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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED: MARCH 31, 1999
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 0-22015
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ARTECON, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-032-4887
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
6305 EL CAMINO REAL
CARLSBAD, CA 92009
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (760) 931-5500
SECURITIES REGISTERED PURSUANT TO
SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO
SECTION 12(g) OF THE ACT:
COMMON STOCK
(TITLE OF CLASS)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
The aggregate market value of voting stock held by non-affiliates of the
registrant as of June 3, 1999 was $12,621,566 based upon the last sales price
reported for such date on the Nasdaq National Market. The foregoing excludes the
Common Stock held by executive officers, directors and shareholders whose
beneficial ownership exceeds 5% of the Common Stock outstanding at June 3, 1999.
Exclusion of such shares should not be construed to indicate that any such
person possesses the power, direct or indirect, to direct or cause the direction
of the management or policies of the Registrant or that such person is
controlled by or under common control with the Registrant.
As of June 3, 1999, registrant had outstanding 21,772,227 shares of Common
Stock.
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DOCUMENTS INCORPORATED BY REFERENCE
NO DOCUMENTS ARE INCORPORATED HEREIN BY REFERENCE.
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ARTECON, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED MARCH 31, 1999
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<S> <C> <C>
PART I
Item 1. Business................................................................................... 3
Item 2. Properties................................................................................. 16
Item 3. Legal Proceedings.......................................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders........................................ 16
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................... 17
Item 6. Selected Financial Data.................................................................... 17
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 19
Item 7A Quantitative and Qualitative Disclosures About Market Risk................................. 25
Item 8. Financial Statements and Supplementary Data................................................ 25
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure....... 25
PART III
Item 10. Directors and Executive Officers of the Registrant......................................... 25
Item 11. Executive Compensation..................................................................... 27
Item 12. Security Ownership of Certain Beneficial Owners and Management............................. 29
Item 13. Certain Relationships and Related Transactions............................................. 30
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................ 32
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PART I
ITEM 1. BUSINESS
BUSINESS
The discussion in this Annual Report on Form 10-K contains forward-looking
statements which involve risks and uncertainties. Actual results could differ
materially from those discussed in the forward-looking statements. Factors that
could cause or contribute to such differences include, without limitation, those
discussed in this section and the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations" as well as those
discussed elsewhere in this Annual Report on Form 10-K.
Artecon Inc. ("Artecon" or the "Company"), founded in 1984, designs,
manufactures, markets and supports a broad range of data storage products used
in Internet and enterprise storage networks and for the open-systems computing
environment. The Company has established itself as a leader in the design,
manufacture and sale of third-party mass storage solutions for a broad range of
customers. The Company's enterprise storage product line includes scalable RAID
systems which allow users to grow modularly from a single mass storage device to
over 30 TB, of fault-tolerant mass storage, thereby meeting the capacity and
performance needs of a wide range of customers while protecting and maintaining
the customer's investment. Telecommunication companies often require
certification of compliance with Bellcore's Network Equipment-Building System,
or NEBS. The Company's telecommunications infrastructure and Internet storage
EXTREME product line represent what the Company believes was the first fully
NEBS-certified, multi-terabyte solution for high-end, application-specific needs
of telecommunications and government customers using commercially available
workstation technology. The Company also provides systems integration and a
variety of other service and support programs for its customers.
In August 1997, Artecon, Inc., a California corporation, formerly a
subsidiary of Artecon, or Artecon California, acquired substantially all of the
assets and liabilities of Falcon Systems, Inc. or Falcon, a network-attached
storage server integrator and storage peripherals reseller, in a transaction
accounted for as a purchase of Falcon by Artecon California, or the Falcon
acquisition. The Falcon acquisition has enabled Artecon to achieve several
important strategic objectives, including the acquisition of the AerREAL(TM)
real-time specialized file server software and other complementary products to
better serve the Company's existing customers, the expansion of the Company's
customer base in the UNIX market and a significant expansion of the Company's
revenue base.
On March 31, 1998, Artecon, Inc. and Storage Dimensions, Inc., or SDI,
completed a reverse merger whereby SDI acquired Artecon in a stock-for-stock
transaction. Immediately after the merger, SDI changed its name to Artecon, Inc.
In the merger, shareholders of the former Artecon, Inc. received approximately
62% of the common stock, and 100% of the preferred stock of the new Artecon.
Since the former Artecon's shareholders received a substantial majority of the
common stock of the new Artecon, the transaction was accounted for as a purchase
of SDI by Artecon. As a result, the historical financial results included in
this Annual Report on Form 10K are those of Artecon and include the results of
operations of business of Falcon following the Falcon acquisition in August 1997
and the results of operations and business of SDI following the reverse merger
on March 31, 1998. Subsequent to the SDI merger the new Artecon wrote off
substantial research and development costs that were in process at SDI prior to
the merger.
In June 1998, Artecon California was merged with and into the Company.
On April 30, 1999, the Company announced that it has entered into a
definitive merger agreement whereby Artecon will merge with Box Hill Systems
Corp., a New York corporation ("Box Hill") in a tax-free, stock-for-stock
transaction intended to be accounted for as a pooling of interests. Under the
terms of the Agreement and Plan of Merger dated April 29, 1999 ("the Merger
Agreement"), each outstanding share of common stock of Artecon will be converted
into 0.40 of a share of Box Hill Common Stock. Each issued and outstanding share
of preferred stock of Artecon will be converted into Box Hill Common Stock based
on the terms defined in the Merger Agreement. In addition to shareholder
approvals, the Merger is subject to customary closing conditions as well as
certain regulatory approvals. The parties anticipate that the Merger will close
by the end of the third quarter of calendar 1999. If the Merger is successfully
completed, the Company will cease to be a separate registrant with the
Securities and Exchange Commission, and future operating results of the Company
would be reported on a combined basis with Box Hill.
INDUSTRY BACKGROUND
The rapid proliferation of new data-intensive applications, such as video,
the Internet, intranets, multimedia, data warehousing and data mining, and the
migration of mission-critical applications away from mainframe computers have
fueled the demand for open-systems data storage. Disk storage systems, tape
backup systems and software-based management tools designed to operate on
multiple platforms are becoming a strategic part of network computing. System
purchase decisions are becoming increasingly focused on data storage and,
increasingly, capital expenditures for storage systems are equal to or greater
than those made on computer processing hardware. Storage architectures based on
protocols such as UltraSCSI and Fibre Channel and topologies such as the SAN are
driving a much greater focus on data center purchasing towards storage.
Currently, the industry is split into solutions based on host-attached storage
and solutions based on network-attached storage.
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UNIX AND WINDOWS NT. Open-systems platforms today employ either UNIX
variants, such as Solaris (Sun), HPUX (HP), AIX (IBM) and IRIX (SGI), or Windows
NT from Microsoft. Together, these operating systems are installed on the vast
majority of computers used in the enterprise. UNIX platforms currently have the
largest installed user base in terms of numbers of units, with the Windows NT
user base expanding.
Many companies use a combination of both types of systems, often employing
Windows NT-based Intel machines for front office work (e.g., accounting, office
support, administration) and UNIX-based RISC workstations and servers for back
office functions such as engineering and manufacturing. More recently, Windows
NT workstations have been developed by companies such as Compaq and Hewlett
Packard, or "HP," among others, to challenge the dominance of UNIX workstations
in the engineering, scientific and other technical arenas. This has resulted in
a gradual but steady transition from the UNIX-installed base towards Windows NT,
further stimulating the demand for open-systems storage solutions that support
multiple operating systems on platforms from a variety of vendors.
HOST-ATTACHED STORAGE. The open-systems market's current host-attached
storage options include disk arrays, RAID storage systems and tape backup
systems. Each of these is generally attached to the host by a SCSI bus. SCSI,
including UltraSCSI, Ultra2 and Ultra3, was designed to transfer data at higher
rates with enhanced reliability and lower error rates, has been the dominant
commercially available interface currently used in most disk array and RAID
storage systems. Fibre Channel, an emerging high-speed serial interface that has
recently become commercially available, is regarded by many industry
participants as the storage industry's next-generation interface. Fibre Channel
enables the transfer of data between computers and peripherals at substantially
increased rates, over greatly increased cabling lengths and among a greater
number of host/device connections. A number of industry leaders, including
Microsoft Corporation, Seagate, Quantum, IBM, Sun, and Emulex, have indicated
support for Fibre Channel technology and have announced that they are producing
or plan to produce products that incorporate it.
SAN BASED ON FIBRE CHANNEL. The requirements of the data intensive network
environment have contributed to the growing importance of SANs, based on Fibre
Channel. SANs represent localized networks of storage pools that can
collectively be accessed by many (and disparate) servers. Centralized management
is a key benefit of SANs, which in their most basic form, could be physically
distributed over the 10km distance limits of fibre channel. The Company's
LynxArrayII and future hardware and software products form the nucleus of
storage area network product suites.
The SAN architecture enhances the potential of open systems storage vendors
as it tends to separate the storage purchasing decision. As a result, the SAN
storage decision becomes one of "best-fit" or "best of breed" as opposed to
simply foregoing the storage as an after thought to the server.
THE INTERNET AND THE WORLD WIDE WEB (WWW). The virtual explosion of the
Internet and subsequently corporate-wide intranets has had a profound impact on
the computer industry in general and on the demand for storage solutions in
particular. The Internet and intranet environments involve intensive processing
or computation of, and frequent user access to, large volumes of data and
consequently require a mission critical level of high-availability mass storage.
Moreover, the data intensity of these environments is expected to continue to
increase substantially due to the development of new applications and services
and the more prevalent use of stored digital graphics, voice and video,
requiring dramatically more data capacity and performance than equivalent
alphanumeric information.
TELECOMMUNICATIONS INDUSTRY. The enactment by Congress of the
Telecommunications Deregulation Act in 1996, the opening up of additional radio
frequency spectrum for wireless communications by the Federal Communications
Commission and other significant recent developments have spurred dramatic
changes in the worldwide telecommunications industry. The development and
build-out of expanded markets and new modes of communication that have been
enabled by these changes, including digital cellular systems, personal
communications systems, or "PCS," satellite-based communications systems,
Internet and cable systems, will require enormous capital expenditures for new
infrastructure. The Company believes that a significant element of the required
infrastructure will consist of high performance mass storage systems that must
be specially adapted and certified for use in the telecommunications industry.
Telecommunications companies are seeking commercial off-the-shelf, or
"COTS,"-based solutions that can be adapted and deployed in their embedded
architectures due to ever-increasing cost pressures and time-to-market
constraints. These solutions are typically based on UNIX and/or Windows NT
systems and employ highly redundant RAID storage systems.
THE ARTECON SOLUTION
The Company develops and markets a comprehensive range of scalable, fully
integrated data storage products and services for the open-systems computing
environment. Artecon's products are both host-attached and network-attached, are
based on a common architecture allowing scalability from the first desktop mass
storage unit purchased to multi-terabyte data center installations and are
compatible with a variety of UNIX and Window NT operating systems. Artecon's
family of products and services is intended to provide users with the following
benefits:
- HIGH PERFORMANCE WITH MISSION-CRITICAL HIGH AVAILABILITY. Recognizing
the increased demand for faster response times, greater capacities,
higher availability of data and minimum system downtime, the Company
has focused on developing high-
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end,high-performance storage products using Ultra SCSI, LVD and Fibre
Channel interfaces. Redundant system components such as dual power
inlets and multiple fans are intended to eliminate any single point of
failure to ensure maximum system uptime.
- SCALABILITY. The Company's products are designed using a flexible,
modular architecture allowing the Company to size and configure
storage systems to the application-specific requirements of individual
customers. In addition, this architecture allows Artecon to resize and
reconfigure these systems to adapt to the changing needs of customers,
while allowing them to retain capital value in their underlying
systems. This scalability preserves the customer's initial and
subsequent storage investments by allowing users to grow modularly
from a single mass storage device to over 30 terabytes of mass
storage.
- MULTI-PLATFORM SUPPORT. As an independent provider of storage
products, the Company is well positioned to provide storage systems
specifically designed to be compatible with a variety of UNIX and
Windows NT platforms. This multi-operating system capability allows
end users to standardize on a single storage system that can readily
be reconfigured and reused at minimal cost even if the user decides to
change operating systems or other components of the network.
- HIGH-PERFORMANCE BACKUP. To satisfy market demand for reliable,
high-quality backup products and systems, the Company offers a broad
variety of backup products, including tape library systems, backup
software, training and documentation. The Company has specialized
expertise in the design and implementation of effective,
well-integrated backup solutions designed to satisfy customers'
individual needs, from departmental server systems to enterprise
network systems.
- CARRIER CLASS RELIABILITY. The Company's products are believed to be
the first open-systems storage RAID products that are fully certified
to the telecommunications industry's demanding NEBS standards. NEBS
certification assures customers that the Company's telecommunications
products deliver true carrier-class reliability.
- ALL-ENCOMPASSING SOLUTIONS. The Company delivers all-encompassing
solutions including design consulting, systems integration,
installation, training, comprehensive service and technical support
and software-based management tools. The Company employs a full staff
of direct sales personnel and applications engineers to assist
customers in making appropriate and effective storage system purchases
and in addressing, analyzing and solving complex storage problems.
This value-added approach is designed to foster customer loyalty and
allow the Company to identify emerging customer requirements for
future data storage products.
ARTECON'S STRATEGY
The Company's objective is to continue its growth and enhance its position
as a leading independent provider of host-attached and network-attached storage
solutions to the open-systems marketplace. To achieve this objective, Artecon
plans to build upon its record of successfully introducing and commercializing
new products and technologies that address the evolving data storage needs of
its broad customer base. Key elements of this strategy are:
- PROVIDE COMPLETE SOLUTIONS AND PRODUCT MIGRATION PATH. The Company's
products are designed to address a wide range of customer needs. By
utilizing common core technology throughout its product line, the
Company enables customers to migrate from product to product across
multiple platforms to address the changing needs of growing companies.
By providing comprehensive solutions, the Company is able to work more
closely with customers, offer additional modules or products and
provide additional services.
- EXPAND MARKET PENETRATION. While maintaining its status as a leading
provider for the Sun market, the Company intends to continue to
provide industry-leading mass storage and enhancement products for use
in the Windows NT market and other UNIX markets. The Company has a
number of products designed for use on Windows NT platforms. In
addition, the Company recently introduced its Redundant Data Path, or
"RDP," software for Windows NT platforms which provides the capability
to support two independent data paths with failover capability.
- FOCUS ON SPECIALIZED STORAGE NEEDS OF DATA-INTENSIVE MARKETS. The
Company intends to continue to target users of UNIX and Windows NT
computing environments who require high-performance, high-availability
and fault-tolerant storage solutions, such as end users in
data-intensive industries, particularly the telecommunications and
Internet/intranet, financial services and multimedia markets. The
Company, as an independent provider of storage systems, believes that
it is well positioned to address the multi-platform, multi-protocol
computing requirements of these targeted high-end users.
- INTERNET AND TELECOMMUNICATIONS STRATEGY. The Company intends to
continue to aggressively pursue Internet and telecommunications
companies by realigning its internal resources and continuing to
develop a series of new products that satisfy their rapidly expanding
storage needs. In the implementation of its strategy the Company will
focus its resources to enhance existing products and develop new
products and services specifically targeted to the Internet and
telecommunications segment of the storage market and increase sales
and marketing efforts to key telecommunications, Internet, and other
storage-intensive companies.
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- REALIGN AND EXPAND DIRECT SALES FORCE WHILE LEVERAGING RESELLER
CHANNELS. The Company believes that a properly managed direct sales
force should result in the greatest penetration of the Company's
markets. Direct customer contact provides the Company with valuable
market feedback and the ability to provide high-quality technical
support and enhance customer loyalty. In certain markets, however, the
Company uses strong vertical market oriented resale partners and
believes that leveraging these reseller channels will provide the
Company with a significant competitive advantage.
PRODUCTS AND SERVICES
The Company's products and services are offered through two distinct sales
groups: the Enterprise Storage Division and the TeleCom Division. In order to
address the unique and highly specialized needs of the telecommunications and
Internet/intranet marketplace, the Company formed its TeleCom Division in June
1996. The Company's Enterprise Storage Division is responsible for the other
markets targeted by the Company, including finance (for example, commodities
brokers and trading analysts), multimedia (such as entertainment providers,
cable companies, news services and the companies building infrastructure to
serve them), government, advanced-technology and industrial markets. Within
these two divisions of the Company, the Company's data storage solutions fall
into three general categories: enterprise storage, telecommunications storage
and systems integration capability.
ENTERPRISE STORAGE DIVISION
The Company provides enterprise storage solutions to its customers through
its Lynx product line. By allowing users to grow modularly from a single mass
storage device to over 30 TB of rack-mounted, fault-tolerant RAID mass storage,
The Company's Lynx hot-swap removable mass storage subsystems address the
capacity and performance needs of customers while maintaining and protecting
customer investment. The Lynx unit is the fundamental building block of all the
Company storage solutions and has several unique and differentiating features,
including interlocking stackability, cableless design, ruggedized hot-swap drive
sleds, front-removable power supplies and auto termination. To date, over 70,000
Lynx storage units have been installed.
The Lynx line of storage solutions includes LynxArray and LynxStak RAID
systems which offer host-attached RAID protection and performance enhancement
for creating highly available, mission-critical storage systems. The Company
believes that the performance, flexibility, true scalability, hot-swap removable
components and compact form factor provide significant benefits to its
customers.
The Company's LynxStak(TM) product is an interlocking modular desktop
storage product that scales from 4 GB to 126 GB as required. The LynxStak system
uses the same disk drives and controllers as the Company's LynxArray preserving
the customer's initial and subsequent storage investment. The Company believes
that the performance, flexibility, scalability, hot-swap removable components
and compact form factor provide significant benefits to its customers. LynxStak
won Windows NT Magazine's "Favorite Storage Product" in 1999.
The Company's LynxArray II is a tower or rackmount product for larger
storage requirements. The LynxArray II uses the same architecture as capacity
scales from 27 GB to more than 30 TB. LynxArray II uses an Intel-based RAID
controller that operates at speeds up to 5000 input/outputs per second. LVD SCSI
channels from host computer through controllers to disk drives allow 80 MB per
second burst and 36 MB per second sustained transfer rates. Each LynxArray II
can support up to 252 GB of hot-swappable disk capacity and two hot-swap
failover RAID controllers. Inline support for tape drives makes backup possible
within the RAID subsystem. Hot-swap removable failover controllers, redundant
power supplies and fans are all available for more fail-safe, potentially
nonstop operation.
To complement its disk products, the Company engineered a family of
high-speed, high-reliability MEGAFLEX tape backup systems that are designed to
address the challenges of backing up increasing amounts of data in
ever-shortening time periods. These tape products are easily integrated and
fully compatible with the Company's disk storage systems. In addition, tape
backup products are offered as stand-alone products to back up data maintained
on other manufacturers' disk storage systems. The Company believes that its disk
and tape storage products are differentiated from competitive products based on
functionality, performance, ease of use and lower life-cycle cost of ownership.
The Company's disk and tape storage products utilize proprietary software
to incorporate leading edge hardware features and capabilities relative to the
storage products offered by computer and server manufacturers, with design
features specifically engineered to minimize system downtime and to support easy
integration and administration.
RAIDScape is a Java-based enterprise storage management software package
that combines configuration, maintenance, and monitoring tools into a single,
easy-to-use application. RAIDScape enables remote administration of the Company
disk arrays attached to Windows NT, Solaris and Netware servers located anywhere
on a local or wide area network, greatly simplifying storage management and
reducing costs. It is ideally suited for centralized information technology
departments managing large, distributed networks.
Redundant Data Path, or "RDP," software provides the new level of
resiliency and performance, as well as multiple server connectivity for the
Company's LynxArray II dual active controller RAID storage systems on NT
operating system. The
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software's host-based driver supports dual active input/output paths from the
server to the storage systems. This enhances resiliency by providing failover
protection should a host bus adapter, cable, hub or controller on either data
path fail. It also enhances performance by doubling the system's throughput
potential.
The Company will continue to enhance its existing extensive proprietary
software library. This library is designed to enable the Company to quickly
integrate new hardware technologies to bring new products to market in a rapid
and cost-effective manner.
WORKSTATION AND SERVER RACK SOLUTIONS. The Company's Sphinx(TM) workstation
and server rack solutions enable users to rackmount COTS desktop workstations
from Sun into powerful, application-specific servers. Sphinx products protect
against shock and vibration events, maintain the thermal integrity of the
workstation/server, enhance system physical security while providing a very
compact expansion capability. The Company believes it offers a superior solution
than the typical rack shelf used for rackmounting workstations and servers.
Sphinx also allows hot swap removable devices to be added so that a variety of
powerful and expandable configurations can be constructed, including high-end
clustered compute servers, high availability failover servers, network servers
and database servers.
The Company's Sphinx customers range from manufacturing floor and computer
center applications, to government agencies with requirements for shipboard,
aircraft and ground vehicle deployment of desktop workstations.
TELECOM DIVISION
The Company's TeleCom Division designs, manufactures, markets and supports
fully integrated, industry-compliant storage products, services and solutions
for the telecommunications and Internet/intranet markets by utilizing
commercially available workstation, server and other application-specific
products for enhanced price/performance characteristics and reduced time to
market. Most of the products and services manufactured and marketed by the
Company's Enterprise Storage Division can be utilized by telecommunications and
Internet service providers. Requirements unique to the telecommunications
industry include -48VDC power (native to the Central Office environment) and
compliance with Bellcore's NEBS areas of standardization, which include
electromagnetic compatibility, thermal robustness, fire resistance, earthquake
and office vibration resistance, transportation and handling, acoustics and
illumination and airborne contaminants. Telco embedded infrastructure projects
are exceptionally demanding in terms of high availability and redundancy due to
the uptime requirements of the world's telephone and communications support
equipment. NEBS testing requires a certified unit to be able to withstand an
earthquake, a lightning strike, a fire, severe airborne particulate
contamination, extreme temperature ranges and other catastrophic events. The
Company believes it was the first open-systems storage company whose RAID
products are fully certified to Bellcore NEBS standards. In addition, the
Company's commercial enterprise storage products are built to the same demanding
standards, yielding very reliable systems for the commercial market.
TELCO STORAGE SOLUTIONS. Most of the Company's enterprise storage products,
including LynxArray II, can be utilized by telecommunications and Internet
service providers. The Company's LynxArray EXTREME products are already in use
by telecommunications and Internet service providers.
WORKSTATION AND SERVER RACK SOLUTIONS. The Company's Sphinx EXTREME product
line is fully NEBS-certified and has been instrumental in bringing Sun
workstation products into the telecommunications and typical Internet service
provider environment. The Company's TeleCom Division Sphinx customers include a
wide range of telecommunications infrastructure and Internet/intranet service
providers building new Internet, wireless and PCS services based on COTS
workstations.
