effected in the form of a 100% stock dividend that was completed on June
26, 1998. On December 25, 1998, there were 11,719 record holders of common stock
of StorageTek.
1998 High Low
- --------------------------------------------------------------------------------
First Quarter $37.750 $28.657
Second Quarter 43.938 37.719
Third Quarter 50.188 21.750
Fourth Quarter 39.625 21.625
1997 High Low
- --------------------------------------------------------------------------------
First Quarter $26.938 $18.625
Second Quarter 23.063 17.000
Third Quarter 27.000 22.563
Fourth Quarter 33.188 24.000
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 credit agreements contain 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 1996 through
1998 (except for the 1996 Balance Sheet Data), has been derived from the
consolidated financial statements appearing elsewhere herein, including the
Consolidated Balance Sheet as of December 25, 1998, and December 26, 1997, and
the related Consolidated Statement of Operations for each of the three years in
the period ended December 25, 1998, and notes thereto. The data, insofar as it
relates to the Balance Sheet Data as of December 27, 1996, December 29, 1995,
and December 30, 1994, and the Statement of Operations Data for the fiscal years
1995 and 1994, 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
--------------------------------------------------------------
1998 1997 1996 1995 1994
--------------------------------------------------------------
STATEMENT OF OPERATIONS DATA
Revenue $2,258,222 $2,144,656 $2,039,550 $1,929,485 $1,871,350
Cost of revenue 1,217,812 1,171,530 1,192,777 1,217,622 1,186,942
---------- ---------- ---------- ---------- ----------
Gross profit 1,040,410 973,126 846,773 711,863 684,408
Research and product development costs 234,677 209,526 176,422 187,275 206,083
Selling, general, administrative and other
income and expense, net 492,928 472,839 444,870 445,889 425,490
Restructuring and other charges 212,207(b) 8,000(c)
---------- ---------- ---------- ---------- ----------
Operating profit (loss) 312,805 290,761 225,481 (133,508) 44,835
Interest income, net 6,943 25,356 1,211 8,978 6,103
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes and
extraordinary item 319,748 316,117 226,692 (124,530) 50,938
Provision for income taxes (121,500) (84,300) (55,900) (17,800) (18,900)
---------- ---------- ---------- ---------- ----------
Income (loss) before extraordinary item 198,248 231,817 170,792 (142,330) 32,038
Extraordinary gain, net of taxes 9,535
---------- ---------- ---------- ---------- ----------
Net income (loss) $ 198,248 $ 231,817 $ 180,327 $ (142,330) $ 32,038
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
Basic earnings (loss) per common share: (a)
Income (loss) before extraordinary item $ 1.91 $ 1.93 $ 1.52 $ (1.46) $ 0.19
Net income (loss) 1.91 1.93 1.61 (1.46) 0.19
Diluted earnings (loss) per common share: (a)
Income (loss) before extraordinary item $ 1.86 $ 1.89 $ 1.43 $ (1.46) $ 0.19
Net income (loss) 1.86 1.89 1.50 (1.46) 0.19
BALANCE SHEET DATA
Working capital $ 538,331 $ 661,206 $ 724,171 $ 425,351 $ 501,065
Total assets 1,842,944 1,740,017 1,884,276 1,888,629 2,144,458
Total debt 295,655 22,391 155,257 449,222 464,690
Stockholders' equity 999,576 1,112,503 1,180,983 962,833 1,265,285
- ---------------
(a)Earnings per share data has been restated to reflect the effect of the
2-for-1 stock split in the form of a stock dividend on June 26, 1998.
(b)In 1995, the Company recognized restructuring charges of $167,175,000,
litigation settlement charges of $30,680,000, and merger and consolidation
charges of $14,352,000.
(c)In 1994, the Company recognized restructuring charges of $8,000,000.
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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 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 BELOW IN "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 THIS FORM 10-K
WITH THE SECURITIES AND EXCHANGE COMMISSION AND MAY BE RELIED UPON ONLY 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 25, 1998, of $198.2
million on revenue of $2.26 billion, compared to net income for the year ended
December 26, 1997, of $231.8 million on revenue of $2.14 billion and net income
for the year ended December 27, 1996, of $180.3 million on revenue of $2.04
billion.