POWER PRODUCTS. The Company believes that its PowerSphinx(TM) EXTREME is
the industry's first 1.75" DC/DC power converter which allows unmodified
workstation, network and storage products to run in the 48VDC environment of the
telecommunications Central Office. PowerSphinx EXTREME enables workstation and
networking products typically used in 110-240VAC environments to run unmodified
in the -48VDC context. The Company believes this feature may significantly
accelerate its customers' time to market for new infrastructure while reducing
costs due to the ability to employ standard (as opposed to custom) workstation,
networking and other products.
PowerSphinx EXTREME is designed for use with 110-240VAC devices such as
workstations, switches, routers and hubs so that they may operate in the -48VDC
telecommunications environment, thereby expanding the limits of available
product choices to engineers and integrators building telecommunications
systems. The Company believes that the compact 1.75" EIA rack height is an
improved and preferable alternative to typically large (often as much as 21" or
12u EIA) power inverters. PowerSphinx EXTREME has two hot-swappable,
load-sharing power modules to assure uninterrupted operation, combined with dual
- -48VDC inlet power connections to help virtually eliminate any single point of
failure. Other features include 1600 watts of total power output, hot-plug
removable power trays and fans, alarm system and dual LED displays. The
PowerSphinx EXTREME is fully certified to Bellcore NEBS standards.
TELECOMMUNICATIONS SERVICES. Most of the regional Bell phone companies,
long-distance service companies and Internet service providers often lack the
resources, time, expertise and inclination to install and integrate storage
solutions and therefore they look to a single source supplier who can provide a
complete storage solution. As a consequence, the Company believes that its
systems
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integration services are well suited to the telecommunications market. The
Company has established a product and integration contract with Motorola.
The Company has extensive experience as a systems integrator producing
expandable systems to suit each client's unique situation. The Company utilizes
commercially available workstation, server, networking and other
application-specific products along with its own EXTREME product line. Utilizing
commercially available equipment and an open-systems approach can accelerate
customers' time to market and provide customers with superior price/performance.
PRODUCTS IN DEVELOPMENT
The Company has several products under development including a full Fibre
Channel RAID storage system and RAID systems that will support Ultra3 SCSI.
In the area of software development for its server-attached disk storage
products, the Company has recently completed development of its RDP software for
Windows NT, that provides the capability to support two or more independent data
paths with failover capability. This same software is being developed for
Solaris and Linux. There is no guarantee that the Company will complete these
projects.
The recently introduced CacheBack products will combine the Company's
rugged carrier-class storage devices with performance enhancement storage and
network capability. These products will utilize the highly regarded Inktomi
traffic server, to provide the first in a series of scalable, carrier-class,
high performance network cache solutions designed for Internet service providers
and large enterprise intranets. This initial product is expected to become the
foundation for an evolving product line of superior storage solutions.
In the rapidly expanding and evolving world of communications, developing
the right technology is only part of the role of the equipment provider.
Operators in today's markets are looking for total support from their suppliers,
for service packages that are unique and tailored to meet their individual needs
and requirements. The Company will carry the service concept far beyond the
traditional vendor approach of simply providing equipment and systems support.
Instead it will be based on the development of a long-term partnership between
the operator and the Company, combining consulting on a strategic business level
with implementation and operational support.
CUSTOMERS
The Company targets both the horizontal markets defined by the primary
workstation vendors, such as Sun, SGI, HP and IBM, and the vertical markets of
the data-intensive Internet, telecommunications, finance and multimedia
industries. The Company's customers include OEMs, systems integrators, value
added resellers, or "VARs," and end users and span market segments ranging from
computer manufacturers to government agencies. The following customers of the
Company accounted for approximately that percentage of the Company's total
revenues set forth below during the periods indicated: Sales to one customer did
not exceed 10% of total net revenue for the fiscal years ended March 31, 1998
and 1999; Tracor Enterprise Solution (25.4%) for the fiscal year ended March 31,
1997. No other customer accounted for more than 10% of the Company's total
revenues during the fiscal years ended March 31, 1999, 1998 and 1997. Sun
Financial Group accounted for approximately 10% of Storage Dimensions' total
revenue for the fiscal year ended December 31, 1997.
SALES AND MARKETING
The Company utilizes both a direct sales force and selected reseller
channels for certain products and markets in the U.S. and overseas to provide
broad market coverage for its products. As of March 31, 1999, the Company's U.S.
and foreign sales, marketing, service and support organization consisted of 112
personnel located in 16 offices around the world. In the U.S., 83 sales,
marketing, service and support people are located in 11 geographical markets,
including, San Jose, Los Angeles, and San Diego, California; Denver, Colorado;
Atlanta, Georgia; Chicago, Illinois; Boston, Massachusetts; New York City, New
York; Bridewater, New Jersey; Cleveland, Ohio; and Washington, D.C. The
Company's international marketing group includes 30 sales, service and support
personnel who work for a Japan-based subsidiary and a Europe-based subsidiary
with offices in England, France and the Netherlands. The Company's sales to
customers located in the United States represented approximately 86.3% and 90%
for the fiscal years ended March 31, 1998 and 1999, respectively. The Company's
sales to customers located outside the United States represented approximately
12% and 10% of the Company's net revenues for the fiscal years ended March 31,
1998 and 1999, respectively. For fiscal year ended March 31, 1997, the Company
sales to customers located in the United States represented approximately 83.8%
of the Company's net revenues and sales to customers located outside the United
States represented approximately 16.2% of Artecon California's net revenues.
Direct sales organizations of the Company's subsidiaries in Japan (Tokyo,
Nagoya), the Netherlands (Encschede), France (Paris) and the United Kingdom
(London) consisted of 10 sales professionals.
The Company also employs a leveraged sales model that utilizes resellers
focused on the needs of specific end users. The Company has developed pricing
structures and field sales commission plans that are designed to minimize sales
channel conflicts. The
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Company believes that this two-pronged sales strategy provides a meaningful
competitive advantage over competitors who only provide products directly to
end-user customers.
The Company will continue to focus much of its sales and marketing efforts
on Internet service providers and telecommunications companies with rapidly
increasing storage requirements. Their storage requirements are driven by their
customers' demand for information that resides in heterogeneous UNIX and Windows
NT operating environments.
CUSTOMER SERVICE AND SUPPORT
The Company believes that its ability to provide comprehensive and
responsive support is an important element in penetrating new customer accounts
and in securing repeat business from existing customers. The Company is
committed to providing superior customer service and support aimed at
simplifying installation, reducing field failures, minimizing system downtime
and streamlining administration.
In certain geographical regions, the Company maintains a staff of on-call
technical personnel who are available to visit the customer's site within a few
hours of receiving a request for service. In other geographical regions, the
Company indirectly provides the same level of support by using third-party
service companies. In all cases, the Company's technical support engineers are
available by phone on a seven-day-per-week, 24-hour-per-day basis. The Company
plans to increasingly utilize the Internet and other on-line services in the
support and distribution of its products.
The Company provides standard warranties with all products sold which are
set forth in various documents and agreements, which are delivered to customers
with each product. As a general policy, the Company ships replacement hardware
components to customers in advance of receiving returns of defective components
under a standard warranty, which generally runs three years. The Company
occasionally issues credit in lieu of replacing a piece of equipment. A customer
may also contract for an extended warranty or maintenance support from the
Company on all products.
RESEARCH AND DEVELOPMENT
To date, the Company has made substantial investments in research and
development, particularly in the areas of RAID, SANs, backup, FC-AL, GUI
software development, and specialized file server software. The Company's
engineering design team employs electrical engineering, mechanical engineering,
systems engineers and computer science professionals and places great importance
on the exchange of information with the Company's sales and marketing and
customer support departments and with its resellers to develop new products and
product enhancements that anticipate and address technological changes and
evolving industry standards and customer needs.
The Company generally designs its products to have a modular architecture
that can be readily modified to respond to technological developments and
paradigm shifts in the open systems computing environment. This flexibility
allows the Company to focus research and development resources on specific
product innovations and advancements. The modular architecture of the products
meets customer needs with solutions tailored to their applications and products
that can be adapted to changes in technology and in their computing
environments.
The Company's engineering design teams work cross-functionally with
marketing managers, applications, technical and production engineers and
customers to develop products and product enhancements. The Company employs a
full staff of applications engineers to assist customers in making appropriate
and effective storage system purchases and in addressing, analyzing and solving
complex pre-deployment storage problems. The Company's technical support
engineering team and production engineering team also contribute to the quality,
manufacturability and usability of products from design to deployment. This
value-added capability fosters customer loyalty and allows the Company to
identify emerging customer requirements for future data storage products.
The Company's expenses for research and development for fiscal years 1997,
1998, and 1999 were $2.4 million, $3.2 million, and $7.3 million, respectively.
As of March 31, 1999, the Company had 32 regular full-time and three contract
employees engaged in research and development activities, of which four were
specifically focused on research and development of products and services
directed at the telecommunications and Internet/intranet markets. Additionally,
Storage Dimensions' expenses for research and development for calendar year 1997
was $6.3 million.
The data storage system market is characterized by rapid technological
change, changing customer needs, frequent new product introductions and evolving
industry standards. The introduction of products embodying new technologies and
increased storage capacities and the emergence of new industry standards could
render the Company's existing products obsolete and unmarketable. The Company's
future success will depend upon its ability to develop and introduce new
products with increasing storage capabilities on a timely basis that keep pace
with technological developments and emerging industry standards and address the
increasingly sophisticated needs of its customers. There can be no assurance
that the Company will be successful in developing and marketing any new products
that respond to technological changes or evolving industry standards, that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of new products, or that its
new products will adequately meet the requirements of the marketplace and
achieve market acceptance. In addition, storage system products like those
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offered by the Company may contain undetected errors or failures when first
introduced or as new versions are released. There can be no assurance that,
despite testing by the Company and by current and potential customers, errors
will not be found in new products after commencement of commercial shipments,
resulting in a loss or delay in market acceptance, which could have a material
adverse effect on the Company's business, operating results or financial
condition.
MANUFACTURING
The Company operates 43,000 square feet of manufacturing space at its
Carlsbad, California facilities. The Company's products are manufactured in a
work cell production process. State-of-the-art equipment and software include
manufacturing resource planning, just-in-time order processing and
total-quality-management. The Company strives to develop close relationships
with its suppliers, exchanging critical information and implementing joint
corrective action programs to maximize the quality of its components, to reduce
costs and inventory investments and to create flexibility for rapid capacity
expansion when required. The Company believes that its current facilities and
capital equipment will be adequate to meet its manufacturing needs in the
foreseeable future.
In July 1998, the Company earned the ISO 9002 certification from the
International Organization for Standardization. ISO 9002 certification covers
the manufacture, distribution and support of the Company's high-performing
storage systems. Attaining the certification entailed meticulous examination of
the Company's manufacturing standards and processes. The Company must undergo
periodic assessment by independent auditors in order to retain the ISO 9002
certification.
The Company subcontracts some of its manufacturing, such as plastic
molding, metal bending, PCB fabrication and assembly, to qualified partners in
the U.S. and Asia. The Company owns the design and tools/molds associated with
the manufacture of these parts. The Company has designed and owns over 50 tools
used to produce various components of its Lynx, LynxStak, and LynxArrayII
products. In addition, the Company relies upon a limited number of suppliers of
several key components utilized in the assembly of the Company's products,
including Seagate, IBM, Quantum, Merisel, Infortrend, ATL, Flextronics, Exabyte
and Mylex. The Company's reliance on its manufacturing subcontractors and
suppliers involves several risks, including: an inadequate supply of required
components; price increases; late deliveries; and poor component quality.
Although to date the Company has been able to obtain its requirements of
components, there can be no assurance that the Company will be able to obtain
its full requirements of such components in the future or that prices of such
components will not increase. In addition, there can be no assurance that
problems with respect to yield and quality of such components and timeliness of
deliveries will not occur. Disruption or termination of the supply of these
components could delay shipments of the Company's products and could have a
material adverse effect on the Company's business, operating results or
financial condition. Such delays could also damage relationships with current
and prospective customers. The Company has experienced delays in the shipments
of its products in the past, principally due to an inability of vendors to
deliver an adequate supply of components, resulting in delay or loss of product
sales. Although these delays in the past have not had a material adverse effect
upon the Company's business, operating results or financial condition, there can
be no assurance that in the future any such delays would not have such a
material adverse effect.
COMPETITION
The storage market is extremely competitive and is characterized by rapidly
changing technology. The Company has a number of competitors in various markets,
including Hewlett Packard, Sun Microsystems, IBM, Hitachi, Data General
Corporation, Compaq Corporation, Network Appliance, nStor Technologies, LSI
Logic, Ciprico, Andataco, StorageTek, Dell Computer Corp, SGI, DEC, Storage
Works, MTI Technology and EMC Corporation, many of which have substantially
greater name recognition, engineering, manufacturing and marketing capabilities,
and greater financial and personnel resources than the Company. In particular, a
number of the Company's customers are also competitors, including Sun and SGI.
The Company expects to experience increased competition from established and
emerging computer storage hardware and management software companies,
particularly HP, Sun, IBM, Dell, Compaq and EMC Corporation.
In addition, increased competitive pressure could lead to intensified
price-based competition, which could have a material adverse effect on the
Company's results of operations. There also has been, and may continue to be, a
willingness on the part of certain large competitors to reduce prices in order
to preserve or gain market share. The Company believes that pricing pressures
are likely to continue as competitors develop more competitive product
offerings.
The principal factors of competition in the Company's markets include rapid
introduction of new technology, product quality and reliability, price and
performance characteristics, service and support and responsiveness to
customers. The Company believes that, in general, it competes favorably with
respect to these factors. The Company intends to maintain its competitive
position by continuing to build a defensible niche in the Internet and
telecommunications markets, while at the same time serving other industries and
customers. Its strengths in product reliability and quality, price/performance
characteristics and new technology are being supplemented by enhanced service
and support. With Inktomi as a strategic partner in developing traffic-server
software, the Company believes it can provide a superior network storage
solution. However, there can be no assurance that the Company will be able to
compete successfully or that competition will not have a material adverse effect
on the Company's business, results of operations or financial condition.
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INTELLECTUAL PROPERTY
The Company's success depends significantly upon its proprietary
technology. The Company relies on a combination of patent, copyright, trademark
and trade secret laws, employee and third-party nondisclosure agreements and
technical measures to protect its proprietary rights in its products.
As of March 31, 1999, the Company had been awarded a total of seven U.S.
patents covering certain elements of its products. There can be no assurance
that any additional patents will be issued, that the Company will develop
proprietary products or technologies that are patentable, that any patent issued
in the future will provide the Company with any competitive advantages or will
not be challenged by third parties, or that the patents of others will not have
a material adverse effect on the Company's ability to do business. The Company
seeks to protect its software, documentation and other written materials under
trade secret and copyright laws, which afford only limited protection. The
Company has registered numerous trademarks and will continue to evaluate the
registration of additional trademarks as appropriate. The Company generally
enters into confidentiality agreements with its employees and consultants and
with key vendors and suppliers. All released documentation of products,
including drawings, requirements specifications, source code, BOMs, costs and
other materials, are kept in a secure, centralized document control area.
The Company expects that companies in the storage system market will
increasingly be subject to infringement claims as the number of products and
competitors in the Company's target markets grows. Although the Company believes
that its products and trade designations do not infringe on the proprietary
rights of third parties, there can be no assurance that third parties will not
assert infringement claims against the Company in the future. If such a claim is
made, the Company will evaluate the claim as it relates to its products and, if
appropriate, may seek a license to use the protected technology. There can be no
assurance that the Company would be able to obtain a license to use such
technology or that such a license could be obtained on terms that would not have
a material adverse effect on the Company. If the Company or its suppliers are
unable to license protected technology, the Company could be prohibited from
incorporating or marketing products incorporating that technology. The Company
could also incur substantial costs to redesign its products or to defend any
legal action taken against it. Should the Company's products be found to
infringe protected technology, the Company could be required to pay damages to
the infringed party or be enjoined from manufacturing and selling such products.
Despite the Company's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy aspects of the Company's products or to obtain and
use information that the Company regards as proprietary. In addition, the laws
of some foreign countries do not protect proprietary rights to as great an
extent as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights will be adequate or that
the Company's competitors will not independently develop similar technology,
duplicate the Company's products or design around patents issued to the Company
or other intellectual property rights of the Company
EMPLOYEES
As of March 31, 1999, the Company had approximately 234 full-time employees
worldwide, including 112 in marketing, sales and service support, 67 in
manufacturing and quality assurance, 29 in engineering and research and
development and 26 in general administration and finance.
None of the Company's employees is represented by a labor union. The
Company has experienced no work stoppages and considers its relations with its
employees to be good.
The Company's future performance depends in significant part upon the
continued service of its key technical and senior management personnel. The
Company provides incentives such as salary and benefits to attract and retain
qualified employees. The loss of the services of one or more of the Company's
officers or other key employees could have a material adverse effect on the
Company's business, operating results or financial condition. The Company's
future success also depends on its continuing ability to attract and retain
highly qualified technical and management personnel. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key technical and management employees or that it can attract, assimilate or
retain other highly qualified technical and management personnel in the future.
CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS
In addition to those risks identified elsewhere in this Annual Report on
Form 10-K, the Company's business and results of operations are subject to other
risks, including the following risk factors:
HISTORY OF OPERATING LOSSES; POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS.
For the fiscal years ended March 31, 1999 and 1998 the Company incurred a loss.
The Company's operating results for the fiscal years ended March 31, 1999 and
1998 included expenses incurred as a result of the acquisition of Falcon and the
acquisition of Storage Dimensions. There can be no assurance that the Company
will be profitable on a quarterly or annual basis.
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The Company's quarterly operating results have in the past varied and may
in the future vary significantly depending on a number of factors, including:
the level of competition; the size, timing, cancellation or rescheduling of
significant orders; product configuration and mix; market acceptance of new
products and product enhancements; new product announcements or introductions by
competitors; deferrals of customer orders in anticipation of new products or
product enhancements; changes in pricing by the Company or its competitors; the
impact of price protection measures and return privileges granted by the Company
to its distributors and VARs; the ability of the Company to develop, introduce
and market new products and product enhancements on a timely basis; hardware
component costs and availability, particularly with respect to hardware
components obtained from sole sources; hardware supply constraints; the
company's success in expanding its sales and marketing programs; technological
changes in the network storage system market, in particular the PC-LAN and UNIX
storage system markets; the mix of sales among the Company's sales channels;
levels of expenditures on research and development; changes in the Company's
strategy; personnel changes; and general economic trends and other factors.
Sales for any future quarter are not predictable with any significant
degree of certainty. The Company generally operates with limited order backlog
because its products typically are shipped shortly after orders are received. As
a result, sales in any quarter are generally dependent on orders booked and
shipped in that quarter. Sales are also difficult to forecast because the PC-LAN
and UNIX storage system markets are rapidly evolving and the Company's sales
cycles vary substantially from customer to customer. The Company's customers
generally have the right to cancel orders at any time and a limited right to
return products for a refund. The cancellation of orders already placed and the
return of products could have a material adverse effect on operating results in
any quarter. Due to the typical timing of customer orders, the Company often
ships products representing a significant portion of its net sales for a quarter
during the last month of that quarter. Any significant deferral of these sales
could have a material adverse effect on the results of operations in any
particular quarter. To the extent that the Company completes significant sales
earlier than expected, operating results for subsequent quarters may be
adversely affected. The Company's expense levels will be based, in part, on its
expectations as to future sales. As a result, if sales levels are below
expectations, net income may be disproportionately affected. There can be no
assurance that the Company will experience sales growth with respect to its
enterprise and OEM products in future periods.
Since the closing of the Storage Dimensions Merger, the Company's combined
business consists of that of Artecon California, the former Storage Dimensions,
Inc. and Falcon. Due to the foregoing, period-to-period comparisons of its
results of operations are not necessarily meaningful and should not be relied
upon as an indicator of future performance. It is possible that in future
quarters the Company's operating results may be below the expectations of public
market analysts and investors. In such event, the price of the Company's Common
Stock would likely be materially and adversely affected.
RELIANCE ON KEY CUSTOMERS AND INDIRECT DISTRIBUTION CHANNELS. The Company
sells its products through a direct sales force and through value-added
resellers ("VARs"). Approximately 26%, 27%, and 35% of revenues for the years
ended March 31, 1999, March 31, 1998, and March 29, 1997 were to four, four, and
two customers, respectively. The following customers of Artecon California
accounted for approximately that percentage of Artecon's total revenues set
forth below during the periods indicated: Sales to one customer did not exceed
10% of total revenue for the fiscal year ended March 31, 1999 and 1998; and
sales to Tracor Enterprise Solution accounted for 25.4% of total revenue for the
fiscal year ended March 31, 1997. No other customer accounted for more than 10%
of Artecon's total revenues during the fiscal years ended March 31, 1999, 1998
tand March 29, 1997. Additionally, Storage Dimensions' top ten customers
accounted for approximately 42% of total net sales in 1997, with Sun Financial
Group accounting for 10% of total net sales. The Company expects that a high
percentage of the Company's sales for the foreseeable future will continue to
come from a relatively small number of customers. There can be no assurance that
orders from existing customers will continue at their historical levels, or that
the Company will be able to obtain orders from new customers. The Company
generally has not entered into long-term volume purchase contracts with its
customers, and customers generally have certain rights to extend or to delay the
shipment of their orders. The Company's distributors and VARs may also carry
competing product lines and could reduce or discontinue sales of the Company's
products, which could have a material adverse effect on the Company's operating
results. Although the Company believes that it provides adequate allowances for
product returns, there can be no assurance that actual returns will not exceed
recorded allowances which could have a material adverse effect on the Company's
operating results. In addition, there can be no assurance that existing end-
user customers will not purchase their storage equipment from the manufacturer
that provides their network computing systems and, as a result, reduce or
eliminate purchases from the Company. The loss of one or more of the Company's
current customers, particularly a principal customer, or cancellation or
rescheduling of orders already placed, could materially and adversely affect the
Company's business, operating results or financial condition.
DEPENDENCE ON NEW PRODUCTS; RAPID TECHNOLOGICAL CHANGE. The storage system
market is characterized by rapid technological change, changing customer needs,
frequent new product introductions and evolving industry standards. The
introduction of products embodying new technologies and increased storage
capacities by the Company's competitors and the emergence of new industry
standards could render the Company's products obsolete and unmarketable. The
Company's future success will depend upon its ability to develop and to
introduce new products with increasing storage capabilities (including new
software releases and enhancements) on a timely basis that keep pace with
technological developments and emerging industry standards and address the
increasingly sophisticated needs of its customers. There can be no assurance
that the Company will be successful in developing and marketing any other
products that respond to technological changes or evolving industry standards,
that the Company will not experience difficulties that could delay or prevent
the successful development, introduction and marketing of new products, or that
its new products will adequately meet the requirements of the marketplace and
achieve market acceptance. If the Company is unable, for technological or other
reasons, to develop and introduce new products, in particular those for use with
Windows NT and UNIX systems, in a timely
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manner in response to changing market conditions or customer requirements, the
Company's business, operating results and financial condition will be materially
and adversely affected.