Revenue increased 5% in 1998, compared to 1997, primarily due to increases in
revenue from storage services and storage management software. Revenue from
storage products increased slightly in 1998 as compared to 1997. Gross profit
margins increased to 46% in 1998 as compared to 45% in 1997, primarily due to
increased sales of higher-margin storage management software. The increased
margins from storage management software were partially offset by decreased
margins from storage services. Net income decreased 15% in 1998 compared to
1997, due to an increase in the effective tax rate.
Revenue increased 5% in 1997 compared to 1996, due to revenue increases in all
segments of the Company's business. Revenue during 1997 was reduced by
unfavorable foreign currency exchange rate movements, particularly in Europe.
Gross profit margins increased to 45% in 1997 as compared to 42% in 1996,
primarily due to increased margins associated with storage products and storage
management software. This increase in margins was partially offset by decreased
margins from storage services.
The Company's future revenue and operating results are significantly dependent
upon effectively managing the introduction of new products and services;
developing new applications for its products; the successful development of new
distribution channels; the successful implementation of the new storage area
network (SAN) strategy; and managing operating expenses. For the discussion of
these and other risk factors, see "Risk Factors That May Affect Future Results"
below.
The Company's cash and short-term investments balances decreased $101.6 million
during 1998 due primarily to cash payments of $359.4 million associated with the
Company's common stock repurchase programs and net investments in property,
plant and equipment of $116.9 million. These payments were partially funded by
net borrowings under the Company's credit facilities of $273.2 million, cash
generated from operating activities of $88.1 million, and a reduction of
short-term investments of $77.3 million. Cash generated from operating
activities decreased to $88.1 million in 1998, as compared to $446.7 million in
1997, primarily as a result of increased cash paid to suppliers and employees.
The increased cash paid to suppliers and employees was primarily a result of
cash paid for additional inventory on hand at December 25, 1998, for new product
ramp-up, and cash payments in 1998 to reduce accrued liabilities outstanding at
December 26, 1997. The accrued liabilities at December 26, 1997, were higher
than at December 25, 1998, primarily as a result of employee bonus and profit
sharing, and restructuring accruals. The Company's cash balances decreased
$132.1 million during 1997. Net cash flows generated from operations in 1997 of
$446.7 million were more than offset by the repurchase of 18.3 million shares of
the Company's common stock at a cost of $485.0 million,
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investments in property, plant and equipment of $65.9 million and an increase in
short-term investments of $48.1 million.
The following table, stated as a percentage of total revenue, presents
Consolidated Statement of Operations information and revenue by segments.
Year Ended December
-------------------------------------------
1998 1997 1996
-------------------------------------------
Storage products:
Tape products 43.1% 45.0% 46.7%
Disk products 20.6 20.6 18.2
Network products 3.6 4.1 6.3
----- ----- -----
Total storage products 67.3 69.7 71.2
Storage services 28.1 27.2 26.6
Storage management software 4.6 3.1 2.2
----- ----- -----
Total revenue 100.0 100.0 100.0
Cost of revenue 53.9 54.6 58.5
----- ----- -----
Gross profit 46.1 45.4 41.5
Research and product development costs 10.4 9.8 8.6
Selling, general, administrative and other income
and expense, net 21.8 22.0 21.8
----- ----- -----
Operating profit 13.9 13.6 11.1
Interest income, net 0.3 1.1
----- ----- -----
Income before income taxes and
extraordinary item 14.2 14.7 11.1
Provision for income taxes (5.4) (3.9) (2.7)
----- ----- -----
Income before extraordinary item 8.8 10.8 8.4
Extraordinary gain, net of income taxes 0.4
----- ----- -----
Net income 8.8% 10.8% 8.8%
----- ----- -----
----- ----- -----
REVENUE
- -------
STORAGE PRODUCTS
The Company's storage products revenue includes sales of tape, disk, and network
products. Revenue generated from storage products increased 2% in 1998, as
compared to 1997, and 3% in 1997, as compared to 1996. These increases are
primarily due to increases in revenue from disk products.