Storage system products like those offered by the Company may contain
undetected software errors or failures when first introduced or as new versions
are released. There can be no assurance that, despite testing, errors will not
be found in new products after commencement of commercial shipments, resulting
in a loss of or delay in market acceptance, which could have a material adverse
effect on the Company's business, operating results or financial condition. The
Company's standard warranty provides that if the system does not function to
published specifications the Company will repair or replace the defective
component without charge. Although to date the Company's suppliers of hardware
components have generally covered the warranty costs associated with such
components, there can be no assurance that such manufacturers will continue to
be willing or able to cover such costs, and their failure to do so would result
in such costs being borne by the Company. There can be no assurance that the
Company's warranty costs will not be significant in the future. Significant
warranty costs, particularly those that exceed reserves, could have a material
adverse effect on the Company's business, operating results or financial
condition.
The Company's agreements with customers typically contain provisions
intended to limit exposure to potential product liability claims. It is possible
that the limitation of liability provisions contained in the Company's
agreements may not be effective. Although the Company has not received any
product liability claims to date, the sale and support of products by the
Company and the incorporation of products from other companies may entail the
risk of such claims. A successful product liability claim against the Company
could have a material adverse effect on the Company's business, operating
results or financial condition.
DEPENDENCE ON KEY PERSONNEL. The Company's future performance will depend
in significant part upon the continued service of its senior management and key
sales and technical personnel. The Company expects to provide incentives such as
salary, benefits and option grants (which are typically subject to vesting over
four years) to attract and retain qualified employees. In recent periods, the
Company has experienced difficulties retaining existing and attracting and
training new, skilled personnel. Any inability to attract, train and retain
skilled sales personnel in future periods or the loss of the services of one or
more of the Company's officers or other key employees could have a material
adverse effect on the Company's business, operating results or financial
condition. The Company's future success will also depend on its ability to
attract and retain highly qualified technical and management personnel.
Competition for such personnel is intense, and there can be no assurance that
the Company can retain its key technical and management employees or that it can
attract, assimilate or retain other highly qualified technical and management
personnel in the future.
COMPETITION. The storage system market is intensely competitive. The
Company has a number of competitors in various markets, including Hewlett
Packard, Sun Microsystems, IBM, Hitachi, Data General Corporation, Compaq
Corporation, Network Appliance, nStor Technologies, LSI Logic, Ciprico,
Andataco, StorageTek, Dell Computer Corp, SGI, DEC, Storage Works, MTI
Technology and EMC Corporation, many of which have substantially greater name
recognition, engineering, manufacturing and marketing capabilities, and greater
financial and personnel resources than the Company. In particular, a number of
the Company's customers are also competitors, including Sun and SGI. The Company
expects to experience increased competition from established and emerging
computer storage hardware and management software companies, particularly HP,
Sun, IBM, Dell, Compaq, and EMC Corporation. Many of the Company's current and
potential competitors have significantly greater financial, technical,
marketing, purchasing and other resources than the Company, and as a result, may
be able to respond more quickly to new or emerging technologies and changes in
customer requirements, to devote greater resources to the development, promotion
and sale of products than can the Company, or to deliver competitive products at
a lower end-user price. The Company also expects that competition will increase
as a result of industry consolidations. Current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the Company's prospective customers. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. Increased competition is likely to result in price
reductions, reduced operating margins and loss of market share, any of which
could have a material adverse effect on the Company's business, operating
results or financial condition.
The Company believes that the principal competitive factors affecting its
markets include: fault-tolerant reliability, performance, ease of use,
scalability, configurability, price and customer service and support. There can
be no assurance that the Company will be able to successfully incorporate these
factors into its products and to compete against current or future competitors
or that competitive pressures faced by the Company will not materially and
adversely affect its business, operating results or financial condition.
DEPENDENCE ON LIMITED NUMBER OF SUPPLIERS OF HIGH QUALITY COMPONENTS. The
Company relies upon a limited number of suppliers of several key components
utilized in the assembly of the Company's products, including Seagate
Technology, Inc. ("Seagate"), Quantum Corporation ("Quantum"), IBM, Infortrend,
Intel, Mylex, Sony and American Megatrends, Inc. The Company's reliance on its
suppliers involves several risks, including: an inadequate supply of required
components; price increases; late deliveries; and poor component quality. These
risks are particularly significant with respect to suppliers of disk drives
because, in order to meet product performance requirements, the Company must
obtain disk drives with extremely high quality and capacity. In addition, there
is currently a significant market demand for disk drives, tape drives and RAID
controllers, and from time to time the Company may experience component
shortages, selective supply allocations and increased prices of such components.
Although to date the Company has not experienced shortages of such components,
there can be no assurance that the Company will be able to obtain its full
requirements of such components in the future or that prices of such components
will not increase. In addition, there can
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be no assurance that problems with respect to yield and quality of such
components and timeliness of deliveries will not occur. Disruption or
termination of the supply of these components could delay shipments of the
Company's products and could have a material adverse effect on the Company's
business, operating results or financial condition. Such delays could also
damage relationships with current and prospective customers.
In the past, due to the Company's quality requirements, the Company has
experienced delays in the shipments of its new products principally due to an
inability to qualify component parts from disk drive manufacturers and other
suppliers, resulting in delay or loss of product sales. The Company has
currently qualified disk drives manufactured by Seagate and IBM, tape drives
from Quantum, and RAID controllers from Mylex Corporation Infortrend and
American Megatrends. Although these delays in the past have not had a material
adverse effect upon the Company's business, operating results or financial
condition, there can be no assurance that in the future any such delays will not
have such a material adverse effect on the Company.
INTERNATIONAL OPERATIONS; CURRENCY FLUCTUATIONS. Artecon California's
international sales represented approximately 10.0%, 11.7% and 14.0% of the
Company's total revenues for the fiscal years ended March 31, 1999, March 31,
1998, and March 29, 1997, respectively. The Company currently has sales offices
in Japan, France, England and the Netherlands. The Company believes that the
continued growth and profitability of the Company will require expansion of
international operations, particularly in Europe and Japan. Accordingly, the
Company intends to expand its international operations and enter additional
international markets, which will require significant management attention and
financial resources. In addition, the Company's international operations are
subject to a variety of risks associated with conducting business
internationally, including fluctuations in currency exchange rates, longer
payment cycles, difficulties in staffing and managing international operations,
problems in collecting accounts receivable, seasonal reductions in business
activity during the summer months in Europe and certain other parts of the
world, increases in tariffs, duties, price controls or other restrictions on
foreign currencies, and trade barriers imposed by foreign countries, any of
which could have a material adverse effect on the Company's business, operating
results and financial condition. In addition, the Company has only limited
experience in developing localized versions of its products and marketing and
distributing its products internationally. There can be no assurance that the
Company will be able to successfully localize, market, sell and deliver its
products internationally. The inability of the Company to expand its
international operations successfully and in a timely manner could have a
material adverse effect on the Company's business, operating results and
financial condition.
A significant portion of the Company's international business is presently
conducted in currencies other than the U.S. dollar. Foreign currency transaction
gains and losses arising from normal business operations are credited to or
charged against earnings in the period incurred. As a result, fluctuations in
the value of the currencies in which the Company conducts its business relative
to the U.S. dollar will continue to cause the currency transaction gains and
losses which Artecon has experienced in the past and continues to experience.
Due to the substantial volatility of currency exchange rates, among other
factors, the Company cannot predict the effect of exchange rate fluctuations
upon future operating results. There can be no assurance that the Company will
not experience currency losses in the future. The Company has not previously
undertaken hedging transactions to cover its currency exposure but may hedge a
portion of its currency exposure in the future as management deems appropriate.
DEPENDENCE ON PROPRIETARY TECHNOLOGY. The Company currently relies on a
combination of patent, copyright and trademark laws, trade secrets,
confidentiality agreements and contractual provisions to protect its proprietary
rights and seeks to protect its software, documentation and other written
materials under trade secret and copyright laws, which afford only limited
protection. The Company has registered numerous trademarks and will continue to
evaluate the registration of additional trademarks as appropriate. The Company
generally enters into confidentiality agreements with its employees and with key
vendors and suppliers. As of March 31, 1999, the Company had been issued a total
of seven U.S. patents covering certain elements of its products. There can be no
assurance that issued patents will provide a meaningful competitive barrier or
that any pending patents at either company will ever be issued, that the Company
will develop proprietary products or technologies that are patentable, that any
patent issued in the future will provide the Company with any competitive
advantages or will not be challenged by third parties, or that the patents of
others will not have a material adverse effect on the Company's ability to do
business. The Company believes that the rapidly changing technology in the
computer storage industry makes future success dependent more on the technical
competence and creative skills of its personnel than on any patents it may be
able to obtain.
There has also been substantial litigation in the computer industry
regarding intellectual property rights, and litigation may be necessary to
protect the Company's proprietary technology. The Company has from time to time
received claims that it is infringing third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
trademarks or other proprietary rights. The Company expects that companies in
the storage system market will increasingly be subject to infringement claims as
the number of products and competitors in the Company's target markets grows.
Any such claims or litigation may be time-consuming and costly, cause product
shipment delays, require the Company to redesign its products or require the
Company to enter into royalty or licensing agreements, any of which could have a
material adverse effect on the Company's business, operating results or
financial condition. Despite the Company's efforts to protect its proprietary
rights, unauthorized parties may attempt to copy aspects of the Company's
products or to obtain and use information that the Company regards as
proprietary. For example, in February 1998, Artecon filed a suit against certain
former employees alleging, among other things, trade secret misappropriation. In
addition, the laws of some foreign countries do not protect proprietary rights
to as great an extent as do the laws of the United States. There can be no
assurance that the Company's means of protecting its proprietary rights will be
adequate or that the Company's competitors will not independently develop
similar technology,
14
<PAGE> 15
duplicate the Company's products or design around patents issued to the Company
or other intellectual property rights of the Company.
YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. Beginning in the year 2000, these date code fields will need to accept
four digit entries to distinguish 21st century dates from 20th century dates. As
a result, in less than two years, computer systems and/or software used by many
companies may need to be upgraded to comply with such "Year 2000" requirements.
Significant uncertainty exists in the software industry concerning the potential
effects associated with such compliance. The cost of making the Company's
products Year 2000 compliant is not expected to be material. For a more complete
description of the Year 2000 issue and its impact on the Company business, see
"Year 2000 Compliance" under Item 7 "Management Discussion and Analysis of
Financial Condition and Results of Operations."
The Company believes that the purchasing patterns of customers and
potential customers may be affected by the Year 2000 issues in a variety of
ways. Many companies are expending significant resources to correct or patch
their current software systems for Year 2000 compliance. These expenditures may
result in reduced funds available to purchase products such as those offered by
the Company. Other companies are delaying purchases of computer equipment,
particularly equipment that contains new technology, until after the Year 2000.
Also, Year 2000 issues could cause a significant number of companies, including
current customers, to reevaluate their current information system needs, and as
a result consider switching to other systems or suppliers. Any of the foregoing
could result in a material adverse effect on the Company's business, operating
results and financial condition.
INFLUENCE OF EXISTING STOCKHOLDERS. As of June 3, 1999, the Company's
executive officers, directors and their affiliates beneficially owned
approximately 72% of the Company's outstanding shares of Common Stock, giving
effect to the conversion of the outstanding Series A Preferred Stock of the
Company which was issued in connection with the Storage Dimensions Merger into
the maximum number of shares of Common Stock. As a result, these stockholders,
if acting together, would be able to influence matters requiring approval by the
stockholders of the Company, including the election of a majority of the
directors. The voting power of these stockholders under certain circumstances
could have the effect of delaying or preventing a change in control of the
Company. The Company has entered into agreements with its executive officers and
directors indemnifying them against losses they may incur in legal proceedings
arising from their service to the Company.
POSSIBLE VOLATILITY OF STOCK PRICE. The market price of the Company's
Common Stock has been, and is expected to continue to be, volatile. This
volatility may result from a number of factors, including fluctuations in the
Company's quarterly revenues and net income, announcements of products by the
Company or its competitors, and conditions in the network storage system market.
Also, the stock market has experienced and continues to experience extreme price
and volume fluctuations which have affected the market prices of securities,
particularly those of technology companies, and which often have been unrelated
to the operating performance of the companies. These broad market fluctuations,
as well as general economic and political conditions, may adversely affect the
market price of the Company's Common Stock in future periods.
EFFECT OF CERTAIN CHARTER PROVISIONS AND DELAWARE ANTI-TAKEOVER LAW.
Certain provisions of the Company's Certificate of Incorporation, as amended,
and Bylaws, as amended, the Delaware General Corporation Law (the "DGCL") and
the Company's indemnification agreements with certain officers and directors of
the Company may be deemed to have an anti-takeover effect. Such provisions may
delay, defer or prevent a tender offer or takeover attempt that a stockholder
might consider to be in that stockholder's best interests, including attempts
that might result in a premium over the market price for the shares held by such
stockholder.
The Board of Directors may issue additional shares of Common Stock or
establish one or more classes or series of Preferred Stock, having the number of
shares (up to 10,000,000), designations, relative voting rights, dividend rates,
liquidation and other rights, preferences and limitations as determined by the
Board without stockholder approval. The Company's Certificate of Incorporation,
as amended, and Bylaws, as amended, contain a number of provisions that could
impede a takeover or change in control of the Company, including but not limited
to the elimination of stockholders' ability to take action by written consent
and a fair price requirement. In addition, the Company's Certificate of
Incorporation provides for a classified Board of Directors and eliminates the
ability of stockholders to remove a director from office without cause except,
until the third annual meeting of the stockholders following the Merger, by the
affirmative vote of at least 80% of the outstanding voting stock of the Company
and by the affirmative vote of at least 66 2/3% of the outstanding voting stock
of the Company thereafter.
In addition, the Company is subject to the anti-takeover provisions of
Section 203 of the DGCL. In general, the statute prohibits a publicly-held
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder.
Each of the foregoing provisions gives the Board, acting without
stockholder approval, the ability to prevent, or render more difficult or
costly, the completion of a takeover transaction that stockholders might view as
being in their best interests.
15
<PAGE> 16
ITEM 2. PROPERTIES
The Company's principal administrative, sales, marketing, manufacturing and
research and development facility is located in approximately 70,000 square feet
of space in Carlsbad, California, including approximately 43,000 square feet of
manufacturing space. This facility is leased through December 1999 with a
two-year option to extend. Artecon leases other sales offices throughout the
U.S., as well as operations sites in Japan, France, England and the Netherlands.
Artecon believes that its existing facilities have the capacity to double its
current production and therefore are adequate to meet expected requirements.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material pending legal proceedings,
other than ordinary routine litigation incidental to the business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
<PAGE> 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Effective April 1, 1998 the Company's Common Stock was listed on the Nasdaq
National Market under the ticker symbol "ARTE." Prior to such time, the
Company's Common Stock had traded on the Nasdaq National Market under the symbol
"STDM" since the Company's initial public offering in March 1997.
The approximate number of holders of record of the Company's Common Stock
as of June 3, 1999 was 2,400.
The last sales price for the Company's Common Stock, as reported by Nasdaq
on June 3, 1999 was $1.88.
The following table sets forth, for the fiscal quarters indicated, the
range of high and low sale prices per share of Artecon common stock as reported
on the Nasdaq National Market, since March 31, 1998. On March 31, 1998, Artecon
concluded a merger with Storage Dimensions, Inc. The stock prices reflected
below for periods prior to that time were those of Storage Dimensions, Inc. and
were reported on Nasdaq under the symbol "STDM."
<TABLE>
<CAPTION>
QUARTERLY PERIOD HIGH LOW
---------------- ------ ------
<S> <C> <C>
Fiscal Year Ended March 31, 1998 ("STDM"):
1st Quarter .................................... $14.50 5.38
2nd Quarter .................................... 8.38 4.50
3rd Quarter .................................... 6.38 3.50
4th Quarter .................................... 4.38 2.63
Fiscal year ended March 31, 1999 ("ARTE"):
1st Quarter .................................... $ 5.25 $ 2.00
2nd Quarter .................................... 3.00 1.38
3rd Quarter .................................... 3.00 1.00
4th Quarter .................................... 6.00 0.94
</TABLE>
The Company has never paid any cash dividends on its Common Stock in the
past, and currently intends to retain future earnings, if any, to fund the
development and growth of its business. The Company does not anticipate paying
any cash dividends in the foreseeable future.
During the period covered by this Annual Report on Form 10-K, the Company
did not issue or sell any equity securities that were not registered under the
Securities Act of 1933, as amended.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial information of Artecon, Inc. as
of March 31, 1998 and March 31, 1999 and for the years ended March 29, 1997,
March 31, 1998 and March 31, 1999 are derived from the audited consolidated
financial statements of Artecon and related notes thereto included elsewhere in
this Annual Report on Form 10K. The selected historical financial information as
of March 25, 1995, March 30, 1996 and March 29, 1997 and for each of the years
ended March 25, 1995 and March 30, 1996 has been derived from the audited
consolidated financial statements of Artecon which are not included in this
Annual Report on Form 10-K. Artecon's selected historical consolidated financial
information includes financial information of Falcon Systems, Inc. following
their acquisition of Falcon in August 1997 and of Storage Dimensions, Inc.
following the acquisition of Storage Dimensions in March 1998. The following
financial information should be read in conjunction with Artecon's financial
statements and related notes thereto and with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," included elsewhere
in this Annual Report on Form 10K.
17
<PAGE> 18
SELECTED HISTORICAL CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED
------------------------------------------------------------------
MARCH 25, MARCH 30, MARCH 29, MARCH 31, MARCH 31,
1995 1996 1997 1998 (2) 1999(3)
-------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenues ............................... $ 47,833 $ 47,172 $ 55,317 $ 66,340 $ 95,879
Gross margin ............................... 9,586 12,455 12,926 15,395 33,518
Operating expenses:
Selling & service ........................ 6,092 6,928 7,643 11,422 26,108
General & administrative ................. 1,795 1,996 1,663 3,584 5,347
Research and development ................. 1,134 1,405 2,392 3,199 7,329
Restructuring expense .................... -- -- -- -- 1,404
Impairment of intangible assets .......... -- -- -- -- 867
Acquired in-process
research and development ............... -- -- -- 18,200 --
Operating income (loss) .................... 565 2,126 1,228 (21,010) (7,537)
Net income (loss) .......................... $ 453 $ 1,590 $ 641 $(19,288) $ (5,350)
======== ======== ======== ======== ========
Basic net income (loss) per share (1) ...... $ 0.09 $ 0.30 $ 0.12 $ (3.30) $ (0.25)
======== ======== ======== ======== ========
Diluted net income (loss) per share (1) ... $ 0.05 $ 0.19 $ 0.08 $ (3.30) $ (0.25)
======== ======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF
------------------------------------------------------------------
MARCH 25, MARCH 30, MARCH 29, MARCH 31, MARCH 31,
1995 1996 1997 1998 1999
-------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents .................. $ 299 $ 793 $ 746 $ 7,992 $ 2,093
Working capital ............................ 4,935 6,772 6,810 16,819 14,952
Total assets ............................... 13,984 14,382 15,194 57,345 43,161
Total long-term debt ....................... 2,500 2,941 2,921 10,484 11,908
Total stockholders' equity ................. 3,553 4,720 5,097 19,679 14,814
</TABLE>
- ----------
(1) See Note 11 of Notes to Consolidated Financial Statements of Artecon, Inc.
for the three years in the period ended March 31, 1999 for an explanation
of shares used in computing basic and diluted net income (loss) per share.
(2) The financial information set forth above includes financial information
for Falcon since August 21, 1997, the effective date of the Falcon
Acquisition.
(3) The financial information set forth above includes financial information
for Storage Dimensions since March 31, 1998, the effective date of the
Storage Dimensions merger.
18
<PAGE> 19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the consolidated
financial statements and the related notes thereto included herein. The
discussion in this Annual Report on Form 10-K contains forward-looking
statements that involve risks and uncertainties. The Company's actual results
could differ materially from those discussed in the forward-looking statements.
Factors that could cause or contribute to such differences include, without
limitation, those discussed in this section and the section entitled "Business,"
as well as those discussed elsewhere in this Annual Report on Form 10-K.
OVERVIEW
The Company designs, manufactures, markets and supports a broad range of
scalable, fully integrated data storage products for the open-systems computing
environment. Artecon has established itself as a leader in the design,
manufacture and sale of third-party mass storage and enhancement products in the
Sun, UNIX and PC-LAN markets, offering both host-attached and network-attached
storage solutions for a broad range of customers. Artecon offers a wide range of
products and services in four principal areas: enterprise storage,
telecommunications and Internet infrastructure and tape backup solutions.
On March 31, 1998, the Company (then known as Storage Dimensions, Inc.)
entered into a merger transaction with Artecon California, in a stock-for-stock
transaction that was accounted for as a purchase (the "Storage Dimensions
merger"). The Storage Dimensions merger created a leading third-party storage
company serving the combined PC-LAN and UNIX open systems network computing
market. For financial reporting purposes, the Storage Dimensions merger was
accounted for as an acquisition of Storage Dimensions by Artecon California,
and, as such, the historical financial results of Artecon for all years ended
prior to and including March 31, 1998 included in this prospectus/joint proxy
statement are those of Artecon California. The historical financial results of
Artecon subsequent to March 31, 1998 that are included in this Annual Report on
Form 10-K include the results of the combined company.
In August 1997, Artecon California acquired substantially all of the assets
and liabilities of Falcon. The Falcon acquisition has enabled the Company to
achieve several important strategic objectives, including the acquisition of
Falcon's AerREAL(TM) real-time specialized file server software and other
complementary products to better serve Artecon's existing customers, the
expansion of Artecon's customer base in the UNIX market and an expansion of
Artecon's revenue base. The acquisition was accounted for as a purchase.
In June 1998, Artecon California was merged with and into the Company.
Except where otherwise noted, the financial and other matters in this Item
7 relate solely to Artecon California (including the results of operations for
the Falcon business following the closing of the Falcon acquisition in August
1997). See Note 1 to Consolidated Financial Statements for certain additional
pro forma combined financial information relating to Artecon California, Storage
Dimensions, Inc. and Falcon.
The Company markets and distributes its products and services through its
direct sales force employed in 11 domestic sales and support offices and 5
overseas sales offices located in Japan, France, England and the Netherlands. In
addition, Artecon utilizes domestic and foreign reseller distribution channels
to market and distribute its products and services. Artecon believes that such a
diverse channel strategy results in the greatest penetration of the market and
enables it to effectively and efficiently penetrate major accounts while at the
same time leveraging its distribution network into vertical markets. Artecon
believes that the direct customer contact resulting from the use of its own
internal sales force provides it with invaluable market feedback and the ability
to tailor its products and high-quality technical support services to enhance
customer satisfaction and loyalty. Artecon generates revenue from the sales of
products and services. Revenue from product sales is recognized upon shipment.
Revenue generated from service contracts is recognized ratably over the term of
the contract. Operating expenses consist primarily of rent, payroll,
commissions, other selling and administrative expenses and research and
development costs and are recognized in the period incurred.
19
<PAGE> 20
The following table sets forth certain items from Artecon's consolidated
statement of operations as a percentage of net sales for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
MARCH 31 MARCH 31 MARCH 29
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Net Revenues ........................................ 100.0% 100.0% 100.0%
Gross Margin ........................................ 35.0 23.2 23.4
Operating expenses
Selling and service ............................... 27.2 17.2 13.8
General and administrative ........................ 5.6 5.4 3.0
Research and development .......................... 7.6 4.8 4.3
Restructuring ..................................... 1.5 -- --
Impairment of intangible assets ................... 0.9 -- --
Acquired in-process research and development ...... -- 27.4 --
Operating income (loss) ............................. (7.9) (31.7) 2.2
Net income (loss) ................................... (5.6)% (29.1)% 1.2%
</TABLE>
RESULTS OF OPERATIONS
YEAR ENDED MARCH 31, 1999 COMPARED TO YEAR ENDED MARCH 31, 1998
NET REVENUES. Net revenues reflect the invoiced amounts for products
shipped less reserves for estimated returns. Net revenues for the year ended
March 31, 1999 ("FY 1999") were $95.9 million compared to $66.3 million for the
year ended March 31, 1998 ("FY 1998"), an increase of approximately 44.5%. The
increase in net revenues is primarily attributable to sales generated from the
Enterprise Storage Division. Net revenues for this division, which includes
sales to the finance, multimedia, government, advanced-technology, and
industrial markets, were $63.0 million for FY 1999 compared to $33.7 million for
FY 1998, an increase of approximately 86.6%. This increase in net revenues from
the Enterprise Storage Division is primarily attributable to revenue from the
Storage Dimensions products.
GROSS MARGIN. Gross margin for FY 1999 was $33.5 million, or 35.0% of net
revenues, compared to a gross margin of $15.4 million, or 23.2% of net revenues,
for FY 1998. The increase in gross margin as a percentage of net revenues from
FY 1998 to FY 1999 was primarily attributable to sales of higher margin
products.
SELLING AND SERVICE EXPENSES. Selling and service expenses are comprised
primarily of salaries, commissions, and marketing costs. Selling and service
expenses increased to $26.1 million, or 27.2% of net revenues for FY 1999, from
$11.4 million, or 17.2% of net revenues, for FY 1998. The increase in selling
and service expenses as a percentage of net revenues is attributable to two
factors: lower than expected revenues, and increased sales management overhead
related to the Storage Dimensions merger.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative ("G & A")
expenses are comprised primarily of overhead costs associated with Artecon's
finance and administrative staff. G & A expenses for FY 1999 were $5.3 million
or 5.6% of net revenues compared to $3.6 million, or 5.4% of net revenues for FY
1998. The increase in G & A expenses is primarily attributable to the following:
- additional amortization expense of $1.7 million for goodwill and other
intangible assets associated with the Falcon acquisition and Storage
Dimensions merger as a result of a full year of amortization in the
current year
- additional depreciation expense of $1.5 million associated with
property and equipment acquired in the Storage Dimensions merger on
March 31, 1998
- a decrease in compensation expense of $700,000 for stock participation
rights granted, and common stock issued, below fair market value to
certain employees in FY 1998.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses are
comprised primarily of prototype expenses, salaries for employees directly
engaged in research and other costs associated with product development.
Research and development expenses increased to $7.3 million, or 7.6% of net
revenues, for FY 1999 compared to $3.2 million, or 4.8% of net revenues for FY
1998. The increase in research and development expenses is attributable to
management's decision to initially maintain the combined Storage Dimensions and
Artecon engineering staff and a separate engineering facility located in
Milpitas, California which was acquired in connection with the Storage
Dimensions merger. The engineering staff was reduced and the engineering
facility located in Milpitas, California was closed in connection with the
December 1998 restructuring discussed below. The increase in research and
development expenses as a percentage of revenues compared to the prior year is
attributable to the items discussed above and lower than expected revenues.
RESTRUCTURING EXPENSES AND IMPAIRMENT OF INTANGIBLE ASSETS. In December
1998, the Board of Directors approved a plan to consolidate one of Artecon's
engineering facilities from Milpitas, California, to Carlsbad, California, to
consolidate certain domestic
20
<PAGE> 21
sales and service locations, and to eliminate certain product lines and
development activities. Artecon recorded pre-tax restructuring charges of $1.8
million to cover the costs associated with these actions. The major components
of the fiscal year 1999 charges and the remaining accrual balance as of March
31, 1999 were as follows:
<TABLE>
<CAPTION>
INITIAL ACCRUED
RESTRUCTURING AMOUNTS RESTRUCTURING
CHARGE UTILIZED COSTS
------------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Employee termination costs ................. $ 254 $ (200) $ 54
Inventory write-downs ...................... 415 (115) 300
Facility closures and related expenses ..... 716 (476) 239
Tooling write-off .......................... 123 (123) --
Intangible asset impairment ................ 300 (300) --
------- ------- -------
Total ............................ $ 1,807 $(1,214) $ 593
======= ======= =======
</TABLE>
Employee termination costs consist primarily of severance payments for 43
employees, all of which were terminated as of March 31, 1999. The majority of
the employees terminated were employed at the engineering facility in Milpitas,
California and at the various domestic sales and service locations. Remaining
costs associated with bi-weekly payroll payments are expected to be paid in the
first quarter of fiscal year 2000. Inventory write-downs and the tooling
write-off primarily relate to the discontinuance of certain low-volume and
low-profit product lines. Of the total restructuring charge associated with the
inventory write-downs, $403,000 has been included as a separate component of
cost of sales in the accompanying financial statements. Facility closures and
related expenses consist of lease termination costs and the write-off of certain
property and equipment disposed of associated with the closures. The majority of
the remaining accrued costs are expected to be paid in fiscal year 2000.
In connection with the acquisitions of Falcon and SDI, the company
allocated $420,000 and $1,600,000, respectively, to an assembled workforce
intangible asset. The company recorded an impairment of these intangible assets
of $300,000 during the year ended March 31, 1999 which has been included as a
component of the restructuring charge, as the impairment was a direct result of
employee terminations associated with restructuring activities. Furthermore, as
a result of significant attrition and terminations of employees which had been
utilized as the basis for the assembled workforce valuation, the company
recognized additional amortization of $867,000 based on a change in estimate of
the remaining useful life of the assembled workforce.
In connection with the merger with SDI, Artecon recorded a reserve for
acquisition related costs of $6.6 million, of which $5.8 million was outstanding
at March 31, 1998. All of the acquisition related costs were included in the
purchase price allocation performed at March 31, 1998. The following is a
summary related to the accrued merger costs at March 31, 1998, amounts utilized
during fiscal year 1999 and remaining reserve balance at March 31, 1999:
<TABLE>
<CAPTION>
ACCRUED MERGER ACCRUED MERGER
COSTS AMOUNTS COSTS
(MARCH 31, 1998) UTILIZED (MARCH 31, 1999)
---------------- -------- ----------------
(IN THOUSANDS)
<S> <C> <C> <C>
Employee termination costs .... $ 2,858 $(2,691) $ 167
Professional service fees ..... 1,726 (1,410) 316
Other costs ................... 1,181 (998) 183
------- ------- -------
Total ............... $ 5,765 $(5,099) $ 666
======= ======= =======
</TABLE>
The majority of the accrued merger costs at March 31, 1999 relate to
remaining severance and benefit payments pursuant to the related agreements,
lease and contract termination costs, and miscellaneous professional service fee
obligations. Artecon anticipates that the remaining merger costs will be paid in
fiscal year 2000 and believes that there are no unresolved issues or additional
liabilities that may result in an adjustment to the purchase price allocation
for the Storage Dimensions merger.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT COSTS. During fiscal 1998,
Artecon California determined that certain hardware and software products in
development that were acquired in the Falcon acquisition had not established
technological feasibility. Accordingly, in fiscal 1998, Artecon California
recognized a $3.7 million charge to earnings for write-off of these in-process
research and development costs. In fiscal 1998 Artecon recognized an additional
charge against earnings of $14.5 million for in-process research and development
costs relating to the Storage Dimensions merger.
TOTAL OTHER EXPENSE. Total other expense is comprised of interest, taxes
and other expenses, if any, relating to such periods presented. Total other
expense for FY 1999 was $0.6 million compared to total other expense of $1.1
million for FY 1998. The decrease in total other expense was primarily
attributable to legal settlement income received in FY 1999.
21
<PAGE> 22
YEAR ENDED MARCH 31, 1998 COMPARED TO YEAR ENDED MARCH 29, 1997
NET REVENUES. Artecon's net revenues for FY 1998 were $66.3 million
compared to $55.3 million for the year ended March 29, 1997 ("FY 1997"), an
increase of approximately 19.9%. Such increase in net revenues was primarily
attributable to the Falcon acquisition. Net revenues attributable to sales of
Falcon products by Artecon from August 21, 1997, the date of the Falcon
Acquisition, to March 31, 1998, were approximately $12.6 million. Net revenues
for FY 1998 attributable to sales of Artecon products (excluding Falcon
products) were $53.7 million, compared to $55.3 million for FY 1997. The decline
in Artecon-only sales was primarily attributable to a decline in orders from a
significant customer from $14.1 million in FY 1997 to $0.3 million in FY 1998.
Future sales to this customer are not expected to be significant.
GROSS MARGIN. Gross margin for FY 1998 was $15.4 million, or 23.2% of net
revenues, compared to a gross margin of $12.9 million, or 23.4% of net revenues,
for FY 1997. The decrease in gross margin as a percentage of net revenues from
FY 1997 to FY 1998 was due primarily to sales of higher margin products which
favorably effected gross margin by approximately 6%, offset by a $5.0 million
write off of inventory in FY 1998. The gross margin derived from sales of Falcon
products during FY 1998 was approximately $3.3 million, or 26.2% of Falcon net
revenues.
SELLING AND SERVICE EXPENSES. Selling and service expenses increased to
$11.4 million, or 17.2% of net revenues for FY 1998, from $7.6 million, or 13.8%
of net revenues, for FY 1997. The increase in selling and service expenses for
FY 1998 was attributable primarily to the increase in Artecon's sales and
marketing force resulting from the Falcon acquisition.
GENERAL AND ADMINISTRATIVE EXPENSES. G & A expenses for FY 1998 were $3.6
million or 5.4% of net revenues compared to $1.7 million, or 3.0% of net
revenues for FY 1997. The increase in G & A expenses is primarily attributable
to professional services and amortization expenses associated with the Falcon
acquisition. In addition, $628,000 of compensation expense was recorded for
issuance of common stock to certain employees in FY 1998.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $3.2 million, or 4.8% of net revenues, for FY 1998 compared to $2.4
million, or 4.3% of net revenues for FY 1997. The increase in research and
development expenses is attributable to Artecon's continued development of new
products.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT COSTS. During FY 1998, Artecon
California determined that certain hardware and software products acquired from
Falcon had not established technological feasibility and had no future
alternative use. Accordingly, in fiscal 1998, Artecon California recognized a
$3.7 million charge to earnings for write-off of these in-process research and
development costs. In FY 1998 Artecon California recognized an additional charge
against earnings of $14.5 million for in-process research and development costs
relating to the Storage Dimensions merger.
TOTAL OTHER EXPENSE. Total other expense is comprised of interest, taxes
and other expenses, if any, relating to such periods presented. Total other
expense for FY 1998 was $1.1 million compared to total other expense of $0.2
million for FY 1997. The increase in total other expense was attributable
primarily to interest payments made on the promissory note issued in connection
with the Falcon acquisition and increased borrowings under Artecon's credit
line.
LIQUIDITY AND CAPITAL RESOURCES. Since inception, Artecon has financed its
operations primarily through a combination of cash generated from operations,
bank borrowings, and through sales of its capital stock. At March 31, 1999,
Artecon had $2.1 million in cash and cash equivalents compared to $8.0 million
at March 31, 1998, a decrease of $5.9 million. This decrease was primarily
attributable to net cash used in operating activities of $6.7 million which
included the current year loss of $5.4 million. Financing activities and
proceeds from Artecon's Stock Option Plans and Stock Purchase Plan provided $1.1
million and $313,000, respectively.
In May 1998, Artecon entered into a revolving credit facility with LaSalle
National Bank (the "line of credit") which permits borrowings of up to
$15,000,000. Under the terms of the line of credit, borrowings are
collateralized by substantially all of Artecon's assets and mature in May 2001
unless otherwise renewed. Borrowings under the line of credit bear interest at
the bank's prime rate. Monthly payments consist of interest only, with the
principal due at maturity. As of March 31, 1999, the total outstanding balance
under the line of credit was approximately $10.6 million. The line of credit
agreement requires that Artecon comply with certain covenants, including minimum
net income and tangible net worth. Artecon is currently not in compliance with
the minimum net income covenant and has obtained a waiver regarding its
non-compliance with this covenant.
Artecon's Japanese subsidiary has two lines of credit with a Japanese bank
for borrowings of up to an aggregate of 35 million Yen (approximately US
$295,000 at March 31, 1999) at interest rates ranging from 1.8% to 2.5%.
Interest is due monthly, with principal due and payable on various dates through
August 2005. Borrowings are secured by the inventories of the Japanese
subsidiary. As of March 31, 1999, the total amount outstanding under the three
credit lines was 33 million Yen (approximately US $275,000 at March 31, 1999).
The Falcon acquisition purchase price of $3,500,000 included $1,000,000 in
cash and a promissory note in the original principal amount of $1,250,000 (the
"Artecon Note"). Subsequent to the issuance of the Artecon Note, Artecon
California and Falcon amended
22
<PAGE> 23
the Artecon Note to decrease the principal amount due thereunder to $750,000.
Concurrently with the Falcon acquisition, Falcon transferred certain technology
assets (the "Falcon Technology") to Founding Partners, a California general
partnership ("Founding Partners"), in exchange for a promissory note in the
principal amount of $1,750,000 (the "Founding Partners Note"). Dana Kammersgard,
James Lambert and W.R. Sauey, each of whom is an executive officer and/or
director of Artecon, are the general partners of Founding Partners. Founding
Partners is considered to be a "special purpose entity" and, accordingly, has
been consolidated with Artecon for financial reporting purposes. The purchase
price was allocated among the acquired assets to $10,232,000 for other assets
acquired, $638,000 to goodwill and other intangible assets, $14,138,000 for
liabilities assumed and to in-process research and development expenses of
$3,700,000. Under the terms of the Artecon Note, as adjusted, and the Founding
Partners Note (collectively, the "Notes"), Artecon and Founding Partners,
respectively, are required to make monthly payments to Falcon of $15,935 and
$37,182, respectively, through August 2002. Each of the Notes bears interest at
the rate of 10% per annum. As of March 31, 1999, the approximate total amount of
principal and interest outstanding under the Artecon Note was $556,000, and the
total approximate amount of principal and interest outstanding under the
Founding Partners Note was $1,298,000.
In connection with the Falcon acquisition and the transfer of the Falcon
Technology, Artecon California and Founding Partners entered into a Technology
License Agreement, dated August 21, 1997, pursuant to which Founding Partners
granted to Artecon an exclusive, perpetual license of the Falcon Technology in
exchange for monthly payments of $39,000 payable through August 2002.
As of March 31, 1999, Artecon's future commitments under its operating
leases totaled approximately $3.1 million.
Capital spending for FY 1999, FY 1998 and FY 1997 was $638,000, $668,000,
and $260,000 respectively.
Artecon's sales and operating results have in the past fluctuated from
quarter to quarter and may vary in the future depending on a number of factors,
including:
- the size and timing of significant purchase orders;
- the timing of hardware shipments by third-party vendors necessary to
recognize revenues;
- Artecon's ability to continue to design, develop and market new
products and services;
- Market acceptance of new products;
- Artecon's success in increasing its domestic and foreign sales force;
- the size and number of new accounts;
- technological changes in the storage systems market;
- the growth of the telecommunications and Internet/intranet industry;
- reduction in demand for Artecon's products as a result of new product
introductions by competitors;
- levels of expenditure on research and development;
- the amount of additional capital needed by Artecon and the timing of
such need;
- product quality problems;
- fluctuations in foreign currency exchange rates; and
- general economic trends and other factors.
Sales and operating results for past periods are not necessarily indicative
of future periods and a period-to-period comparison of its sales or results of
operations are not necessarily meaningful and should not be relied upon as an
indicator of future performance.
Artecon's management believes that its expected cash resources from
operations and amounts available under the line of credit are sufficient to meet
its current capital commitments and the operating requirements of its existing
business for at least the next twelve months. However, there can be no assurance
that Artecon will not need to obtain additional capital before such time. The
actual amount and timing of working capital and capital expenditures that
Artecon may incur in future periods may vary significantly and will depend upon
numerous factors, including the amount and timing of the receipt of revenues
from continued operations, the increase in manufacturing capabilities, the
timing and extent of the introduction of new products and services, and growth
in personnel and operations.
23
<PAGE> 24
YEAR 2000 COMPLIANCE.
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. Beginning in the year
2000 ("Y2K"), these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than one year, computer systems and/or software used by many companies may need
to be upgraded to comply with such Y2K requirements.
STATE OF READINESS
Artecon has defined Y2K compliance in accordance with the British Standards
Institute (BSI). According to the BSI DISC PD2000, Y2K conformity shall mean
that neither performance nor functionality is affected by dates prior to, during
and after Y2K. Y2K compliance is based on the following factors: 1) during the
normal operation, the value for the current date will not cause any interruption
in operation; 2) date-based functionality must behave consistently for dates
prior to, during and after Y2K; 3) in all interfaces and data storage, the
century in any date must be specified either explicitly or by unambiguous
algorithms or inferencing rules; and 4) Y2K must be recognized as a leap year.
In 1996, Artecon started a comprehensive Y2K program for its data storage
products. This program includes verification testing of existing products,
implementation of date code programming policies, and the integration of
compliance tests for all enhancements and future products. Artecon established
certain criteria to obtain Y2K compliance, expanding year fields to four digits,
windowing, date encoding techniques, and absence of date code dependency.
Artecon's technology generally lends itself to being Y2K compliant based on the
absence of date dependencies in the hardware, software, and firmware code.
Artecon certifies to its customers that the hardware, software, and firmware
developed, manufactured and distributed by Artecon is Y2K compliant. In
addition, Artecon's products also recognize Y2K as a leap year. Management
believes that all of Artecon's data storage products are Y2K compliant.
In 1997, Artecon implemented a Y2K assessment program for its internal
processing systems. The program currently includes an inventory and assessment
of information systems, testing and implementation. Artecon has identified the
major systems that will require modification to make them Y2K compliant and
anticipates completion of the process by the end of March 1999. To date,
approximately 80% of these internal processing systems are Y2K compliant, and
Artecon anticipates having the remaining internal processing systems Y2K
compliant by the second quarter of calendar 1999 with any additional testing of
such systems to be completed by the third quarter of calendar 1999.
Artecon may include software from third party vendors as a part of its data
storage products. Artecon has received compliance statements from such software
vendors and has conducted internal testing to verify their Y2K compliance
statements. Artecon has initiated communications with its significant supplier
to determine the extent to which Artecon may be impacted by those third party
suppliers who fail to remedy their own Year 2000 issues. To date Artecon has
contacted 55% of its significant suppliers and has received assurance of Year
2000 compliance from a number of those contacted. Most suppliers under existing
contracts with Artecon are under no contractual obligation to provide such
information to Artecon. Artecon is taking steps with respect to new supplier
agreements to assure that the suppliers' products and internal systems are Year
2000 compliant.
COSTS TO ADDRESS ARTECON'S Y2K ISSUES.
While it is difficult to quantify the total cost to Artecon of Y2K
compliance activities, Artecon's best estimate of resources that are allocated
to this program is approximately $500,000. However, there can be no assurance
that Y2K issues will not have a material adverse impact on Artecon's business,
results of operations or financial condition.
RISKS OF ARTECON'S Y2K ISSUES
Artecon believes that the Y2K issue may affect the purchasing patterns of
customers and potential customers in a variety of ways. Many companies are
expending significant resources to correct or patch their current software
systems for Y2K compliance. These expenditures may result in reduced funds
available to purchase products such as those offered by Artecon. Conversely, Y2K
issues may cause other companies to accelerate purchases, thereby causing an
increase in short-term demand and consequent decrease in long-term demand for
products. Additionally, Y2K issues could cause a significant number of
companies, including current customers, to reevaluate their current information
system needs, and as result consider switching to other systems or suppliers.
Any of the foregoing could result in a material adverse effect on Artecon's
business, operating results and financial condition.
ARTECON'S CONTINGENCY PLAN
Artecon currently does not have a contingency plan in place if any of the
systems, processes or third party suppliers mentioned is not Y2K compliant.
Currently, Artecon is in the process of preparing a contingency plan for Y2K
compliance issues, and anticipates having such a contingency plan in place by
the end of the third quarter of calendar 1999.
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<PAGE> 25
THE EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the European
Union established fixed conversion rates between their existing sovereign
currencies and the euro. These countries have agreed to adopt the euro as their
common legal currency on that date. The euro will then trade on currency
exchanges and be available for non-cash transactions. These countries will issue
sovereign debt exclusively in euro and will re-denominate outstanding sovereign
debt. Effective on this date, these countries will no longer control their own
monetary policies by directing independent interest rates for the legacy
currencies. Instead, the authority to direct monetary policy, including money
supply and official interest rates for the euro, will be exercised by the new
European Central Bank.
Following introduction of the euro, the legacy currencies are scheduled to
remain legal tender in these countries as a denominations of the euro between
January 1, 1999 and January 1, 2002 (the "transition period"). During the
transition period, public and private parties may pay for goods and services
using either the euro or the country's legacy currency on a "no compulsion, no
prohibition" basis. However, conversion rates no longer will be computed
directly from one legacy currency to another. Instead a "triangulation" process
will be applied whereby an amount denominated in one legacy currency first will
be converted into an amount denominated in euro, and the resultant
euro-denominated amount is converted into the second legacy currency.
Two countries that will convert to the euro, the Netherlands and France,
generated revenue of approximately $894,000 and $763,000, respectively, or 1.7%
of Artecon's total revenue for FY 1999. Based on this percentage of revenue
generated from these two countries, Artecon does not anticipate that this
conversion of the euro will have a significant impact on its financial
statements. Artecon is continuing to evaluate the impact this conversion will
have on its financial condition and results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference from
pages F-1 through F-19 of this Annual Report on Form 10-K.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of Artecon and their ages as of June
3, 1999, were as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- ------ --------
<S> <C> <C>
James L. Lambert.................. 46 President, Chief Executive Officer and Director
Dana W. Kammersgard............... 43 Secretary, Senior Vice President, Engineering
Norman Farquhar................... 53 Director
William J. Filip.................. 54 Director
Brian D. Fitzgerald............... 54 Director
Dr. Chong Sup Park................ 51 Director
Jason C. Sauey.................... 37 Director
W.R. Sauey........................ 71 Chairman of the Board
</TABLE>
James L. Lambert, a founder of Artecon California, has served as President,
Chief Executive Officer and director of Artecon since March 1998 and, prior to
such time, had served as President, Chief Executive Officer and a director of
Artecon California since its inception in 1984. Prior to co-founding Artecon,
from 1979 to 1984, Mr. Lambert served in various positions at CALMA, a division
of General Electric Company, a publicly traded company, most recently, from 1981
to 1984, as Vice President of Research and Development. Mr. Lambert currently
serves as a director of Snow Valley, Inc., a privately-held resort enterprise
affiliated with the Nordic Group. Mr. Lambert serves as a director with the
Nordic Group. He holds a B.S. and an M.S. in Civil and Environmental Engineering
from the University of Wisconsin, Madison.