TAPE PRODUCTS
Tape product revenue increased 1% in 1998, as compared to 1997. Revenue from
TimberWolf(TM), a family of automated tape libraries designed for the
client-server market; and PowderHorn(R) 9310, an automated cartridge system
library; increased in 1998, as compared to 1997, but was offset by decreased
revenue from TimberLine(R)- 9490, a 36-track cartridge subsystem, and earlier
generation tape products. The decrease in TimberLine revenue is primarily the
result of an increase in pricing pressure and delays during the second half of
1998 in customer purchase decisions associated with the evaluation of the
Company's new 9840, a high-performance tape drive. The 9840 tape drive became
generally available and provided initial revenue contribution in December 1998.
Tape product revenue increased 1% in 1997, as compared to 1996, primarily due to
increased revenue from TimberWolf and RedWood(R) SD-3, a high-capacity cartridge
subsystem. This increase was offset by decreased revenue from earlier generation
tape products, TimberLine, and PowderHorn. The
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decrease in TimberLine revenue was primarily a result of an increase in pricing
pressure. Tape product revenue was unfavorably affected by foreign currency
exchange rate movements during 1997.
DISK PRODUCTS
Disk product revenue increased 5% in 1998, as compared to 1997, primarily due to
increased revenue from the OPENstorage(TM) Disk subsystem, a family of disk
products for the client-server market. While unit sales of the Iceberg(R) disk
storage product for the mainframe market increased in 1998 as compared to 1997,
the revenue remained unchanged due to price decreases provided for under the
terms of an OEM agreement with IBM. A significant portion of the Company's total
revenue in 1998 was derived from sales of disk products to IBM. See "Risk
Factors That May Affect Future Results -- Dependence on IBM," for discussion of
the risks associated with IBM.
Disk product revenue increased 20% in 1997, as compared to 1996, primarily due
to increased revenue from disk products sold to IBM under the OEM agreement, and
OPENstorage Disk subsystems.
NETWORK PRODUCTS
Network product revenue decreased 5% in 1998, as compared to 1997, and decreased
32% in 1997 as compared to 1996. The decreases are primarily due to reduced
revenue from the earlier generation connectivity products.
Future revenue growth in the Company's storage products is significantly
dependent upon increased manufacturing volumes for the new 9840 tape drive,
developing new business solution applications for storage products, developing
new products and distribution channels for the client-server disk market,
increasing the direct sales of Iceberg, and successfully implementing the SAN
strategy. See "Risk Factors That May Affect Future Results -- New Products,
Markets and Distribution Channels," for discussion of the risks associated with
the manufacture of new products.
STORAGE SERVICES
Storage services include support service revenue from the Company's and third
party storage products, as well as integration service revenue associated with
new applications, IT business consulting and technology services revenue.
Storage services revenue increased 9% in 1998, as compared to 1997, primarily
due to an increase in storage products under maintenance contracts and growth in
the multi-vendor support services area.
Storage services revenue increased 8% in 1997, as compared to 1996, primarily
due to an increase in consulting services revenue. The revenue from product
maintenance was relatively unchanged in 1997 as compared to 1996.
Future revenue growth from storage services is significantly dependent on the
Company's initiative to drive consulting services as part of a packaged solution
with products and software to address customer information storage requirements.
Storage services revenue is also dependent on the Company's continued success in
capturing the maintenance business for its products as the indirect sales
channel expands and the Company focuses on the client-server market.
STORAGE MANAGEMENT SOFTWARE
Storage management software revenue increased 58% in 1998 as compared to 1997,
primarily due to increased revenue from SnapShot(TM), software designed for use
with the Company's Iceberg product; and Virtual Storage Manager (VSM), a
software driven data storage management solution designed to improve
performance, cartridge utilization, and overall storage management. The increase
in SnapShot revenue was primarily due to increased OEM sales to IBM. VSM became
available and brought initial revenue contribution in December 1998. Storage
management software revenue increased 47% in 1997, as compared to 1996,
primarily due to increased sales of SnapShot.
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Future revenue growth from storage management software is significantly
dependent upon gaining market acceptance for VSM. There can be no assurances
that the Company will be successful in gaining market acceptance for VSM. In
addition, the Company must develop new distribution channels for SnapShot, which
is currently distributed primarily by IBM under an OEM agreement. See "Risk
Factors That May Affect Future Results -- Dependence on IBM," for discussion of
the risks associated with IBM.