Dana W. Kammersgard, a founder of Artecon California, has served as
Artecon's Secretary and Senior Vice President, Engineering since March 1998. Mr.
Kammersgard served as a director of Artecon California from its inception in
1984 and as its Vice President, Sales and Marketing from March 1997 until March
1998. Between 1984 and March 1997, Mr. Kammersgard served in various positions
at Artecon California in engineering and customer support. Prior to co-founding
Artecon California, Mr.
25
<PAGE> 26
Kammersgard was the Director of Software Development at CALMA, a division of
General Electric Company, a publicly traded utility company. Mr. Kammersgard
holds a B.A. in Chemistry from the University of California, San Diego.
Norman R. Farquhar has served as a director of Artecon since April 1998.
Mr. Farquhar has served as Executive Vice President and Chief Financial Officer
of Epicor Software Corporation (formerly known as Platinum Software
Corporation), a developer of client/server enterprise resource planning software
since December 1998. Mr. Farquhar served as Executive Vice President and Chief
Financial Officer of DataWorks Corporation, a supplier of information systems to
manufacturing companies ("DataWorks"), from February 1996 to December 1998 and
as a director of DataWorks from August 1995 to December 1998. From April 1993 to
December 1995, Mr. Farquhar served as Senior Vice President, Chief Financial
Officer and Secretary of Wonderware Corporation, a manufacturer of software for
the industrial automation industry. From December 1991 to April 1993, he was
Vice President of Finance and Chief Financial Officer of MTI Technology
Corporation, a developer of system-managed storage solutions. From November 1987
to December 1991, he was Senior Vice President and Chief Financial Officer of
Amperif Corporation, a manufacturer of cache-based data storage subsystems. Mr.
Farquhar is also a member of the Board of Directors of Alteer Corporation, a
medical software company. Mr. Farquhar holds a B.S. from California State,
Fullerton, and an MBA from California State, Long Beach.
William J. Filip has served as director of the Company since April 1998.
From 1966 to 1996 he held a variety of positions with IBM, including Assistant
General Manager of the Personal Systems Group, IBM Director of Plans and
Strategies and Vice President of Marketing. Most recently, he served as General
Manager of IBM's RS/6000 Division where he was responsible for development,
manufacturing and worldwide marketing for IBM's RS/6000 family of workstations,
servers and supercomputers. Mr. Filip also served as a member of IBM's Worldwide
Management Committee, a member of the board of directors of IBM Credit
Corporation, and a member of the Conference Board Council of Strategy Planning
Executives. Mr. Filip graduated from the University of Illinois with a Bachelors
degree in Physics, and attended the Executive Program at the University of
Virginia, Darden School.
Brian D. Fitzgerald has served as a director of the Company since 1992 and
was its Chairman of the Board from 1992 until March 1998. In 1982, Mr.
Fitzgerald formed Capital Partners and Capital Partners I, L.P. and has since
served as President of Capital Partners and a General Partner to Capital
Partners I, L.P. Capital Partners acts as a diversified investment holding and
operating company. Mr. Fitzgerald co-formed Capital Partners II, L.P. in 1990.
Capital Partners I, Capital Partners II and related entities hold majority
ownership positions and various officer and director positions in seven other
businesses in diversified industries. From 1977 to 1982, Mr. Fitzgerald was a
General Partner of Industrial Capital Group, a diversified investment holding
and operating company, and from 1974 to 1977 served as strategic planning
manager and corporate staff consultant at General Electric Company, a publicly
traded company. Mr. Fitzgerald was formerly a director of Bryant Universal
Roofing, Inc., a private corporation that filed for bankruptcy in 1996 under
Chapter 11 of the U.S. Bankruptcy Code. Mr. Fitzgerald is also the Chairman of
the Board of Security Capital Corporation, a public company, a position he has
held since 1990, and is an officer and director of a number of privately-held
companies. Mr. Fitzgerald holds a B.A. degree from Princeton University and an
M.B.A. from the Harvard Graduate School of Business.
Chong Sup Park has served as a director of the Company 1996. Since 1996,
Dr. Park has also served as the President of Hyundai Electronics America, an
electronics company and the Chairman of Maxtor Corporation, a disk drive
manufacturer. Dr. Park was the President of Maxtor Corporation from 1995 to
1996, the President of Axil Computer Inc., a workstation manufacturing company,
from 1993 to 1995, the Executive Vice President at Ernst & Young Consulting,
Inc., a public accounting firm, from 1992 to 1993, and the Senior Vice President
of Hyundai Electronics Company Limited from 1990 to 1992. Dr. Park holds a B.A.
in Management from Yonsei University, an M.A. in Management from Seoul National
University, an M.B.A. from the University of Chicago and a Doctorate in
Management from Nova SouthEastern University.
Jason C. Sauey has served as a director of the Company since March 1998
and, prior to such time, had served as a director of Artecon California since
1988. Since 1992, Jason Sauey has served as President of Flambeau Products
Corporation and since 1994 has served as President of Flambeau Airmold
Corporation, both privately-held plastics manufacturing companies affiliated
with the Nordic Group. Jason Sauey holds a B.B.A. from the University of
Wisconsin, Madison and an M.B.A. from the University of Chicago.
W.R. Sauey, a founder of Artecon California, has served as Chairman of the
Board of Artecon since March 1998 and prior to such time, had served as Chairman
of the Board of Artecon California since its inception in 1984. From 1984 to
1997, Mr. Sauey also served as Treasurer of Artecon California. Mr. Sauey
founded and serves as Chairman of the Board for a number of manufacturing
companies in the Nordic Group of Companies, a group of privately-held
independent companies for which Mr. Sauey is the principal shareholder (the
"Nordic Group"). Mr. Sauey is an advisory board member of Liberty Mutual
Insurance Company, a publicly traded insurance company, and also serves as a
Trustee to the State of Wisconsin Investment Board. Mr. Sauey holds an M.B.A.
from the University of Chicago
Messrs. Farquhar and Filip are serving as Class I directors, whose term
will expire at the first Annual Meeting following the Storage Dimensions Merger.
Mr. Jason Sauey and Dr. Park are serving as Class II directors, whose term will
expire at the second Annual Meeting following the Storage Dimensions Merger.
Messrs. W.R. Sauey, Lambert and Fitzgerald are serving as Class III directors,
whose term will expire at the third Annual Meeting following the Storage
Dimensions Merger. Officers serve at the discretion of the Board of Directors.
There are no family relationships between any of the directors or executive
officers of the
26
<PAGE> 27
Company, except that W.R. Sauey, Chairman of the Board of Directors, is (i) the
father-in-law of James Lambert, the President, Chief Executive Officer and a
director and (ii) the father of Jason Sauey, a director.
COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
directors and executive officers, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file with the Commission
initial reports of ownership and reports of changes in ownership of Common Stock
and other equity securities of the Company. Officers, directors and greater than
ten percent stockholders are required by Commission regulation to furnish the
Company with copies of all Section 16(a) forms they file.
To the Company's knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, during the fiscal year ended March 31, 1999, all Section
16(a) filing requirements applicable to its officers, directors and greater than
ten percent beneficial owners were complied with.
BOARD COMMITTEES
The Company has an Audit Committee and a Compensation Committee. The Audit
Committee consists of Messrs. Farquhar (Chairman), Fitzgerald and W.R. Sauey.
The Audit Committee recommends to the Board of Directors the engagement of
Artecon's independent accountants, reviews with such accountants the plan, scope
and results of their examination of the consolidated financial statements and
determines the independence of such accountants. The Compensation Committee
consists of Dr. Park (Chairman), and Messrs. Filip and Jason Sauey. The
Compensation Committee reviews and makes recommendations to the Board of
Directors regarding all forms of compensation to be provided to the executive
officers, directors and consultants to Artecon and also administers Artecon's
equity-based employee benefits plans.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table shows, for the fiscal years ended March 31, 1999, March
31, 1998 and March 29, 1997, compensation awarded or paid to, or earned by, (i)
the individuals who served as the Company's Chief Executive Officer during the
fiscal year ended March 31, 1999, and (ii) the Company's only other executive
officer earned at least $100,000 during the fiscal year ended March 31, 1999
(collectively, the "Named Executive Officers):
<TABLE>
<CAPTION>
COMPENSATION
ANNUAL COMPENSATION OTHER ANNUAL SECURITIES ALL OTHER
NAME AND PRINCIPAL ------------------------ COMPENSATION UNDERLYING COMPENSATION
POSITION YEAR SALARY ($) BONUS ($) ($) OPTION (#) ($)(1)
- ------------------ ------- ---------- --------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
James L. Lambert ............. 1999 227,702 96,808(2) -- 40,000 906
President and 1998 138,462 14,938(2) 291,250(4) -- 906
Chief Executive 1997 103,708 6,959 -- -- 906
Officer
Dana W. Kammersgard .......... 1999 172,614 48,870(3) -- 25,000 --
Senior Vice President, 1998 124,139 27,782(3) 145,625(5) -- --
Engineering and 1997 102,307 10,315 -- -- --
Secretary
</TABLE>
- -------
(1) Includes term life insurance premium paid on behalf of Mr. Lambert.
(2) Includes tax gross-ups paid to Mr. Lambert of $44,808 in 1999 and $14,938
in 1998.
(3) Includes tax gross-ups paid to Mr. Kammersgard of $44,808 in 1999 and
$14,938 in 1998.
(4) Represents the dollar value of shares of Artecon California common stock
purchased pursuant to an option exercise, calculated by multiplying the
difference between the fair market value of such stock on the date of grant
($1.20 per share) and the exercise price ($0.035 per share) by the number
of shares of Artecon California common stock purchased (250,000 shares).
(5) Represents the dollar value of shares of Artecon California common stock
purchased pursuant to an option exercise, calculated by multiplying the
difference between the fair market value of such stock on the date of grant
($1.20 per share) and the exercise price ($0.035 per share) by the number
of shares of Artecon California common stock purchased (125,000 shares).
27
<PAGE> 28
OPTION GRANTS IN LAST FISCAL YEAR
Artecon grants options to its executive officers under its 1996 Stock
Option Plan (the "1996 Plan"). The following table sets forth for each of
Messrs. Lambert and Kammersgard information concerning stock options granted
during the year ended March 31, 1999.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------------------------------
POTENTIAL REALIZABLE
VALUE
AT ASSUMED ANNUAL
RATES
PERCENT OF OF STOCK PRICE
NUMBER OF TOTAL OPTIONS APPRECIATION
UNDERLYING GRANTED TO EXERCISE FOR OPTION TERM(3)
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION ------------------------
NAME GRANTED(1) 1999(2) SHARE DATE 5% 10%
- ---- ----------- ------------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
James L. Lambert ....... 40,000 1.8% $ 3.75 4/1/08 $ 94,500 $238,500
Dana W. Kammersgard .... 25,000 1.1 3.75 4/1/08 59,062 149,062
</TABLE>
- ----------
(1) Options granted have a ten year term, and vest at the rate of 1/4
(one-fourth) of the shares subject to the Option shall vest on the first
one (1) year anniversary of the vesting commencement date, and an
additional 1/4th (one-fourth) of the shares shall vest on each one (1) year
anniversary thereafter.
(2) Based on options to purchase 2,225,000 shares of Artecon common stock
granted to employees, including Messrs. Lambert and Kammersgard, under the
1996 Plan during the fiscal year ended March 31, 1999.
(3) Calculated on the assumption that the market value of the underlying stock
increases at the stated values, compounded annually. The total appreciation
of the options over their ten-year terms at 5% and 10% is 63% and 159%,
respectively
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES
During the fiscal year ended March 31, 1999, none of the Company's named
executive officers exercised any stock options, nor were any stock options
exercisable as of March 31, 1999.
EMPLOYEE BENEFIT PLANS
1996 STOCK OPTION PLAN
The 1996 Plan provides for granting to employees, including officers,
directors, and consultants, of non-statutory stock options. A total of 3,000,000
shares of Artecon common stock are currently reserved for issuance pursuant to
the 1996 Plan. As of March 31, 1999, options to purchase 1,410,497 shares of
Artecon common stock were outstanding under the 1996 Plan and 1,589,503 shares
of Artecon common stock remained available for issuance under the 1996 Plan. In
April 1998, Artecon granted options to purchase 1,471,500 shares at exercise
prices ranging from $3.38 to $3.75. Additionally, 217,500 options with exercise
prices ranging from $5.13 to $7.00 were cancelled and re-granted at $3.375 per
share.
1996 EMPLOYEE STOCK PURCHASE PLAN
The 1996 Employee Stock Purchase Plan (the "Purchase Plan") provides for
the opportunity to purchase Artecon common stock through accumulated payroll
deductions. A total of 400,000 shares of Artecon common stock are currently
reserved for issuance under the Purchase Plan. As of March 31, 1999, 298,401
shares of Artecon common stock had been purchased under the Purchase Plan and
101,599 shares remained available for purchase under the Purchase Plan.
401(k) PLAN
Artecon has a savings plan under Section 401(k) of the Internal Revenue
Code (the "401(k) Plan"). The 401(k) Plan allows eligible employees to
contribute up to 15 percent of their compensation on a pre-tax basis up to the
statutorily prescribed annual limit ($10,000 in 1998). Artecon matches 50
percent of the employee's contribution up to a specified limit. Such matching
contributions vest incrementally over 5 years.
DIRECTOR COMPENSATION
For services as directors, effective April 1998, each non-employee member
of the Artecon board of directors receives an annual fee of $10,000, plus $2,000
for each board meeting attended in person, $1,000 for each board meeting
attended via telephone conference, $1,000 for each committee meeting attended in
person and $500 for each committee meeting attended via telephone conference,
provided that the committee meeting is not on the same date as the board meeting
and reimbursement for reasonable expenses. The 1996 Plan provides that options
may be granted to non-employee directors. See "-- Employee Benefit Plans -- 1996
28
<PAGE> 29
Stock Option Plan." In April 1998, each non-employee director received an
initial grant of options to purchase 50,000 shares of Common Stock at an
exercise price of $3.75 per share. Concurrently with such grant, Mr. Fitzgerald
and Dr. Park, two current Artecon directors, surrendered for cancellation
certain non-employee director stock options granted to them prior to the Storage
Dimensions merger.
OPTION REPRICING INFORMATION
In April 1998, following the Storage Dimensions merger, Artecon implemented
an employee option exchange program (the "1998 Repricing") applicable to Artecon
employees (other than executive officers). Under the program, outstanding
options held by qualifying employees with an exercise price greater than $3.38
per share, the closing price of the Artecon common stock on the date of the
exchange (the "1998 Exchange Price"), were exchanged for new options to purchase
the same number of shares at an exercise price equal to the 1998 Exchange Price.
Subject to certain exceptions, the new options are not exercisable until one
year after the date of issuance, at which time they will continue to vest to the
same extent as the old options surrendered therefor. During the past ten years,
no options held by executive officers of Artecon have been repriced.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to
beneficial ownership of the Company's Common Stock and Preferred Stock as of
June 3, 1999, by:
- each shareholder who is known by the Company to own beneficially more
than 5% or more of the outstanding shares of Common Stock;
- each named executive officer of the Company;
- each director of the Company; and
- all directors and executive officers of the Company as a group.
Unless otherwise indicated, to the knowledge of Artecon, all persons listed
below have sole voting and investment power with respect to their shares of
Artecon common stock and preferred stock, except to the extent authority is
shared by spouses under applicable law.
<TABLE>
<CAPTION>
SHARES OF PERCENT OF
STOCK COMMON PREFERRED STOCK PERCENT OF
BENEFICIALLY STOCK BENEFICIALLY PREFERRED STOCK
NAME AND ADDRESS OWNED(1) OWNED(2) OWNED(1) OWNED(2)
- ---------------- ------------ ---------- --------------- ----------------
<S> <C> <C> <C> <C>
5% Stockholders
Capital Partners Group .......... 2,900,623(3) 13.3% -- --
Maxtor Corporation .............. 1,600,000 7.3% -- --
Officers & Directors
W.R. Sauey ...................... 5,295,384(4) 24.3% 2,494,159(5) 100%
James L. Lambert ................ 3,509,777(6) 16.1% -- --
Dana W. Kammersgard ............. 1,388,087(7) 6.4% -- --
Jason C. Sauey .................. 373,104(8) 1.7% -- --
Dr. Chong Sup Park .............. 1,612,500(9) 7.4% -- --
Brian D. Fitzgerald ............. 2,913,123(3)(10) 13.4% -- --
Norman R. Farquhar .............. 12,500(11) * -- --
William J. Filip ................ 27,500(12) * -- --
All executive officers and
directors as a Group
(9 persons)(13) ............... 15,131,975 69.2% 2,494,159 100%
</TABLE>
- ------------
* Represents beneficial ownership of less than 1%.
(1) This table is based upon information supplied by executive officers,
directors, principal stockholders and the company's transfer agent.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, and includes generally sole voting
and investment power with respect to securities. Except as indicated by
footnote, and subject to community property laws where applicable, the
Company believes that the persons named in the table above have sole
voting and investment power with respect to all shares of common stock
and preferred stock shown as beneficially owned by them.
(2) Percentage of beneficial ownership is based on 21,772,227 shares of
common stock outstanding as of June 3, 1999. Preferred stock is based on
2,494,159 shares of Series A Preferred Stock outstanding as of June 3,
1999.
29
<PAGE> 30
(3) Represents 1,676,440 shares held by CP Acquisition, L.P. No. 4A, 926,790
shares held by CP Acquisition, L.P. No. 4B, 3,612 shares held by Capital
Partners, Inc., and 293,781 shares held by FGS, Inc. The following
affiliated entities are included in "Capital Partners Group"; (a) CP
Acquisition, L.P. No. 4A, a Delaware limited partnership; (b) CP
Acquisition, L.P. No. 4B, a Delaware limited partnership; (c) Capital
Partners, Inc., a Connecticut corporation, of which Brian D. Fitzgerald
is the sole stockholder, an officer and a director, and (d) FGS, Inc., a
Delaware corporation, of which Mr. Fitzgerald is the controlling
stockholder, an officer and a director. Mr. Fitzgerald may be deemed to
beneficially own the shares held by the entities comprising the Capital
Partners Group.
(4) Includes (i) 891,151 shares of common stock held by Flambeau Corp., (ii)
235,507 shares of common stock held by Flambeau Products Corp., (iii)
38,333 shares of common stock held by Seats, Inc. and (iv) 1,038,103
shares of common stock held by the W.R. & Floy A. Sauey Grandparents
Trust established for the benefit of certain grandchildren of W.R. Sauey.
Mr. Sauey is Chairman of the Board and the principal shareholder in each
of Flambeau Corp., Flambeau Products Corp. and Seats, Inc. (collectively,
the "Sauey Affiliates"). Mr. Sauey disclaims beneficial ownership of all
the above-listed shares, except to the extent of his pecuniary or pro
rata interest in such shares. Also, includes options to purchase 12,500
shares of common stock exercisable at or within 60 days of June 3, 1999.
(5) Includes (i) 1,038,604 shares of preferred stock held by Flambeau Corp.,
(ii) 1,038,604 shares of preferred stock held by Flambeau Products Corp.
and (iii) 169,074 shares of preferred stock held by Seats, Inc. Mr. Sauey
disclaims beneficial ownership of all the above-listed shares, except to
the extent of his pecuniary or pro rata interest in such shares.
(6) Includes (i) 3,492,681 shares held jointly with Pamela Lambert, the
spouse of Mr. Lambert, (ii) 3,600 shares of common stock held by Pamela
Lambert, and 166 shares of common stock held by Mr. Lambert's daughter
and (iii) options to purchase 10,000 shares of common stock exercisable
at or within 60 days of June 3, 1999.
(7) Includes (i) 546 shares of common stock held by Lisa Kammersgard, the
spouse of Mr. Kammersgard and (ii) options to purchase 6,250 shares of
common stock exercisable at or within 60 days of June 3, 1999.
(8) Includes options to purchase 12,500 shares of common stock exercisable at
or within 60 days of June 3, 1999.
(9) Includes 1,600,000 shares held by Maxtor Corporation. Dr. Park is
President and Chief Executive Officer of Hyundai Electronics America, the
parent of Maxtor Corporation, and Chairman of the Board of Maxtor
Corporation. Also, includes options to purchase 12,500 shares of common
stock exercisable at or within 60 days of June 3, 1999.
(10) Includes options to purchase 12,500 shares of common stock exercisable at
or within 60 days of June 3, 1999.
(11) Includes options to purchase 12,500 shares of common stock exercisable at
or within 60 days of June 3, 1999.
(12) Includes options to purchase 12,500 shares of common stock exercisable at
or within 60 days of June 3, 1999.
(13) Includes 2,203,094 shares of common stock held by the Sauey Affiliates
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Falcon acquisition purchase price of $3,500,000 included $1,000,000 in
cash and a promissory note in the original principal amount of $1,250,000 (the
"Artecon Note"). Subsequent to the issuance of the Artecon Note, Artecon
California and Falcon amended the Artecon Note to decrease the principal amount
due thereunder to $750,000. Concurrently with the Falcon Acquisition, Falcon
transferred the Falcon Technology to Founding Partners, a California general
partnership ("Founding Partners"), in exchange for a promissory note in the
principal amount of $1,750,000 (the "Founding Partners Note"). Dana Kammersgard,
James Lambert and W.R. Sauey, each of whom is an executive officer and/or
director of Artecon, are the general partners of Founding Partners. Founding
Partners is considered to be a "special purpose entity" and, accordingly, has
been consolidated with Artecon for financial reporting purposes. The purchase
price was allocated among the acquired assets to $10,232,000 for other assets
acquired, $638,000 to goodwill and other intangible assets, $14,138,000 for
liabilities assumed and to in-process research and development expenses of
$3,700,000, which had no future alternative use, based on management
assumptions. Under the terms of the Artecon Note, as adjusted, and the Founding
Partners Note (collectively, the "Notes"), Artecon and Founding Partners are
required to make monthly payments to Falcon of $15,935 and $37,182,
respectively, through August 2002. Each of the Notes bears interest at the rate
of 10% per annum. As of March 31, 1999, the approximate amount of principal
outstanding under the Artecon Note was $552,000, and the approximate amount of
principal outstanding under the Founding Partners Note was $1,287,000.
In connection with the Falcon acquisition and the transfer of the Falcon
Technology, Artecon California and Founding Partners entered into a Technology
License Agreement, dated August 21, 1997, pursuant to which Founding Partners
granted to Artecon California an exclusive, perpetual license of the Falcon
Technology in exchange for monthly payments of $39,000 payable through August
2002.
30
<PAGE> 31
On December 27, 1997, Founding Partners and Artecon California amended the
Technology License Agreement to provide for, among other things, the transfer of
the Falcon Technology from Founding Partners to Artecon California upon the
satisfaction in full of Founding Partners' obligations under the Founding
Partners Note.
Pursuant to certain commitments between Artecon and the Nordic Group, in
which W.R. Sauey holds a controlling interest, Artecon was obligated to pay fees
to the Nordic Group for certain software maintenance services provided by and
overhead costs incurred by the Nordic Group. Such fees totaled approximately
$9,000 to $11,000 per month and represented Artecon's portion of overhead costs
paid by the Nordic Group on its behalf. Such payments terminated effective upon
the closing of the Merger. In addition, Artecon leases certain real property
from W.R. Sauey at a monthly rental fee of approximately $1,125 under a
month-to-month lease between the parties.
Since January 1997, Artecon California made a series of short-term loans to
Flambeau Corp., a company in which W.R. Sauey is the principal shareholder, in
the aggregate principal amount of $6,145,000. Such loans were made pursuant to
the terms of a promissory note dated January 16, 1997 which bore interest at a
rate of 7.25% per annum and which was due and payable on demand. The aggregate
principal amount (including $14,506 in total interest payments) was paid in full
by Flambeau Corp. in August 1997.
During the fiscal years ended March 29, 1997, March 31, 1998, and March 31,
1999, Artecon made payments to certain entities affiliated with W.R. Sauey (the
"Nordic Group Companies") of approximately $85,000, $130,000 and $80,000,
respectively, for the purchase of certain products and services from the Nordic
Group Companies. In addition, during the fiscal years ended March 29, 1997,
March 31, 1998 and March 31, 1999, the company received payments for the sale of
certain products and services from certain of the Nordic Group Companies of
approximately $74,000, $125,000 and $48,000, respectively. As of March 31, 1999,
Artecon had accounts receivable from certain Nordic Group Companies of
approximately $13,000 and accounts payable of zero.
In February 1999, the Company issued a promissory note to Flambeau
Corporation, a company affiliated with Mr. W.R. Sauey, for the principal amount
of $500,000 at an interest rate of prime minus one-half of one percent. Such
note was paid in full by Artecon on March 30, 1999.
31
<PAGE> 32
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents Filed With Report
(1) Financial Statements
The consolidated balance sheets for the years ended March 31, 1999 and
1998, and the consolidated statements of operations, statements of
shareholders' equity and cash flows for each of the years ended March
31, 1999, March 31, 1998 and March 29, 1997, together with the notes
thereto.
(2) Financial Data Schedules
See Exhibit 27.1 below
(3) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
<S> <C>
2.1 Agreement and Plan of Merger and Reorganization by and
among the Registrant, BH Acquisition Corp. and Box
Hill Systems Corp. ("Box Hill"), dated as of April 29,
1999.(1)(3)
3.1 Second Amended and Restated Certificate of
Incorporation of Registrant.(2)
3.2 Certificate of Amendment of Amended and Restated
Certificate of Incorporation of Registrant.(7)
3.3 Bylaws of Registrant.(5)
4.1 Form of Registrant's Common Stock Certificate.(5)
4.2 Form of Registrant's Series A Preferred Stock
Certificate.(4)
10.1 Form of Voting Agreement, dated April 29, 1999,
between Registrant and the shareholders of Box Hill as
named therein.(3)
10.2 Form of Voting Agreement, dated April 29, 1999,
between Box Hill and the stockholders of the
Registrant as named therein.(3)
10.3 Form of Indemnification Agreement entered into between
the Registrant and its directors and officers.(2)
10.4 Registrant's 1996 Stock Option Plan, as amended.(5)(6)
10.5 Registrant's 1996 Employee Stock Purchase Plan, as
amended.(5)(6)
10.6 Stockholders Agreement, dated December 26, 1992, among
the Registrant, Gene E. Bowles, Jr., David A. Eeg, CP
Acquisition, L.P. No. 4A, CP Acquisition, L.P. No. 4B,
Capital Partners, Inc., FGS, Inc., Maxtor Corporation
and certain other management investors.(2)
10.7 Lease, dated October 8, 1993, between the Registrant
and Callahan-Pentz Properties, McCarthy Four. (2)
10.8 First Amendment to Lease, dated June 28, 1995, between
the Registrant and Callahan-Pentz Properties, McCarthy
Four.(2)
10.9 Credit Agreement, Revolving Credit Note, Security
Agreements, Guaranty of Payment, Patent Security
Agreement and Trademark Security Agreement, each dated
May 15, 1998, among the Registrant, LaSalle National
Bank and the other parties named therein.(1)(7)
10.10 Lease, dated July 9, 1993, as amended, between
Artecon, Inc. and Vector Associates.(7)
10.11 Asset Purchase Agreement, dated August 21, 1997, among
Artecon California, Falcon Systems, Inc. and Craig
Caudill.(7)
10.12 Technology Purchase Agreement, dated August 21, 1997,
among Founding Partners, Falcon Systems, Inc. and
Craig Caudill.(7)
10.13 Promissory Note, dated August 21, 1997, issued by
Artecon California to Falcon Systems, Inc.(7)
10.14 Promissory Note, dated August 21, 1997, issued by
Founding Partners to Falcon Systems, Inc.(7)
10.15 Technology License Agreement, dated August 21, 1997,
between Artecon California and Founding Partners.(7)
10.16 Amendment to Technology License Agreement, dated
December 22, 1997, between Artecon California and
Founding Partners.(7)
</TABLE>
32
<PAGE> 33
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
<S> <C>
10.17 Form of employment agreement between the Registrant
and certain employees.(2)(6)
10.18 Amendment No. 1 to the Employment Agreement, dated
March 9, 1998, between the Registrant and David A.
Eeg.(6)(7)
10.19 Amendment No. 1 to the Employment Agreement, dated
March 9, 1998, between the Registrant and Robert
Bylin.(6)(7)
21 Subsidiaries of Registrant.
23.1 Consent of Deloitte & Touche LLP.
24 Power of Attorney. Reference is made to page 34.
27 Financial Data Schedule.
</TABLE>
- ----------
(1) Schedules omitted pursuant to Regulation S-K, Item 601(b)(2) of the
Commission. Registrant undertakes to furnish such schedules to the
Commission supplementally upon request.
(2) Filed as an exhibit to Registrant's Registration Statement on Form S-1
(No. 333-20045), as amended, and incorporated herein by reference.
(3) Filed as an exhibit to the Current Report on Form 8-K of Box Hill dated
April 29, 1999, and incorporated herein by reference.
(4) Filed as an exhibit to Registrant's Registration Statement on Form S-4
(No. 333-47593) and incorporated herein by reference.
(5) Filed as an exhibit to Registrant's Registration Statement on Form S-8
(No. 333-56281) and incorporated herein by reference.
(6) Indicates management or compensatory plan or arrangement required to be
identified pursuant to Item 14(c).
(7) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended March 31, 1998 and incorporated herein by reference.
(b) Reports on Form 8-K
None
(c) See response to Item 14(a)(3) above.
(d) See response to Item 14(a)(2) above.
33
<PAGE> 34
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARTECON, INC.
By: /s/ JAMES L. LAMBERT
------------------------------------
James L. Lambert
President
Date: June 29, 1999
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James L. Lambert and each of them, as his
true and lawful attorneys-in-fact and agents, with full power of substitution
and resubstitution, for him and in his name, place, and stead, in any and all
capacities, to sign any and all amendments to this Report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection therewith,
as fully to all intents and purposes as he might or could do in person, hereby
ratifying and confirming that all said attorneys-in-fact and agents, or any of
them or their or his substitute or substituted, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Registration Statement has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<S> <C> <C>
/s/ JAMES L. LAMBERT President and Chief Executive Officer and Director June 29, 1999
- -------------------------------------- (Principal Executive Officer and Principal Financial
James L. Lambert and Accounting Officer)
/s/ W.R. SAUEY Chairman of the Board of Directors June 29, 1999
- --------------------------------------
W.R. Sauey
/s/ NORMAN R. FARQUHAR Director June 29, 1999
- --------------------------------------
Norman R. Farquhar
/s/ WILLIAM J. FILIP Director June 29, 1999
- --------------------------------------
William J. Filip
/s/ BRIAN D. FITZGERALD Director June 29, 1999
- --------------------------------------
Brian D. Fitzgerald
/s/ DR. CHONG SUP PARK Director June 29, 1999
- --------------------------------------
Dr. Chong Sup Park
Director
- --------------------------------------
Jason C. Sauey
</TABLE>
34
<PAGE> 35
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
<S> <C>
2.1 Agreement and Plan of Merger and Reorganization by and
among the Registrant, BH Acquisition Corp. and Box
Hill Systems Corp. ("Box Hill"), dated as of April 29,
1999.(1)(3)
3.1 Second Amended and Restated Certificate of
Incorporation of Registrant.(2)
3.2 Certificate of Amendment of Amended and Restated
Certificate of Incorporation of Registrant.(7)
3.3 Bylaws of Registrant.(5)
4.1 Form of Registrant's Common Stock Certificate.(5)
4.2 Form of Registrant's Series A Preferred Stock
Certificate.(4)
10.1 Form of Voting Agreement, dated April 29, 1999,
between Registrant and the shareholders of Box Hill as
named therein.(3)
10.2 Form of Voting Agreement, dated April 29, 1999,
between Box Hill and the stockholders of the
Registrant as named therein.(3)
10.3 Form of Indemnification Agreement entered into between
the Registrant and its directors and officers.(2)
10.4 Registrant's 1996 Stock Option Plan, as amended.(5)(6)
10.5 Registrant's 1996 Employee Stock Purchase Plan, as
amended.(5)(6)
10.6 Stockholders Agreement, dated December 26, 1992, among
the Registrant, Gene E. Bowles, Jr., David A. Eeg, CP
Acquisition, L.P. No. 4A, CP Acquisition, L.P. No. 4B,
Capital Partners, Inc., FGS, Inc., Maxtor Corporation
and certain other management investors.(2)
10.7 Lease, dated October 8, 1993, between the Registrant
and Callahan-Pentz Properties, McCarthy Four. (2)
10.8 First Amendment to Lease, dated June 28, 1995, between
the Registrant and Callahan-Pentz Properties, McCarthy
Four.(2)
10.9 Credit Agreement, Revolving Credit Note, Security
Agreements, Guaranty of Payment, Patent Security
Agreement and Trademark Security Agreement, each dated
May 15, 1998, among the Registrant, LaSalle National
Bank and the other parties named therein.(1)(7)
10.10 Lease, dated July 9, 1993, as amended, between
Artecon, Inc. and Vector Associates.(7)
10.11 Asset Purchase Agreement, dated August 21, 1997, among
Artecon California, Falcon Systems, Inc. and Craig
Caudill.(7)
10.12 Technology Purchase Agreement, dated August 21, 1997,
among Founding Partners, Falcon Systems, Inc. and
Craig Caudill.(7)
10.13 Promissory Note, dated August 21, 1997, issued by
Artecon California to Falcon Systems, Inc.(7)
10.14 Promissory Note, dated August 21, 1997, issued by
Founding Partners to Falcon Systems, Inc.(7)
10.15 Technology License Agreement, dated August 21, 1997,
between Artecon California and Founding Partners.(7)
10.16 Amendment to Technology License Agreement, dated
December 22, 1997, between Artecon California and
Founding Partners.(7)
10.17 Form of employment agreement between the Registrant
and certain employees.(2)(6)
10.18 Amendment No. 1 to the Employment Agreement, dated
March 9, 1998, between the Registrant and David A.
Eeg.(6)(7)
10.19 Amendment No. 1 to the Employment Agreement, dated
March 9, 1998, between the Registrant and Robert
Bylin.(6)(7)
21 Subsidiaries of Registrant.
23.1 Consent of Deloitte & Touche LLP.
24 Power of Attorney. Reference is made to page 34.
27 Financial Data Schedule.
</TABLE>
- ----------
36
<PAGE> 36
(1) Schedules omitted pursuant to Regulation S-K, Item 601(b)(2) of the
Commission. Registrant undertakes to furnish such schedules to the
Commission supplementally upon request.
(2) Filed as an exhibit to Registrant's Registration Statement on Form S-1
(No. 333-20045), as amended, and incorporated herein by reference.
(3) Filed as an exhibit to the Current Report on Form 8-K of Box Hill dated
April 29, 1999, and incorporated herein by reference.
(4) Filed as an exhibit to Registrant's Registration Statement on Form S-4
(No. 333-47593) and incorporated herein by reference.
(5) Filed as an exhibit to Registrant's Registration Statement on Form S-8
(No. 333-56281) and incorporated herein by reference.
(6) Indicates management or compensatory plan or arrangement required to be
identified pursuant to Item 14(c).
(7) Filed as an exhibit to Registrant's Annual Report on Form 10-K for the
fiscal year ended March 31, 1998 and incorporated herein by reference.
- ----------
37
<PAGE> 37
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
ARTECON, INC.
Independent Auditors' Report................................ F-2
Consolidated Balance Sheets as of March 31, 1999 and March
31, 1998.................................................. F-3
Consolidated Statement of Operations and Comprehensive
Operations for the years ended March 31, 1999, March 31,
1998 and March 29, 1997................................... F-5
Consolidated Statement of Shareholders' Equity for the years
ended March 31, 1999, March 31, 1998 and March 29, 1997... F-6
Consolidated Statement of Cash Flows for the years ended
March 31, 1999, March 31, 1998 and March 29, 1997......... F-7
Notes to Consolidated Financial Statements.................. F-10
Independent Auditor's Report on Schedule.................... S-1
Schedule II--Valuation and Qualifying Accounts.............. S-2
</TABLE>
F-1
<PAGE> 38
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Artecon, Inc.
We have audited the accompanying consolidated balance sheets of Artecon,
Inc. and its subsidiaries (the Company) as of March 31, 1999 and 1998, and the
related consolidated statements of operations, comprehensive operations,
shareholders' equity and cash flows for each of the three years in the period
ended March 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in
all material respects, the financial position of Artecon, Inc. and its
subsidiaries at March 31, 1999 and 1998 and the results of their operations and
their cash flows for each of the three years in the period ended March 31, 1999,
in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Costa Mesa, California
May 6, 1999
F-2
<PAGE> 39
ARTECON, INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 1999 AND 1998
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE AMOUNTS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 2,093 $ 7,992
Accounts receivable, less allowance for doubtful
accounts and sales returns of $1,017 at March 31,
1999 and $893 at March 31, 1998..................... 12,231 18,415
Inventories, net....................................... 11,673 12,354
Deferred income taxes.................................. 3,239 3,510
Prepaid expenses and other............................. 1,970 1,654
-------- --------
Total current assets................................ 31,206 43,925
Property and Equipment:
Machinery and equipment................................ 3,811 4,474
Tooling molds.......................................... 932 1,158
Furniture and fixtures................................. 136 105
Computer software...................................... 183 347
-------- --------
5,062 6,084
Less accumulated depreciation.......................... (3,426) (2,358)
-------- --------
Property and equipment, net......................... 1,636 3,726
Other assets............................................. 114 133
Goodwill, net............................................ 1,252 4,668
Other intangible assets, net............................. 1,059 3,291
Deferred income taxes.................................... 7,894 1,602
-------- --------
$ 43,161 $ 57,345
======== ========
</TABLE>
F-3
<PAGE> 40
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE AND PER SHARE AMOUNTS)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable....................................... $ 9,663 $ 14,253
Accrued compensation................................... 1,446 2,431
Accrued merger and restructuring liabilities........... 1,259 5,765
Other accrued liabilities.............................. 2,016 3,684
Unearned maintenance revenue........................... 1,387 182
Current portion of long-term debt...................... 483 756
Short-term borrowings.................................. 35
-------- --------
Total current liabilities........................... 16,254 27,106
Long-term liabilities.................................... 133 13
Borrowings under lines of credit......................... 10,552 7,899
Long-term debt........................................... 1,356 2,585
Minority interest........................................ 52 63
Commitments (Note 14)....................................
Shareholders' equity:
Convertible preferred A shares, $.005 par value, 10,000
shares authorized, 2,494 shares issued and
outstanding at March 31, 1999 and
March 31, 1998; liquidation preference of $4,988.... 12 12
Common shares, $.005 par value ; 40,000 shares
authorized; 21,707 and 21,387 shares issued and
outstanding at March 31, 1999 and March 31, 1998,
respectively........................................ 109 107
Additional paid-in capital............................. 39,596 39,148
Accumulated other comprehensive operations............. (62) (97)
Accumulated deficit.................................... (24,841) (19,491)
-------- --------
Total shareholders' equity.......................... 14,814 19,679
-------- --------
$ 43,161 $ 57,345
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 41
ARTECON, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE OPERATIONS
FOR THE YEARS ENDED MARCH 31, 1999, MARCH 31, 1998
AND MARCH 29, 1997
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Net revenues................................. $95,879 $ 66,340 $55,317
Cost of sales................................ 61,958 50,945 42,391
Restructure expenses......................... 403 -- --
------- -------- -------
Gross margin................................. 33,518 15,395 12,926
Operating expenses:
Selling & service.......................... 26,108 11,422 7,643
General & administrative................... 5,347 3,584 1,663
Research and development................... 7,329 3,199 2,392
Restructure expenses....................... 1,404 -- --
Additional amortization of intangible
assets.................................. 867 -- --
Acquired in-process research and
development costs....................... -- 18,200 --
------- -------- -------
Total operating expenses................ 41,055 36,405 11,698
------- -------- -------
Operating (loss) income...................... (7,537) (21,010) 1,228
Other expense:
Other income (expense), net................ 395 (124) (10)
(Loss) gain on foreign currency
transactions, net....................... (14) (141) 45
Interest expense, net...................... (1,018) (820) (282)
------- -------- -------
Total other expense..................... (637) (1,085) (247)
------- -------- -------
(Loss) income before income tax benefit
(provision)................................ (8,174) (22,095) 981
Income tax benefit (provision)............... 2,824 2,807 (340)
------- -------- -------
Net (loss) income............................ $(5,350) $(19,288) $ 641
======= ======== =======
Basic net (loss) income per share............ $ (0.25) $ (3.30) $ 0.12
======= ======== =======
Weighted average shares used to calculate
basic net income (loss) per share.......... 21,549 5,841 5,202
======= ======== =======
Diluted net (loss) income per share.......... $ (0.25) $ (3.30) $ 0.08
======= ======== =======
Weighted average shares used to calculate
diluted net income (loss) per share........ 21,549 5,841 8,410
======= ======== =======
COMPREHENSIVE OPERATIONS:
Net (loss) income............................ $(5,350) $(19,288) $ 641
Foreign currency translation adjustments, net
of tax..................................... 35 233 (18)
------- -------- -------
Comprehensive (loss) income.................. $(5,315) $(19,055) $ 623
======= ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 42
ARTECON, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1999, MARCH 31, 1998
AND MARCH 29, 1997
<TABLE>
<CAPTION>
CONVERTIBLE CONVERTIBLE
CONVERTIBLE PREFERRED B PREFERRED A
PREFERRED SHARES SHARES SHARES COMMON SHARES
---------------- ---------------- --------------- ----------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------- ------ ------- ------ ------ ------ -------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, April 1, 1996.......... 1,212 $2,419 1,405 $2,810 -- $-- 5,210 $ 601
Repurchase of common and
preferred shares............... (100) (200) (17)
Foreign currency translation
adjustment.....................
Net income......................
------ ------- ------ ------- ----- --- ------ -------
BALANCE, March 29, 1997......... 1,112 2,219 1,405 2,810 5,193 601
Issuance of common shares....... (57) (68) 851 817
Conversion of preferred shares
to common shares............... (23) (46) 29 46
Conversion of convertible
preferred and preferred B
shares to convertible preferred
A shares....................... (1,089) (2,116) (1,405) (2,742) 2,494 12
Assumed issuance of common stock
in connection with
acquisition.................... 15,314 (1,357)
Foreign currency translation
adjustment.....................
Net loss........................
------ ------- ------ ------- ----- --- ------ -------
BALANCE, March 31, 1998......... 2,494 12 21,387 107
Common stock issued under
employee stock purchase plan... 167 1
Common stock issued under
employee stock option plan..... 153 1
Stock options income tax
benefits.......................
Foreign currency translation
adjustment.....................
Net loss........................
------ ------- ------ ------- ----- --- ------ -------
BALANCE, March 31, 1999......... -- $ -- $ -- 2,494 $12 21,707 $ 109
====== ======= ====== ======= ===== === ====== =======
<CAPTION>
OTHER
COMPREHEN- ACCUM-
PAID-IN SIVE ULATED TOTAL
CAPITAL OPERATIONS DEFICIT EQUITY
------- ---------- -------- --------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C> <C> <C>
BALANCE, April 1, 1996.......... $(312) $ (798) $ 4,720
Repurchase of common and
preferred shares............... (46) (246)
Foreign currency translation
adjustment..................... (18) (18)
Net income...................... 641 641
------- ----- -------- --------
BALANCE, March 29, 1997......... (330) (203) 5,097
Issuance of common shares....... 692
Conversion of preferred shares
to common shares...............