GROSS PROFIT
- ------------
Gross profit margins increased to 46% in 1998, as compared to 45% in 1997,
primarily due to the increased sales of higher-margin storage management
software and improved efficiencies associated with the manufacture of storage
products. This increase in gross profit was partially offset by reduced margins
associated with storage services. The decrease in storage service margins is due
primarily to increased pricing pressures associated with maintenance of storage
products in the client-server market and reduced margins associated with the
Company's consulting services.
Gross profit margins increased to 45% in 1997, as compared to 42% in 1996,
primarily due to increased manufacturing volumes and improved manufacturing
efficiencies associated with storage products, and increased sales of
higher-margin storage management software. This increase was partially offset by
a decrease in gross margins associated with storage services. The decrease in
storage services gross margins reflects the reduced margins associated with the
Company's consulting services. Gross margins in 1997, as compared to 1996, 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.
The markets for most of the Company's products and services are subject to
intense price competition. In addition to the price competition in the markets,
the Company is subject to scheduled price reductions under the terms of the OEM
agreement with IBM. The Company anticipates that price competition for its
products will continue to be a major factor. Gross margin as a percent of
revenue is expected to be impacted as the Company increases its market presence
in the lower-margin client-server market and as a result of incremental start-up
costs associated with the new products introduced in the fourth quarter of 1998.
The Company's ability to sustain or improve gross margins is significantly
dependent upon its ability to continue to reduce manufacturing costs and to
continue to increase sales of higher-margin storage management software. Storage
product and storage management software gross margins may be affected in future
periods by inventory reserves and writedowns resulting from rapid technological
changes and delays in gaining market acceptance for new products. Storage
services margins may be adversely affected in the future as a result of
increased competition and lower margins associated with the Company's consulting
services.
RESEARCH AND PRODUCT DEVELOPMENT
- --------------------------------
Research and product development expenditures increased 12% in 1998, as compared
to 1997. The increased investment in new development activities during 1998 was
partially offset by the receipt of approximately $50 million of research and
product development funding from third-parties. Research and product development
expenditures increased 19% in 1997, as compared to 1996. Research and product
development costs for 1997, as compared to 1996, include incremental costs of
approximately $34.7 million associated with a change in the classification of
costs associated with certain advanced manufacturing activities that were
previously included within cost of revenue. Increased investments during 1997 in
developing new products were offset by the receipt of approximately $46 million
of research and product development funding from third-parties.
The Company's research and development costs are expected to continue to
increase in 1999 as a result of the significant product development activities
currently under way and an anticipated decline in the level of funding received
from third-parties in 1999, as compared to 1998. The Company anticipates that
the expected increase in research and product development expense as a result of
the decreased
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funding, will be partially offset due to reduced spending as the Company is
consolidating various research and product development efforts.
SELLING, GENERAL, ADMINISTRATIVE AND OTHER
- ------------------------------------------
Selling, general, administrative and other income and expense (SG&A) increased
4% in 1998, as compared to 1997. The increase is primarily because of spending
on internal business and financial information systems, selling expenses
associated with the Company's storage product sales and branding initiatives.
The increase was partially offset by reduced accruals for employee bonus and
profit-sharing payments in 1998, as compared to 1997, as the Company did not
attain certain financial goals in 1998. SG&A increased 6% in 1997, as compared
to 1996, primarily because of spending on internal business and financial
information systems, employee profit-sharing and bonus expenses associated with
increased earnings levels, and selling expenses associated with the Company's
storage product sales initiatives. SG&A during 1997 also includes gains realized
on the sale of accounts receivable of $33.8 million in 1997.
Gains and losses associated with foreign currency transactions and translation
adjustments, net of associated hedging results, are included in SG&A and
aggregated a net loss of $0.4 million for 1998, compared to a net gain of $0.5
million in 1997 and a net loss of $0.5 million in 1996. See "International
Operations" and "Market Risk Management/Foreign Currency Exchange Risk," 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 decreased 49% in 1998, as compared to 1997, primarily as a
result of a decrease in cash available for investment. Interest expense
increased 77% in 1998, as compared to 1997, due to borrowing under the Company's
unsecured credit facilities. See "Liquidity and Capital Resources -- Available
Financing Lines," for further discussion of the Company's credit facilities.
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, as the Company redeemed all of its
outstanding convertible debentures.
INCOME TAXES
- ------------
The Company utilized substantially all of its remaining United States net
operating loss and tax credit carryforwards during 1997, which resulted in an
increase in the Company's effective tax rate from 27% in 1997, to 38% in 1998.
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
$130.6 million of deferred income tax assets as of December 25, 1998. The
Company's valuation allowance of approximately $25.9 million as of December 25,
1998, relates principally to net deductible temporary differences and net
operating loss carryforwards associated with the Company's foreign subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
WORKING CAPITAL
The Company's cash and short-term investments balances decreased $101.6 million
during 1998 due primarily to cash payments of $359.4 million associated with the
Company's common stock repurchase programs and net investments in property,
plant and equipment of $116.9 million. These payments were partially funded by
net borrowings under the Company's credit facilities of $273.2 million, cash
generated from operating activities of $88.1 million, and a reduction of
short-term investments of
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$77.3 million. Cash generated from operating activities decreased to $88.1
million in 1998, as compared to $446.7 million in 1997, primarily as a result of
increased cash paid to suppliers and employees. The increased cash paid to
suppliers and employees was primarily a result of cash paid for additional
inventory on hand at December 25, 1998, for new product ramp-up, and cash
payments in 1998 to reduce accrued liabilities outstanding at December 26, 1997.
The accrued liabilities at December 26, 1997, were higher than at December 25,
1998, primarily as a result of employee bonus and profit sharing, and
restructuring accruals.
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 18.3 million of the
Company's common stock at a cost of $485.0 million. 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.
AVAILABLE FINANCING LINES
The Company has a $350 million unsecured revolving credit facility (the $350
million Revolver) which expires in October 2001. The credit limit available
under the $350 million Revolver will be reduced by $12.5 million on the last day
of each calendar quarter with the first reduction beginning December 31, 1998.
The interest rates under the $350 million Revolver depend on the type of advance
selected. The basic advance rate is not less than the London Interbank Offered
Rate (LIBOR) plus .625% (approximately 6.25% as of December 25, 1998). The
interest rate on the outstanding borrowings under the $350 million Revolver as
of December 25, 1998, has varied from approximately 6.04% to 7.75%. As of
December 25, 1998, the Company had borrowings of $195.0 million and had issued
letters of credit for approximately $800,000 under the $350 million Revolver.
The remaining available credit under the $350 million Revolver as of December
25, 1998, was approximately $154.2 million. The $350 million Revolver contains
certain financial and other covenants, including restrictions on the Company's
payment of cash dividends on its common stock.
The Company has a financing agreement with a bank that 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 January 2000, provides for commitments by the
bank to purchase promissory notes denominated in a number of foreign currencies.
As of December 25, 1998, the Company had outstanding borrowings of $81.7 million
and had committed to borrowings between January 1999 and December 1999 in the
cumulative principal amount of approximately $364.7 million. The notes must be
repaid only to the extent of future revenue and obligations under the agreement
are not cancelable by the Company or the bank. Gains and losses associated with
changes in the underlying foreign currencies are deferred during the commitment
period and recognized as an adjustment to the revenue supporting the note
repayment at the time the bank purchases the promissory notes. 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
plus 0.35% (approximately 5.98% as of December 25, 1998). Under the terms of the
agreement, the Company is required to comply with certain covenants and, under
certain circumstances, may be required to maintain a collateral account,
including cash and qualifying investments, in an amount not less than the
outstanding promissory notes.
In January 1999, the Company entered into an additional $150 million unsecured
revolving credit facility (the $150 million Revolver) which expires in January
2000. The interest rates under the $150 million Revolver depend on the type of
advance selected. The basic advance rate is not less than the LIBOR plus 1.00%.
The $150 million Revolver contains certain financial and other covenants,
including restrictions on the payment of cash dividends on the Company's common
stock.
The Company intends to continue to commit substantial working capital to
research and product development projects, and the rollout of new products and
services. The Company may invest in or acquire complementary businesses,
products or technologies as market and business conditions warrant. The Company
believes it has adequate working capital and financing capabilities to meet its
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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-capitalization ratio increased from 2% as of
December 26, 1997, to 23% as of December 25, 1998, primarily due to short-term
borrowings of $276.7 million under the Company's credit facilities, coupled with
a decrease in stockholders' equity as a result of the Company's common stock
repurchases. See "Liquidity and Capital Resources -- Working Capital" and Note 8
of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for further discussion of the
Company's common stock repurchase programs.