Conversion of convertible
preferred and preferred B
shares to convertible preferred
A shares....................... 4,846
Assumed issuance of common stock
in connection with
acquisition.................... 34,302 32,945
Foreign currency translation
adjustment..................... 233 233
Net loss........................ (19,288) (19,288)
------- ----- -------- --------
BALANCE, March 31, 1998......... 39,148 (97) (19,491) 19,679
Common stock issued under
employee stock purchase plan... 236 237
Common stock issued under
employee stock option plan..... 75 76
Stock options income tax
benefits....................... 137 137
Foreign currency translation
adjustment..................... 35 35
Net loss........................ (5,350) (5,350)
------- ----- -------- --------
BALANCE, March 31, 1999......... $39,596 $ (62) $(24,841) $ 14,814
======= ===== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 43
ARTECON, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1999, MARCH 31, 1998
AND MARCH 29, 1997
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income.......................... $(5,350) $(19,288) $ 641
Adjustments to reconcile net (loss) income
to net cash (used in) provided by
operating activities, net of effects of
acquisition:
Depreciation and amortization........... 5,152 1,001 664
Write-off of property and equipment..... 323 -- --
Compensation expense related to stock
issuances............................. -- 699 --
Acquired in-process research and
development costs..................... -- 18,200 --
Provision for doubtful accounts and
sales returns......................... 123 271 10
Deferred income taxes................... (3,307) (2,868) (18)
Impairment of intangible assets......... 300 -- --
Changes in operating assets and
liabilities, net of effects of
acquisitions:
Accounts receivable................... 6,061 258 226
Inventories........................... 682 3,276 (980)
Prepaid expenses and other assets..... (308) (580) (175)
Accounts payable...................... (4,498) 96 240
Accrued compensation.................. (985) 406 (327)
Accrued merger and restructuring
liabilities........................ (4,261) (816) --
Other accrued liabilities............. (2,005) (506) 518
Unearned maintenance revenue.......... 1,205 49 (39)
Long-term liabilities................. 120 (91) (13)
Other................................. 36 20 (5)
------- -------- --------
Net cash (used in) provided by
operating activities............ (6,712) 127 742
Cash flows from investing activities:
Purchases of property and equipment........ (638) (668) (260)
Cash received from acquisitions, net of
cash paid............................... -- 7,351 --
------- -------- --------
Net cash (used in) provided by investing
activities............................ (638) 6,683 (260)
</TABLE>
F-7
<PAGE> 44
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from financing activities:
Proceeds from bank and other borrowings.... 48,292 24,988 23,116
Payments on bank and other borrowings...... (47,210) (24,802) (23,381)
Issuance of common shares.................. 313 17 --
Repurchase of preferred shares............. -- -- (230)
Repurchase of common shares................ -- -- (16)
------- -------- --------
Net cash provided by (used in) financing
activities............................ 1,395 203 (511)
Effect of exchange rate changes on cash...... 56 233 (18)
------- -------- --------
Net (decrease) increase in cash.............. (5,899) 7,246 (47)
Cash and cash equivalents, beginning of
year....................................... 7,992 746 793
------- -------- --------
Cash and cash equivalents, end of year....... $ 2,093 $ 7,992 $ 746
======= ======== ========
Supplemental disclosures of cash flow
information:
Cash paid during the year for:
Interest................................... $ 817 $ 663 $ 307
======= ======== ========
Income taxes (refunded) paid............... $ (961) $ 880 $ 289
======= ======== ========
Supplemental schedule of noncash investing
and financing activities:
Acquisitions of property and equipment for
note payable............................ $ 360
========
Adjustment of deferred income taxes and
goodwill (Notes 1 and 14)............... $ 2,576
=======
Stock Option income tax benefits........... $ 137
=======
Detail of businesses acquired in purchase
business combinations:
On August 21, 1997, the Company acquired
certain net assets of Falcon Systems,
Inc.
A summary of the transaction is as follows:
Fair value of other assets acquired..... $ 10,232
Acquired in-process research and
development costs..................... 3,700
Other intangible assets................. 420
Goodwill................................ 127
Acquired developed technology........... 91
Note to Falcon shareholder.............. (2,500)
</TABLE>
F-8
<PAGE> 45
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid for acquisition, net of cash
acquired.............................. (432)
--------
Liabilities assumed.......................... $ 11,638
========
On March 31, 1998, the Company acquired the
net assets of Storage Dimensions, Inc.
(SDI)
A summary of the transactions is as
follows:
Fair value of other assets acquired..... $ 17,281
Acquired in-process research and
development........................... 14,500
Other intangible assets................. 2,400
Goodwill................................ 4,538
Acquired developed technology........... 500
Cash acquired........................... 7,783
Fair market value of stock.............. (32,945)
--------
Liabilities assumed.......................... $ 14,057
========
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE> 46
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MARCH 31, 1999, MARCH 31, 1998, AND MARCH 29, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. DESCRIPTION OF BUSINESS ACTIVITIES
DESCRIPTION OF BUSINESS -- Artecon, Inc. and its wholly- and majority-owned
subsidiaries, (collectively, the Company or Artecon), are manufacturers and
suppliers of value-added computer products and services in the open systems
workstation and server markets. The Company's principal markets include the
United States, Europe, Canada, and Japan. The Company sells its products through
a direct sales force, reseller distribution channels, worldwide government
agencies and Fortune 1000 companies.
On August 21, 1997, the Company acquired certain net assets of Falcon
Systems, Inc. (Falcon), a manufacturer and distributor of computer peripheral
equipment. The purchase price of $3,500 included $1,000 in cash and $2,500 of
promissory notes (Note 9). The acquisition was recorded as a purchase and the
results of operations for the period from August 21, 1997 to March 31, 1998 are
included in the accompanying consolidated financial statements. The purchase
price was allocated $10,232 to assets acquired (consisting primarily of
inventories, accounts receivable, property and equipment and other current
assets), $638 to goodwill and other intangible assets, $14,138 to liabilities
assumed, and $3,700 to in-process research and development expenses, which had
no future alternative use, based on management assumptions. In connection with
the acquisition, a partnership was created to purchase certain assets from
Falcon. The partners are majority shareholders of the Company. The partnership
is considered to be a Special Purpose Entity and, accordingly, the accompanying
consolidated financial statements include the accounts of the partnership and
all intercompany transactions have been eliminated.
On March 31, 1998, Artecon, Inc. and Storage Dimensions, Inc. (SDI)
completed a reverse merger whereby SDI acquired Artecon, Inc. Immediately after
the merger, SDI changed its name to Artecon, Inc. In the merger, shareholders of
the former Artecon, Inc. received approximately 62% of the total issued and
outstanding common stock, and 100% of the total issued and outstanding Preferred
Stock of the new Artecon, Inc. Since the former Artecon shareholders received a
substantial majority of the shares of common stock of the newly named Artecon,
the transaction was treated as a purchase of SDI by Artecon for accounting
purposes. As a result, the historical financial statements of Artecon, Inc. for
the periods prior to the merger are those of Artecon, Inc., rather than those of
SDI. The fair market value of stock was contractually determined based on the
average bid and ask price of Storage Dimensions common stock of 3.96875 on
December 18, 1997. The purchase price was allocated $25,064 to assets acquired
(consisting primarily of cash and cash equivalents, accounts receivable,
inventories, property and equipment, deferred tax assets, and other assets),
$7,438 to goodwill and other intangible assets, $14,057 to liabilities assumed
and $14,500 to in-process research and development expenses, which had no future
alternative use, based on management assumptions.
During the year ended March 31, 1999, the Company recorded adjustments
associated with certain tax-related matters that existed at the time of the
merger with SDI. The amount of the purchase price allocated to goodwill was
decreased by approximately $581 as a result of these adjustments.
F-10
<PAGE> 47
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Unaudited pro forma results of operations of the Company for the years
ended March 31, 1998 and March 29, 1997 are included below. Such pro forma
presentation has been prepared assuming that the acquisitions had occurred as of
April 1, 1996 for the Company.
<TABLE>
<CAPTION>
MARCH 31, MARCH 29,
1998 1997
--------- ---------
<S> <C> <C>
Net revenues..................................... $144,595 $183,298
Net loss......................................... (10,942) (18,183)
Pro forma basic and diluted net loss per share... $ (0.53) $ (1.39)
Weighted average shares used to calculate pro
forma basic and diluted net loss per share..... 20,667 13,074
</TABLE>
The pro forma results include the historical accounts of the Company,
Falcon and SDI and pro forma adjustments, as may be required, including the
in-process research and development expense, the amortization of goodwill and
other intangible assets, and the interest expense related to the promissory
notes issued to Falcon's previous shareholder. The in-process research and
development expense has been included as if recorded on April 1, 1996 and has
been excluded from the year ended March 31, 1998. The pro forma results of
operations are not necessarily indicative of actual results that may have
occurred had the operations of Falcon and SDI been combined in prior years.
Effective December 31, 1997, the Company changed its fiscal year as ending
on March 31 and its fiscal quarters as ending on June 30, September 30 and
December 31, respectively. Prior to this change, the Company's fiscal year was
previously on a 52- to 53-week basis that ended on the Saturday nearest to March
31. The fiscal year ended March 29, 1997 contained 52 weeks.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION -- The accompanying consolidated financial
statements include the accounts of Artecon, Inc. and its subsidiaries. All
significant intercompany transactions and balances have been eliminated in
consolidation.
CREDIT RISK -- The Company performs ongoing credit evaluations of its
customers and requires no collateral. The Company maintains reserves for
potential credit losses.
INVENTORIES -- Inventories are comprised of purchased parts and assemblies,
which include direct labor and overhead, and are valued at the lower of cost
(first-in, first-out) or market.
PROPERTY AND EQUIPMENT -- Property and equipment are stated at cost.
Depreciation and amortization are computed using the straight-line method over
the estimated useful lives of the assets (ranging from three to five years).
Depreciation expense was $2,371, $859, and $664 for the years ended March 31,
1999, March 31, 1998 and March 29, 1997 respectively.
FOREIGN CURRENCY -- The accounts of foreign subsidiaries consolidated
herein have been translated from their respective functional currencies at
appropriate exchange rates in accordance with Financial Accounting Standards
Board (FASB) Statement of Financial
F-11
<PAGE> 48
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accounting Standards (SFAS) No. 52. Cumulative translation adjustments are
included as a separate component of shareholders' equity. Gains and losses on
short-term intercompany foreign currency transactions are recognized as
incurred.
LONG-LIVED ASSETS -- The Company accounts for the impairment and
disposition of long-lived assets in accordance with SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
In accordance with SFAS No. 121, long-lived assets to be held are reviewed
whenever events or changes in circumstances indicate that their carrying value
may not be recoverable. The Company periodically reviews the carrying value of
long-lived assets to determine whether or not an impairment to such value has
occurred. Based on its most recent analysis, the Company believes that no
impairment exists at March 31, 1999. During the years ended March 31, 1999 and
1998, the Company recognized an impairment of certain long-lived assets in
connection with the merger and restructuring activities (Note 4).
SOFTWARE LICENSE COSTS -- Software license costs are amortized as the
related products which include the software are shipped. Included in other
current assets in the accompanying consolidated financial statements at March
31, 1999 is $1,000 in unamortized software license costs that are expected to be
utilized in fiscal year 2000.
GOODWILL AND OTHER INTANGIBLE ASSETS -- Goodwill related to acquisitions is
being amortized on a straight-line basis over a period of seven years.
Accumulated amortization was $679 and $12 at March 31, 1999 and March 31, 1998,
respectively. Other intangible assets related to acquisitions are being
amortized on a straight-line basis over two to four years. Goodwill and other
intangible assets are periodically reviewed for events or changes whenever
circumstances which indicate that their carrying value may not be recoverable.
The Company periodically reviews the carrying value of goodwill and other
intangible assets to determine whether or not an impairment to such values has
occurred. During the year ended March 31, 1999, the Company recorded an
impairment associated with certain other intangible assets of $300 and
additional amortization of $867 associated with a change in estimate of the
remaining useful lives of such assets (Note 4).
REVENUE RECOGNITION -- The Company recognizes revenue from product sales
upon shipment, including products sold under a stock rotation program that
entitles the buyer to the right to return products under certain conditions. The
Company provides allowance for estimated returns. Revenue from service contracts
is recognized ratably over the term of the contract.
USE OF ESTIMATES -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
INCOME TAXES -- The Company accounts for income taxes in accordance with
SFAS No. 109, Accounting for Income Taxes, which requires recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Under
this statement, deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax
F-12
<PAGE> 49
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bases of assets and liabilities using the enacted tax rates in effect for the
year in which the differences are expected to reverse.
CONCENTRATIONS -- The Company currently utilizes a limited number of
suppliers for certain devices used in its products but has no long-term supply
contracts with them. Due to the cyclical nature of the industry and competitive
conditions, there can be no assurance that the Company will not experience
difficulties in meeting its supply requirement in the future.
Approximately 26%, 27% and 35% of revenues for the years ended March 31,
1999, March 31, 1998 and March 29, 1997, were to four, four and two customers,
respectively. For the years ended March 31, 1999 and 1998, no customer accounted
for 10% or more of total revenues. For the year ended March 29, 1997, one
customer accounted for 25% of total net revenues. The loss of, or a reduction in
sales to, any such customers would have a material adverse effect on the
Company's business, operating results and financial condition.
Revenues derived from various U.S. government agencies were approximately
$1,440, $1,861 and $1,400 for the years ended March 31, 1999, March 31, 1998 and
March 29, 1997, respectively. Export sales to international customers amounted
to approximately $8,064, $7,737 and $7,675 for the years ended March 31, 1999,
March 31, 1998 and March 29, 1997, respectively.
ACCOUNTING FOR STOCK-BASED COMPENSATION -- The Company accounts for
stock-based compensation in accordance with Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees.
EARNINGS (LOSS) PER SHARE -- Basic earnings (loss) per share is computed
using the weighted average number of common shares outstanding during the
reporting period. Diluted earnings (loss) per share is computed using the
weighted average number of common shares outstanding and the potential dilutive
effect of the convertible Preferred A shares and options to purchase common
stock (see Note 10).
RECENT ACCOUNTING PRONOUNCEMENTS -- In June 1997, the FASB issued SFAS No.
131, Disclosures About Segments of an Enterprise and Related Information. This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosure about products and services, geographic areas and major
customers (see Note 16).
In February 1998, the FASB issued SFAS No. 132, Disclosures about Pensions
and Other Post-Retirement Benefits. This statement revises and standardizes
employers' disclosure requirements about pension and other post-retirement
benefit plans, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis and eliminates certain disclosures that are no longer useful. The
Company does not maintain an employee pension plan or any other post-retirement
benefit plans.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. The Company
does not invest in derivative
F-13
<PAGE> 50
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
investments and engaged in limited hedging activity in the prior year (Note 15).
The Company does not presently engage, nor does it intend to engage in future
hedging activities.
RECLASSIFICATIONS -- Certain prior year balances have been reclassified to
conform with the current year presentation.
3. OTHER COMPREHENSIVE OPERATIONS
Accumulated other comprehensive operations for each of the three years in
the period ended March 31, 1999 is comprised of the following:
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
OPERATIONS
-------------
<S> <C>
Balance, April 1, 1996................................. $(312)
Foreign currency translation adjustment................ (18)
-----
Balance, March 29, 1997................................ (330)
Foreign currency translation adjustment................ 233
-----
Balance, March 31, 1998................................ (97)
Foreign currency translation adjustment................ 35
-----
Balance, March 31,1999................................. $ (62)
=====
</TABLE>
4. ACCRUED MERGER AND RESTRUCTURING LIABILITIES AND IMPAIRMENT OF INTANGIBLE
ASSETS
In December 1998, the Board of Directors approved a plan to consolidate one
of the Company's engineering facilities from Milpitas, California, to Carlsbad,
California, to consolidate certain domestic sales and service locations, and to
eliminate certain product lines and development activities. The Company recorded
pre-tax restructuring charges of $1,807 to cover the costs associated with these
actions. The major components of the fiscal year 1999 charges and the remaining
accrual balance as of March 31, 1999 were as follows:
<TABLE>
<CAPTION>
INITIAL ACCRUED
RESTRUCTURING AMOUNTS RESTRUCTURING
CHARGE UTILIZED COSTS
------------- -------- -------------
<S> <C> <C> <C>
Employee termination costs................ $ 254 $ (200) $ 54
Inventory write-downs..................... 415 (115) 300
Facility closures and related expenses.... 715 (476) 239
Tooling write-off......................... 123 (123) --
Intangible asset impairment............... 300 (300) --
------ ------- ----
Total................................ $1,807 $(1,214) $593
====== ======= ====
</TABLE>
F-14
<PAGE> 51
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Employee termination costs consist primarily of severance payments for 43
employees, all of which were terminated as of March 31, 1999. The majority of
the employees terminated were employed at the engineering facility in Milpitas,
California and at the various domestic sales and service locations. Remaining
costs associated with bi-weekly payroll payments are expected to be paid in the
first quarter of fiscal year 2000. Inventory write-downs and the tooling
write-off primarily relate to the discontinuance of certain low-volume and
low-profit product lines. Of the total restructuring charge associated with the
inventory write-downs, $403 has been included as a separate component of cost of
sales in the accompanying financial statements. Facility closures and related
expenses consist of lease termination costs and the write-off of certain
property and equipment which was disposed of associated with the closures. The
majority of the remaining costs are expected to be paid in fiscal year 2000.
In connection with the acquisitions of Falcon and SDI, the Company
allocated $420 and $1,600, respectively, to an assembled workforce intangible
asset. The Company recorded an impairment of these intangible assets of $300
during the year ended March 31, 1999, which has been included as a component of
the restructuring charge, as the impairment was a direct result of employee
terminations associated with restructuring activities. Furthermore, as a result
of significant attrition and terminations of employees, which had been utilized
as the basis for the assembled workforce valuation, the Company recognized
additional amortization of $867 based on a change in estimate of the remaining
useful life of the assembled workforce.
In connection with the merger with SDI, the Company recorded a reserve for
acquisition related costs of $6,581, of which $5,765 was outstanding at March
31, 1998. All of the acquisition related costs were included in the purchase
price allocation performed at March 31, 1998. The following is a summary related
to the accrued merger costs at March 31, 1998, amounts utilized during fiscal
year 1999 and remaining reserve balance at March 31, 1999:
<TABLE>
<CAPTION>
ACCRUED ACCRUED
MERGER MERGER
COSTS COSTS
(MARCH 31, AMOUNTS (MARCH 31,
1998) UTILIZED 1999)
---------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Employee termination costs................... $2,858 $(2,691) $167
Professional service fees.................... 1,726 (1,410) 316
Other costs.................................. 1,181 (998) 183
------ ------- ----
Total................................... $5,765 $(5,099) $666
====== ======= ====
</TABLE>
The majority of the accrued merger costs at March 31, 1999 relate to
remaining severance and benefit payments pursuant to the related agreements,
lease and contract termination costs, and miscellaneous professional service fee
obligations. The Company anticipates that the remaining merger costs will be
paid in fiscal year 2000 and believes that there are no unresolved issues or
additional liabilities that may result in an adjustment to the purchase price
allocation for the SDI merger.
F-15
<PAGE> 52
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
--------- ---------
<S> <C> <C>
Purchased parts and materials.................... $ 8,385 $ 6,972
Work-in-process.................................. 163 1,599
Finished goods................................... 3,125 3,783
------- -------
$11,673 $12,354
======= =======
</TABLE>
6. ACCOUNTS AND TRANSACTIONS WITH RELATED PARTIES
Revenues from sales to affiliated companies for the years ended March 31,
1999, March 31, 1998, and March 29, 1997 were approximately $48, $125, and $74,
respectively. Accounts receivable from affiliated companies were approximately
$13 and $3 at March 31, 1999 and March 31, 1998, respectively, and are included
in accounts receivable in the accompanying consolidated balance sheets.
The Company purchases certain goods from affiliates and was subject to a
management fee of approximately $4 per month from an affiliate which was
terminated upon completion of the merger with SDI. Purchases from affiliated
companies for the years ended March 31, 1999, March 31, 1998, and March 29, 1997
were approximately $80, $130, and $85, respectively.
7. SHORT-TERM BORROWINGS
As a result of the merger with SDI (Note 1), the Company assumed a Loan and
Security Agreement with a financial institution. Borrowings outstanding under
the line at March 31, 1998 included $35 representing borrowings under the loan
provisions. Amounts outstanding under this agreement were repaid during the year
ended March 31, 1999 and this agreement was not renewed upon expiration in May
1998.
8. BORROWINGS UNDER LINE OF CREDIT
The Company has a $15,000 revolving credit facility with a United States
bank (the Agreement). The Agreement provides for financing collateralized by all
assets of the Company, as defined by the Agreement, and matures May 14, 2001,
unless otherwise renewed. The line of credit bears interest, at the bank's prime
rate. Monthly payments consist of interest only, with the principal due at
maturity. The Agreement requires that the Company comply with certain covenants
including quarterly and annual profitability covenants. The Company was not in
compliance with the net income covenants at March 31, 1999 and obtained a waiver
from the bank which included a modification of the future net income
requirements.
The Japanese subsidiary has two lines of credit with a Japanese bank for
borrowings up to an aggregate 35 million Yen (US$295 at March 31, 1999) at rates
ranging from 1.8% to 2.5%. At March 31, 1999, 33 million Yen (approximately
US$275) were
F-16
<PAGE> 53
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
outstanding. Interest is due monthly with the principal due on various dates
through August 2005. Borrowings are collateralized by inventories of the
Japanese subsidiary.
At March 31, 1999, the Company's borrowings under lines of credit were as
follows:
<TABLE>
<S> <C>
U.S. bank line, variable interest at prime (7.75% at March
31, 1999)................................................. $10,277
Japan bank lines, interest ranging from 1.8% to 2.5%........ 275
-------
$10,552
=======
</TABLE>
During the year ended March 31, 1999, the Company received a short-term
loan totaling $500 from an affiliate. The loan bore interest at 7.25% and
interest expense related to the loan was immaterial. During the year ended March
31, 1998, the Company made a short-term loan totaling $754 to an affiliate. The
loan bore interest at 7.25% per annum and interest income related to the loan
was immaterial.. No amounts related to the loans were outstanding at March 31,
1999 and March 31, 1998.
9. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
--------- ---------
<S> <C> <C>
Promissory notes payable to former shareholder of Falcon
(Note 1), bearing interest at 10% per annum, monthly
installments of principal and interest of $53 through
August 2002............................................ $1,839 $2,268
Term loan payable to bank, bearing interest at 7.72% per
annum, collateralized by property and equipment and
monies in possession of the bank, paid in full in May
1998................................................... 190
Term loan payable to bank, bearing interest at 8.5% per
annum, collateralized by substantially all of the
assets of the Company, paid in full in May 1998........ 883
------ ------
1,839 3,341
Less current portion..................................... (483) (756)
------ ------
$1,356 $2,585
====== ======
</TABLE>
Long-term debt at March 31, 1999 matures as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING:
- -------------------
<S> <C>
2000......................................... $ 483
2001......................................... 525
2002......................................... 580
2003......................................... 251
------
$1,839
======
</TABLE>
F-17
<PAGE> 54
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Interest expense related to long-term debt was $207, $160 and $13 for the
years ended March 31, 1999, March 31, 1998, and March 29, 1997, respectively.
10. SHAREHOLDERS' EQUITY
Immediately prior to the merger with SDI, there were two classes of
preferred shares: the "Preferred" shares and the "Preferred B" shares. There
were 10,000 shares of each preferred class authorized. All Preferred shares were
nonvoting, did not provide for dividends, and had a liquidation preference over
common shares. The shares were convertible into common shares, at the option of
the holder, at the earlier of three years after issuance or upon the occurrence
of certain other events, at the conversion rate of one common share for each 0.8
Preferred share. The liquidation preference for the Preferred was $.01 per share
and for the Preferred B was $2.00 per share.
In December 1994, the Company entered into a repurchase agreement with
certain shareholders who were holders of the Company's outstanding Preferred
shares. The agreement required the Company to redeem 100 shares of the
outstanding Preferred shares and grants the Company the option to repurchase the
remaining shares at any time during the five-year period ending December 22,
1999 at prices ranging from $2.00 to $2.50 per share. During the year ended
March 29, 1997, the Company repurchased 100 Preferred shares under the agreement
at $2.30 per share.