INTERNATIONAL OPERATIONS
- ------------------------
During 1998, 1997 and 1996, approximately 37%, 34% and 41%, respectively, of the
Company's revenue was generated by its international operations. The decrease in
international revenue during 1997 is principally because of a shift in sales of
Iceberg and SnapShot from the Company's worldwide direct sales channel to OEM
sales to IBM in the United States. The Company also sells other products and
software through domestic indirect distribution channels that have end-user
customers located outside the United States. The Company expects that it will
continue to generate a significant portion of its revenue from international
operations in the future. The majority of the Company's international operations
involve transactions denominated in the local currencies of countries within
Western Europe, principally Germany, France and the United Kingdom; Japan;
Canada and Australia. An increase in the exchange value of the United States
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 foreign currency hedging program. See "Market Risk
Management/Foreign Currency Exchange Risk," below.
The Company's international business may be affected by changes in demand
resulting from global and localized economic and business conditions. 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
these factors will have no 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. Foreign currency options and forward
exchange contracts are also used to reduce foreign currency 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 derivatives or any other financial instruments for trading
purposes. See Note 12 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. Gains and losses
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associated with changes in the underlying foreign currencies are deferred during
the commitment period and recognized as an adjustment to the revenue supporting
the note repayment at the time the bank purchases the promissory notes. See
"Available Financing Lines," for a description of the financing agreement.
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 underlying revenue transactions.
To the extent an option is terminated or ceases to be effective as a hedge, any
gains and losses as of that date are deferred and recognized as an adjustment to
the underlying revenue transaction.
The Company also utilizes forward exchange contracts, generally with maturities
of less than two months, to hedge its exposure to exchange-rate fluctuations
associated with monetary assets and liabilities held in foreign currencies and
anticipated revenues from its international operations. The carrying amounts of
these forward 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 exchange contracts used to hedge monetary assets and
liabilities are recognized as incurred within SG&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 revenues are recognized as incurred as adjustments 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 25, 1998, and as of December 26, 1997, would result in a hypothetical
loss of approximately $59.2 million and $26.6 million, respectively. The
increase in the hypothetical loss for 1998 is primarily due to an increase in
committed borrowings under the financing agreement. These hypothetical losses do
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.
The Company had outstanding borrowings under its $350 million Revolver at
December 25, 1998. The interest rate on these borrowings is dependent on the
LIBOR which is sensitive to interest rate changes. A hypothetical 10% adverse
movement in the LIBOR applied to the borrowings would not have a material
adverse effect on the Company's results of operations, cash flows, or financial
position in 1999.
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 software. 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 software in the future.
In December 1998, the Company's new 9840 tape drive and VSM software became
available. The Company's financial results in 1999 are significantly dependent
on increased manufacturing capacity and volumes for the 9840 tape drive and
gaining market acceptance for VSM. The manufacture of new
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products involves integrating complex designs and processes, and collaborating
with suppliers of key components from a sole-source supplier. A design flaw or
the failure to obtain sufficient quantities of key components could adversely
affect the Company's operating and financial results.
The Company historically has generated a significant portion of its revenue and
operating profits from the mainframe market. While storage capacity in the
mainframe market continues to increase, the rate of revenue growth has slowed as
a result of significant price competition. The Company's future financial
results are significantly dependent upon successfully competing in the rapidly
growing client-server and SAN markets. The Company currently is making
significant investments in developing new products, services and software for
these markets. There can be no assurances that the Company will be successful in
these activities.
The Company is increasing its reliance on indirect distribution channels, such
as OEMs, value-added resellers and value-added distributors. Indirect channel
activities make the Company's production and inventory planning more complex.
The Company's operating and financial results may be adversely affected in the
event an indirect partner establishes a new relationship with a competitor,
delays or changes its purchasing patterns, or experiences financial
difficulties. See "Dependence on IBM," below, for a discussion of issues
associated with the Company's distribution channels for its disk products.
DEPENDENCE ON IBM
In 1998, approximately 20% of the Company's total revenue was derived from sales
of products and software to IBM. The Company currently anticipates that in 1999,
IBM will serve as the primary distribution channel for Iceberg and SnapShot.
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. 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 of the agreement. The OEM agreement with IBM
includes certain indemnities by the Company. The Company has received notice
from IBM that it may seek indemnification from the Company in the event of an
adverse outcome of a pending patent infringement lawsuit.
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 consent decree which
was approved by the U.S. District Court for the District of Columbia on March
20, 1998. Under the terms of the consent decree, which expires in December 2002,
the Company must develop complementary domestic distribution channels for
delivery of certain disk products in 1999 or the Company could be subject to
limitations on its sales to IBM in the future.
The Company's OEM agreement with IBM expires in December 2000. IBM has indicated
that it is currently developing a competitive disk product. As a result, the
Company anticipates that IBM will reduce its purchasing patterns in the future
and may not extend the relationship with respect to future products and
software. The Company is currently ramping-up its direct sales channel to drive
increased sales of Iceberg and SnapShot during 1999. Failure to develop new
distribution channels for the Company's disk products and software could
adversely affect the Company's financial results.
COMPETITION
The markets for the Company's products, software and services are intensely
competitive and are subject to continuous, rapid technological change, frequent
product performance improvements, short product life cycles and aggressive
pricing. The Company believes that its ability to remain competitive includes
factors such as price and cost of the Company's and its competitors' product
offerings, the timing and success of new products and offerings, and new product
introductions by the Company's competitors. This competitive environment gives
rise to aggressive pricing strategies and puts pressure on the Company's gross
margins. The Company's competitors include, among others, Compaq Computer
Corporation, EMC Corporation, Hewlett-Packard Company, Hitachi Ltd., IBM, and
Sun
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Microsystems, Inc. A number of the Company's competitors have significantly
greater market presence and financial resources than the Company. In the highly
competitive client-server market, a number of the Company's competitors are able
to offer customers a bundled server and storage product, which may provide them
a competitive advantage.
The Company expects to address some of these competitive issues through its SAN
strategy, which is capable of operating in a range of environments. The SAN
market is characterized by various alliances formed to promote industry
standards and deliver tested, interoperable SAN technology. The Company is a
member of several associations, which also include the Company's competitors. In
addition, a number of the Company's competitors in the product, services and
software markets have formed alliances with the stated objective of developing
interoperable SAN solutions. For example, 3Com Corporation, Legato Systems, Inc.
and MTI Technology Corporation have formed an alliance to deliver tested SAN
solutions. In the storage management software market, the Company competes with
vendors with which it has established partnerships, including that of Legato
Systems, Inc. and VERITAS Software Corporation. The Company also anticipates
that it will continue to establish distribution partnerships with other
equipment manufacturers, software vendors and service providers to address
competitive factors. There can be no assurances that the Company will be able to
successfully compete against other companies in these markets.
VOLATILITY OF STOCK PRICE; EARNINGS FLUCTUATIONS; RESTRUCTURING
The trading price of the Company's common stock is subject to significant
fluctuations. The Company's stock price may be impacted if the Company's revenue
or earnings fail to meet the expectations of the investment community. The
Company's stock price may also be affected by broad economic and market trends,
which are unrelated to the Company's performance.
The Company's financial and operating results may fluctuate from quarter to
quarter due to a number of reasons. In the past, the Company's results have
followed a seasonal pattern, which reflects the tendency of customers to make
their purchase decisions at the end of a calendar year. During any fiscal
quarter, a disproportionately large portion of total product sales are completed
in the last weeks and days of the quarter. These factors make the forecasting of
revenue inherently difficult. The Company plans its operating expenses on the
expected revenue and a revenue shortfall may cause results to be below
expectation in that period. A shortfall in revenue could be caused by a number
of factors, such as product and technology transitions announced by the Company
or its competitors, delays in the availability of new products, changes in the
purchasing patterns of the Company's customers and distribution partners, the
timing of customers' acceptance of certain solutions, rapid price erosion, or
global economic conditions.
The Company operates in the high-technology market which is inherently
susceptible to rapid changes in customer demand, technological advances, and
intense competition. In order to address these factors, the Company has
restructured its business in the past in order to re-align its business with the
market or establish a more cost efficient business structure. These
restructurings have resulted in expenses which have adversely affected reported
results of operations in the period the restructuring plan was adopted. There
can be no assurance that changes in the Company's business or in its industry
will not necessitate restructuring charges in the future.