As consideration for the option to repurchase the Preferred shares, in the
period ended March 29, 1997, the Company issued 276 common shares to the holders
of Preferred shares at the ratio of approximately one share of common stock for
each ten shares of Preferred stock that were valued at $0.50 per common share.
The value ascribed to the common stock outstanding at the date of issuance has
been shown as a reduction in the carrying value of the Preferred stock.
In June and October 1997, the Company issued a total of 95 shares of common
stock to certain employees in exchange for stock participation rights previously
granted. The common stock was issued at prices of $1.20 and $2.00 per share. No
stock participation rights or other options to purchase common stock were
outstanding at March 31, 1998. Management has recorded $73 in compensation
expense for the period ended March 31, 1998 as a result of these issuances.
In July 1997, the Company issued 475 shares of common stock to certain
officers of the Company at a price of $0.035 per share. Management has recorded
$553 in compensation expense for the period ended March 31, 1998 as a result of
these issuances.
As a result of, and immediately following the merger with SDI, each share
of common stock of the former Artecon, Inc. was converted into 2.19 shares of
common stock of the new Artecon, Inc., and each share of convertible Preferred
stock and convertible Preferred B stock of the former Artecon, Inc. was
converted into one share of Series A convertible Preferred stock of the new
Artecon, Inc.
The convertible Preferred A shares have voting rights, provide for
dividends when and if declared by the Board of Directors and have liquidation
preference over common shares. The convertible Preferred A shares are
convertible into common shares, at the option of the holder, any time after
January 1, 1999 at the conversion rate, as defined in the amended Articles of
Incorporation.
F-18
<PAGE> 55
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The convertible Preferred A shares are automatically converted into common
shares upon a unanimous resolution by the Board of Directors or upon the close
of business on the first day following the date on which the average of the
closing per share sales price of the common stock as reported on the NASDAQ
National Market for 20 consecutive trading days equals or exceeds $9.00 per
share, at the conversion rate defined in the amended Articles of Incorporation.
11. EARNINGS PER SHARE
Basic net (loss) income per share is computed using the weighted average
number of common shares outstanding during the periods presented.
Diluted net (loss) income per share is computed using the weighted average
number of common and common stock equivalent shares outstanding during the
periods presented assuming the conversion of all shares of the Company's
Convertible preferred stock into common stock. Common stock equivalent shares
have not been included where inclusion would be antidilutive.
The following is a reconciliation between the components of the basic and
diluted net income per share calculations (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
MARCH 31, 1999 MARCH 31, 1998 MARCH 29, 1997
--------------------------- ---------------------------- --------------------------
PER PER PER
NET WEIGHTED SHARE NET WEIGHTED SHARE NET WEIGHTED SHARE
LOSS SHARES AMOUNT LOSS SHARES AMOUNT INCOME SHARES AMOUNT
------- -------- ------ -------- -------- ------ ------ -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic net (loss) income per
share......................... $(5,350) 21,549 $(0.25) $(19,288) 5,841 $(3.30) $641 5,202 $0.12
Effect of dilutive securities --
preferred stock............... 3,208
------- ------ ------ -------- ----- ------ ---- ----- -----
Diluted net (loss) income per
share plus assumed
conversions................... $(5,350) 21,549 $(0.25) $(19,288) 5,841 $(3.30) $641 8,410 $0.08
======= ====== ====== ======== ===== ====== ==== ===== =====
</TABLE>
12. EMPLOYEE STOCK AND SAVINGS PLANS
SAVINGS PLAN -- The Company has a savings plan, which qualifies under
Section 401(k) of the Internal Revenue Code. Under the plan, participating U.S.
employees may defer up to 15% of their pretax salary, but not more than
statutory limits. The Company matches 50% of eligible employees' contributions
up to a specified limit ($500). The Company's matching contributions to the
savings plan were $67, $38 and $23 for the years ended March 31, 1999, March 31,
1998, and March 29, 1997, respectively.
STOCK PLANS -- In connection with the merger with SDI, the Company adopted,
and the Board of Directors approved, the following employee stock plans:
1996 EMPLOYEE STOCK PURCHASE PLAN
Under the Company's 1996 Employee Stock Purchase Plan (the Purchase Plan),
a total of 200 shares of SDI's common stock was originally reserved for issuance
under the Purchase Plan. The Purchase Plan was amended in January 1998 and a
total of 400 shares of Artecon common stock has been reserved for issuance under
the amended purchase plan. As of March 31, 1999, 298 shares of common stock had
been purchased under the Purchase Plan and 102 shares of common stock remained
available for purchase under the Purchase Plan.
F-19
<PAGE> 56
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1993 STOCK OPTION PLAN
The 1993 Stock Option Plan (the 1993 Plan) provides for the granting of
non-statutory stock options for the purchase of up to an aggregate of 556 shares
of the Company's common stock by officers, employees, consultants and directors
of the Company. The Board of Directors is responsible for administration of the
1993 Stock Option Plan. The Board of Directors determines the term of each
option, option exercise price, number of shares for which each option is granted
and the rate at which each option is exercisable. Options granted under the 1993
Stock Option Plan generally vest over a four-year period.
1996 STOCK OPTION PLAN
The 1996 Stock Option Plan (the 1996 Plan) provides for the granting to
employees and consultants of non-statutory stock options. A total of 3,000
shares of common stock are currently reserved for issuance pursuant to the 1996
Plan. As of March 31, 1999, 3,214 options have been granted under the 1996 Plan.
As of March 31, 1999, options to purchase 1,410 shares of common stock were
outstanding under the 1996 plan and 1,590 shares of common stock remain for
issuance under the 1996 plan.
In April 1998, the Company approved the cancellation of 218 previously
outstanding SDI options with exercise prices ranging from $5.13 to $7.00 per
share, and regranted the stock options at an exercise price of $3.38 per share,
the fair market value on the date of the regrant. The options were considered
granted on April 3, 1998 and are exercisable prospectively in accordance with
the agreements evidencing those grants.
Non-statutory stock options may be granted at an exercise price per share
of not less than 100% of the fair value per common share on the date of the
grant (not less than 110% of the fair value in the case of holders of more than
10% of the Company's voting stock). Options granted under the 1993 and 1996
Stock Option Plans generally expire ten years from the date of the grant.
Transactions under the 1993 and 1996 Stock Option Plans are summarized as
follows (in thousands except per share amounts):
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER OF EXERCISE
OPTIONS PRICE
--------- --------
<S> <C> <C>
OUTSTANDING, March 30, 1996.............................. 458 $0.20
Granted (weighted average fair value of $5.11)......... 718 $5.11
Exercised.............................................. (70) $0.20
Canceled............................................... (116) $0.37
------ -----
OUTSTANDING, March 29, 1997.............................. 990 $3.99
Granted (weighted average fair value of $5.94)......... 492 $5.77
Exercised.............................................. (146) $0.40
Canceled............................................... (277) $5.47
------ -----
OUTSTANDING, March 31, 1998.............................. 1,059 $5.06
Granted (weighted average fair value of $3.17)......... 2,225 $3.17
Exercised.............................................. (154) $0.49
Canceled............................................... (1,624) $4.38
------ -----
OUTSTANDING, March 31, 1999.............................. 1,506 $3.48
====== =====
</TABLE>
F-20
<PAGE> 57
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
and exercisable at March 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------------- OPTIONS EXERCISABLE
AVERAGE --------------------------
NUMBER REMAINING WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT CONTRACTUAL AVERAGE EXERCISABLE AT AVERAGE
RANGE OF MARCH 31, LIFE EXERCISE MARCH 31, EXERCISE
EXERCISE PRICES 1999 (YEARS) PRICE 1999 PRICE
- --------------- -------------- ----------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.20 - $3.00........ 367 8.33 $1.49 91 $0.28
$3.38 - $3.38........ 560 9.01 3.38 0 0
$3.75 - $3.75........ 365 9.00 3.75 0 0
$4.06 - $7.25........ 214 8.01 6.70 214 6.70
----- ---- ----- --- -----
1,506 8.70 3.48 305 4.77
===== ==== ===== === =====
</TABLE>
FAIR VALUE DISCLOSURES
Had compensation cost for options granted in fiscal years 1999, 1998 and
1997 under the Company's option plan been determined based on the fair value at
the grant dates, as prescribed in SFAS No. 123, the Company's net (loss) income
and pro forma net (loss) income per share would have been as follows (in
thousands except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Net (loss) income:
As reported................................ $(5,350) $(19,288) $ 641
Pro forma.................................. $(7,528) $(20,313) $ 579
Basic net (loss) income per share:
As reported................................ $ (0.25) $ (3.30) $0.12
Pro forma.................................. $ (0.35) $ (3.48) $0.11
Diluted net (loss) income per share:
As reported................................ $ (0.25) $ (3.30) $0.08
Pro forma.................................. $ (0.35) $ (3.48) $0.07
</TABLE>
The fair value of each option grant is estimated on the date of grant using
the minimum value method with the following assumptions used for grants during
the applicable periods: dividend yield of 0.0% for all periods, risk-free
interest rates of 4.54% to 5.63% for options granted during the year ended March
31, 1999, risk-free interest rates of 5.49% to 6.57% for options granted during
the year ended March 31, 1998, and risk-free interest rates of 5.97% to 6.48%
for options granted during the year ended March 29, 1997. An 80% volatility
factor was used for the years ended March 31, 1998 and March 27, 1997, and a
137% volatility factor was used for the year ended March 31, 1999. A weighted
average expected option term of five years was used for all periods.
F-21
<PAGE> 58
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Because the determination of the fair value of all options granted after
the Company became a public entity includes an expected volatility factor and
because additional option grants are expected to be made each year, the above
pro forma disclosures are not representative of pro forma effects of reported
net income for future years.
13. INCOME TAXES
Significant components of the (benefit) provision for income taxes are as
follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal.................................... $ 352 $ 17 $245
State...................................... 105 (11) 145
Foreign.................................... 27 20 9
------- ------- ----
484 26 399
Deferred:
Federal.................................... (2,838) (2,150) 53
State...................................... (402) (602) (66)
Foreign.................................... (68) (81) (46)
------- ------- ----
(3,308) (2,833) (59)
------- ------- ----
$(2,824) $(2,807) $340
======= ======= ====
</TABLE>
A reconciliation of the Company's effective tax rate compared to the
statutory federal tax rate is as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Statutory federal rate............... (35)% (35)% 35%
State taxes, net of federal
benefit............................ (2) (2) 5
In-process research and
development........................ 23
Foreign tax (benefit) provision...... (6)
Goodwill............................. 3
Other................................ (1) 1 1
--- --- --
(35)% (13)% 35%
=== === ==
</TABLE>
F-22
<PAGE> 59
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the Company's deferred tax assets and liabilities
are as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1999 1998
--------- ---------
<S> <C> <C>
Deferred tax assets
Uniform capitalization................................. $ 129 $ 100
Tax credit carryforwards............................... 1,566 713
Inventory reserve...................................... 1,556 2,117
Other reserves and accruals............................ 1,504 1,258
Book over tax depreciation............................. 160 501
In-process research and development.................... 1,418 1,523
Acquisition costs...................................... 64 1,002
Net operating losses................................... 5,972 2,125
Restructuring reserve.................................. 231
------- -------
Total deferred tax assets........................... 12,600 9,339
Deferred tax liabilities:
Import reserve......................................... $ 277 $ 346
Amortization........................................... 152 160
State taxes............................................ 784 537
Acquired intangibles................................... 254 1,189
------- -------
Total deferred tax liabilities...................... 1,467 2,232
Valuation allowance.................................... (1,995)
------- -------
Net deferred tax assets................................ $11,133 $ 5,112
======= =======
</TABLE>
A valuation allowance of $1,995 was established at the date of the
Company's merger with SDI in order to reflect limitations on the company's usage
of SDI's net operating loss carryforwards associated with, among other factors,
SDI continuing to be a separate subsidiary of Artecon. The valuation allowance
has been reduced to zero in the fourth quarter of fiscal year 1999 as a result
of the Company dissolving the subsidiary structure of SDI and making the
determination that it is now more likely than not that these losses will be
utilized. The reduction in the valuation allowance of $1,995 has reduced
goodwill related to the SDI acquisition.
As of March 31, 1999, the Company has federal and state net operating
losses of $15,612 and $7,512, which begin to expire in the tax years ending 2009
and 2010, respectively. In addition, the Company has federal and state tax
credit carryforwards of $875 and $691, respectively.
F-23
<PAGE> 60
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. COMMITMENTS
The Company leases office and equipment under non-cancelable operating
leases. Lease terms range from three to five years. The Company's United States
headquarters is leased under an operating lease that has been extended to
December 1999.
Future minimum lease commitments for all operating leases are as follows:
<TABLE>
<CAPTION>
FISCAL YEAR ENDING:
<S> <C> <C>
2000....................................................................... $1,610
2001....................................................................... 1,002
2002....................................................................... 366
2003....................................................................... 91
2004....................................................................... 55
------
$3,124
======
</TABLE>
Total rent expense for the years ended March 31, 1999, March 31, 1998, and
March 29, 1997 was approximately $1,951, $1,027, and $698, respectively.
15. HEDGING ACTIVITIES
The company engaged in limited hedging activity in the prior year and the
Company does not presently engage, nor does it intend to engage in future
hedging activities.
In the prior year, the Company's Japanese subsidiary entered into
derivative financial instruments, primarily foreign currency forward exchange
contracts, to manage foreign exchange risk on foreign currency transactions and
did not use the contracts for trading purposes. These financial instruments were
used to protect the Company from the risk that the eventual net cash inflows
from the foreign currency transactions would be adversely affected by changes in
exchange rates. Gains and losses related to hedges of firmly committed
transactions were deferred and recognized when the hedged transaction occurred.
The following table summarizes the notional amount, which approximates fair
market value, of the Company's outstanding foreign exchange contracts at March
31, 1998 (none outstanding at March 31, 1999):
<TABLE>
<CAPTION>
U.S.
DOLLAR
EQUIVALENT MATURITY
---------- ----------
<S> <C> <C>
U.S. Dollars.................................... $100 April 1998
U.S. Dollars.................................... 100 May 1998
U.S. Dollars.................................... 100 June 1998
----
$300
====
</TABLE>
F-24
<PAGE> 61
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The counterparties to these instruments were major financial institutions.
The Company was exposed to credit losses in the event of nonperformance by
counterparties to its forward exchange contracts but had no off-balance sheet
credit risk of accounting loss. The Company anticipated, however, that the
counterparties would be able to fully satisfy their obligations under the
contracts. The Company did not obtain collateral or other security to support
the forward exchange contracts subject to credit risk but monitored the credit
standing of the counterparties.
16. GEOGRAPHICAL AND SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
Company's chief operating decision maker, or decision making group, in deciding
how to allocate resources and in assessing performance. The Company's chief
operating decision-maker is its Chief Executive Officer. The operating segments
of the Company are managed separately because each segment represents a
strategic business unit that offers different products or services.
The Company's reportable operating segments include the Enterprise Storage
Division (ESD), the Telecommunications (Telco) Division and the International
Division. The ESD Division provides enterprise storage solutions to the
following markets: finance, multimedia, government, advanced-technology and
industrial. The Telco Division designs, manufactures, markets, and supports
fully integrated, industry-compliant storage products, services and solutions
for the telecommunications and Internet/intranet markets by utilizing
commercially available workstation, server and other application-specific
products for enhanced price/performance characteristics and reduced time to
market. The International Division provides storage solutions in various
international markets.
The accounting policies of the Company's operating segments are the same as
those described in Note 2, Summary of Significant Accounting Policies. The
Company evaluates performance based on stand-alone segment gross margin. Because
the Company does not evaluate performance based on segment operating income or
return on assets at the operating segment level, Company operating expenses and
total assets are not tracked internally by segment. Therefore, such information
is not presented.
F-25
<PAGE> 62
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Operating segment data for the years ended March 31, 1999, March 31, 1998,
and March 29, 1997 are as follows:
<TABLE>
<CAPTION>
ESD TELCO INTERNATIONAL CONSOLIDATED
------- ------- ------------- ------------
<S> <C> <C> <C> <C>
Year ended March 31, 1999
Net Revenues.................. $62,967 $23,306 $9,606 $95,879
Gross Margin.................. 21,786 8,063 3,669 33,518
Year ended March 31, 1998
Net Revenues.................. $33,746 $23,531 $9,063 $66,340
Gross Margin.................. 7,983 4,601 2,811 15,395
Year ended March 29, 1997
Net Revenues.................. $44,982 $ 1,392 $8,943 $55,317
Gross Margin.................. 10,080 248 2,598 12,926
</TABLE>
Information concerning principal geographic areas in which the Company
operates was as follows:
<TABLE>
<CAPTION>
AS OF AND FOR THE YEAR ENDED
-----------------------------------
MARCH 31, MARCH 31, MARCH 29,
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
REVENUE:
North America.............................. $87,638 $ 58,557 $48,169
Europe..................................... 5,781 4,271 3,176
Japan...................................... 2,460 3,512 3,972
------- -------- -------
$95,879 $ 66,340 $55,317
======= ======== =======
INCOME (LOSS) BEFORE TAXES:
North America.............................. $(8,189) $(21,873) $ 996
Europe..................................... 140 (74) 59
Japan...................................... (125) (148) (74)
------- -------- -------
$(8,174) $(22,095) $ 981
======= ======== =======
ASSETS:
North America.............................. $42,292 $ 56,187 $14,057
Europe..................................... 416 232 579
Japan...................................... 902 1,539 1,967
Eliminations............................... (449) (613) (1,409)
------- -------- -------
$43,161 $ 57,345 $15,194
======= ======== =======
</TABLE>
F-26
<PAGE> 63
ARTECON, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH FISCAL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Year ended March 31, 1999
Revenues................ $26,945 $30,968 $19,639 $ 18,327 $ 95,879
Income (loss) before
income taxes......... 125 527 (7,079)(a) (1,747)(a) (8,174)
Net income (loss)....... 69 282 (6,795) 1,094(C) (5,350)
Basic earnings (loss)
per share............ 0.00 0.01 (0.32) (0.05) (0.25)
Diluted earnings (loss)
per share............ 0.00 0.01 (0.32) (0.04) (0.25)
Year ended March 31, 1998
Revenues................ $12,158 $18,042 $22,401 $ 13,739 $ 66,340
Income (loss) before
income taxes......... 275 (2,607)(b) 145 (19,908)(b) (22,095)
Net income (loss)....... 104 (1,565) (153) (17,674)(c) (19,288)
Basic earnings (loss)
per share............ 0.02 (0.26) (0.03) (2.84) (3.30)
Diluted earnings (loss)
per share............ 0.01 (0.26) (0.03) (2.84) (3.30)
</TABLE>
- -------------------------
(a) Includes pre-tax charges of $2,387 in the third quarter of 1999 and $287 in
the fourth quarter of 1999 for restructuring and impairment of certain
intangible assets.
(b) Includes pre-tax in-process research and development costs relating to the
acquisition of Falcon of $3,700 in the second quarter of fiscal year 1998
and $14,500 in the fourth quarter of fiscal year 1998 relating to the
acquisition of SDI.
(c) Includes the recognition of an income tax benefit of $2,841 and $2,234
during the fourth quarter of fiscal year 1999 and 1998, respectively.
18. SUBSEQUENT EVENT
On April 29, 1999, the Company and Box Hill Systems Corporation (Box Hill)
signed an agreement and plan of merger (the Merger Agreement), whereby the two
companies would be merged in a tax-free, stock-for-stock transaction intended to
be accounted for as a pooling of interests. Under the terms of the Merger
Agreement, each share of the Company's common stock will be converted into 0.40
of a share of Box Hill's common stock. Additionally, the Company's convertible
Preferred A shares will be converted into Box Hill common stock based on the
terms defined in the Merger Agreement.
F-27
<PAGE> 64
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Stockholders and the Board of Directors
Artecon, Inc.
Carlsbad, California
We have audited the financial statements of Artecon, Inc. and its subsidiaries
(the Company) as of March 31, 1999 and 1998 and for each of the three years in
the period ended March 31, 1999, and have issued our report thereon dated May 6,
1999; such report is included elsewhere in this Form 10-K. Our audits also
included the financial statement schedule of the Company listed in Item 14. The
consolidated financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such financial statement schedule, when considered in relation to
the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
May 6, 1999
Costa Mesa, California
S-1
<PAGE> 65
SCHEDULE II
ARTECON, INC.
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO
BEGINNING OF COSTS AND OTHER BALANCE AT
PERIOD EXPENSES ACCOUNTS(1) DEDUCTIONS END OF PERIOD
------------ ---------- ----------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts
and sales returns
Year ended March 31, 1999.............. $ 893 $ 1,299 $ -- $ 1,175(2) $ 1,017
Year ended March 31, 1998.............. 170 259 1,215 751(2) 893
Year ended March 29, 1997.............. 180 32 -- 42(2) 170
Inventory reserves
Year ended March 31, 1999.............. $ 4,941 $ 3,574 $ -- $ 4,883(3) $ 3,632
Year ended March 31, 1998.............. 525 3,800 1,338 722(3) 4,941
Year ended March 29, 1997.............. 400 797 -- 672(3) 525
</TABLE>
- ----------
(1) Reserves of companies acquired
(2) Uncollectible receivables charged off and credit issued for product returns
(3) Consists primarily of the write-off of excess/obsolete inventories
S-2
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
1. SDI Foreign Operations, Inc., a Delaware corporation
2. SDI GmbH, a company organized under the laws of Germany
3. Artecon Japan Ltd., a Japanese corporation
4. Artecon Foreign Sales Corporation, a Barbados corporation
5. Artecon Europe B.V., a Netherlands corporation
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement No.
333-56281 and the Post Effective Amendment No. 1 to Registration Statement No.
333-29129 on Form S-8 of our report dated May 6, 1999, appearing in this Annual
Report on Form 10-K of Artecon, Inc. for the year ended March 31, 1999.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
June 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This Schedule contains summary financial information extracted from the
Financial statements contained in the body of the Form 10-K and is qualified in
its entirety by reference to such Financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 2,093
<SECURITIES> 0
<RECEIVABLES> 13,241
<ALLOWANCES> (1,010)
<INVENTORY> 11,673
<CURRENT-ASSETS> 31,206
<PP&E> 5,062
<DEPRECIATION> (3,426)
<TOTAL-ASSETS> 43,161
<CURRENT-LIABILITIES> 16,254
<BONDS> 0
0
12
<COMMON> 109
<OTHER-SE> 14,693
<TOTAL-LIABILITY-AND-EQUITY> 43,161
<SALES> 95,879
<TOTAL-REVENUES> 95,879
<CGS> 62,361
<TOTAL-COSTS> 62,361
<OTHER-EXPENSES> 41,055
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,018
<INCOME-PRETAX> (8,174)
<INCOME-TAX> (2,824)
<INCOME-CONTINUING> (5,350)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,350)
<EPS-BASIC> (0.25)
<EPS-DILUTED> (0.25)
</TABLE>