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. Many non-standard parts are
obtained from a single source or a limited group of suppliers; however, there
are other vendors who could produce these in satisfactory quantities after a
period of pre-qualification and product ramping. 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
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for which alternative sources of supply are not readily available. In
particular, Imation Corporation is a single source supplier for the 9840 tape
cartridges, and the Company is dependent upon Sumitomo Corporation for materials
used in the Company's tape drive recording heads. The Company is also dependent
on IBM for disk drives used in the Company's Iceberg product which are sold to
IBM under an OEM agreement and which the Company sells through its own direct
sales channel.
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
the inability to secure comparable components in a timely manner, could result
in a shortage of key components, longer lead times, and reduced control over
production and delivery schedules. These factors 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.
INFORMATION SYSTEMS TRANSITION
The Company is in the process of replacing many of its internal information
systems with new, integrated information systems that are complex and that will
affect numerous operational, transactional, financial and reporting processes.
The transition to these new systems and processes is currently expected to be
completed during the third quarter of 1999, and involves a number of risks and
uncertainties. The Company must successfully manage the transfer of critical
information to the new systems, the integration of these systems, and the
implementation of associated process changes and employee training programs. The
Company intends to conduct extensive tests on these new systems and processes
prior to implementation; however, these tests may not be able to fully simulate
the transition phase and day-to-day operating environment. There can be no
assurance that the transition to the new information systems will cause no
interruptions in the Company's critical business processes. Failure to
successfully manage the transition could adversely affect the Company's
operating and financial results.
RISKS ASSOCIATED WITH THE YEAR 2000
The Company's product lines include information storage products and software
which collect, move, store, share, and protect data. In order to properly
process data, the Company's products must successfully manage and manipulate
data that includes both 20th and 21st century dates (Year 2000 Ready). The
Company has evaluated all of its currently offered products and software and
believes that they are Year 2000 Ready, provided they have been upgraded to
include all recommended engineering changes. However, there can be no assurance
that the Company's current products and software will be Year 2000 Ready in all
environments. In addition, the Company does not currently intend to develop
modifications to certain of its older products and software to make them Year
2000 Ready and is in the process of notifying the affected maintenance customers
of potential year 2000 problems with older products and software in order to
raise their awareness.
The Company generally believes that it is not legally responsible for costs
incurred by its customers to achieve their year 2000 readiness. Should the
Company's products and software fail to be Year 2000 Ready, however, the Company
may experience increased warranty and other customer satisfaction costs. Since
the year 2000 complications are not fully known and potential liability issues
are uncertain, the effect of the year 2000 on the Company's warranty costs and
financial results are not known at this time, but could be material in any given
quarter.
The Company is currently in the process of replacing many of its internal
information systems with new integrated information systems. See "Information
Systems Transition" above. These new systems are believed to be Year 2000 Ready.
The Company has also completed its assessment on its other critical
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internal information systems which are not being replaced and has implemented
remediation programs on non-Year 2000 Ready systems. The Company has
substantially completed assessing critical non-information systems to determine
if they are Year 2000 Ready. The remediation programs for its information and
non-information systems that are not Year 2000 Ready are expected to be
substantially completed and tested by June 1999. The Company is currently
formulating contingency plans in the event of a system failure or delay.
The costs incurred to date directly related to the Company's remediation
activities total approximately $2 million. Future costs related to the
remediation activities are not expected to exceed approximately $3 million;
however, the amount may change as the year 2000 activities progress during 1999.
These remediation costs do not include the costs associated with the Company's
new information systems, which are expected to be Year 2000 Ready. The Company
has invested approximately $35 million in these new information systems as of
December 25, 1998, and the investment in these systems in 1999 is estimated to
be approximately $15 million. While the Company has not yet completed its year
2000 remediation and testing activities on all of its information and
non-information systems, the Company does not currently believe that these
activities will have a material adverse effect on the Company's operations and
financial results. Delays in implementing new internal information systems or a
failure to fully identify all year 2000 dependencies in the Company's systems
could have material adverse consequences, including delays in the delivery or
sale of the Company's products, or cause the Company to incur unexpected
additional costs.
The Company also has implemented a program to assess the possible effects on its
operations of the year 2000 readiness of key suppliers and vendors and is in the
process of receiving information concerning the suppliers' and vendors' Year
2000 Ready status. The Company's dependence on suppliers and vendors and,
therefore, on the prop