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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report (Date of earliest event reported) September 21, 2000
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Computer Network Technology Corporation
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(Exact name of registrant as specified in charter)
Minnesota 0-139944 41-1356476
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(State or other (Commission (IRS Employer
jurisdiction of File Number) Identification No.)
incorporation)
6000 Nathan Lane North, Plymouth, Minnesota 55442
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (763) 268-6000
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(Former name or former address, if changed since last report.)
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Item 5. Other Events.
The registrant's board of directors has determined to sell or spin-off its
Enterprise Integration Solutions Division in order to focus all of its resources
on its storage area networking, or SAN, and other storage area networking
products. The board has set January 31, 2001 as a target date for completing any
sale or decision to proceed with a spin-off. As a result of this decision, the
Enterprise Integration Solutions Division has been shown as discontinued
operations in the registrants consolidated statement of operations, meaning the
division's revenues, costs and expenses are not shown and its net income (loss)
for all periods is included under the "Discontinued Operations" caption.
Accordingly:
- Part I of this Form 8-K includes management's discussion and analysis
which reflects the discontinued operations status for the Enterprise
Integration Solutions Division.
- Part II of this Form 8-K includes an updated description of the
registrant's business.
- Part III of this 8-K includes the registrant's (i) audited consolidated
balance sheets as of December 31, 1998 and 1999, and related audited
consolidated statement of operations, shareholders' equity and
comprehensive income, and cash flows for each of the years in the three
year period ended December 31, 1999 and (ii) and unaudited balance sheet
as of July 31, 2000 and related unaudited consolidated statement of
operations and cash flow for the six month periods ended June 30, 1999
and July 31, 2000, and unaudited statement of shareholders' equity and
comprehensive income for the six months ended July 31, 2000.
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FORWARD LOOKING INFORMATION
Information contained herein and in the Exhibits hereto may contain forward
looking statements that involve risks and uncertainties with respect to the fair
value of assets acquired, the amount of liabilities assumed and otherwise. These
forward looking statements include the words "believes," "expects,"
"anticipates" and similar expressions. These forward looking statements involve
certain risks and uncertainties, including those related to general economic and
business conditions, changes in market conditions and competitive pressures.
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Part I - Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
We are a leading provider of hardware and software products and related
professional services in the rapidly growing storage networking market. We focus
primarily on helping our clients design, develop, deploy and manage SANs. Our
storage networking products represent our core business and account for a
substantial majority of our revenue and profit. Our SAN products consist
primarily of our UltraNet(R) and Channelink(R) families of products. We also
market our established channel networking products, which enable computers to
transmit data over unlimited distances.
On January 12, 2000, we changed our fiscal year end to January 31, from
December 31. References in this Form 8-K to the first half of 2000 represent the
six months ended July 31, 2000. References in this Form 8-K to the first half of
1999 represent the six months ended June 30, 1999. We have not submitted
financial information for the six months ended July 31, 1999 in this Form 8-K
because the information is not practical or cost beneficial to prepare. We
believe that the six months ended June 30, 1999 provide a meaningful comparison
to the first half of fiscal 2000. There are no factors, of which we are aware,
seasonal or otherwise, that would impact the comparability of information or
trends, if results for the six months ended July 31, 1999 were presented in lieu
of results for the six months ended June 30, 1999.
DISCONTINUED OPERATIONS -- DIVESTITURE OF ENTERPRISE INTEGRATION SOLUTIONS
DIVISION
Our discontinued operations, which we have historically referred to as our
Enterprise Integration Solutions Division, develops and sells our EAI software
that automates the integration of computer applications and business workflow
processes, as well as our traditional server gateways and tools which enable
multiple desktop computers and mainframe terminals to communicate with one
another. Our board of directors has determined to sell or spin off our
Enterprise Integration Solutions Division in order to focus all of our resources
on our SAN and other storage networking products. The board has set January 31,
2001 as a target date for completing any sale or a decision to proceed with a
spin-off. As a result of this decision, the Enterprise Integration Solutions
Division is shown as a discontinued operation in our consolidated statements of
operations, meaning that the division's revenues, costs and expenses are not
shown and its net income (loss) for all periods are included under the
"Discontinued Operations" caption. For additional information regarding the
results of operations of the Enterprise Integration Solutions Division, see note
4, "Discontinued Operations" to the consolidated financial statements. Certain
general and administrative, facility and information technology infrastructure
costs that had previously been allocated to and reported in the operating
results of the Enterprise Integration Solutions Division have been reallocated
and reported in the results for continuing operations.
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RESULTS OF CONTINUING OPERATIONS
The following table sets forth financial data for our continuing operations
for the periods indicated as a percentage of total revenue except for gross
profit, which is expressed as a percentage of the related revenue.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED
-------------------------- ------------------------------
1997 1998 1999 JUNE 30, 1999 JULY 31, 2000
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<S> <C> <C> <C> <C> <C>
Revenue:
Product sales........................... 70.0% 72.8% 70.8% 71.3% 71.2%
Service fees............................ 30.0 27.2 29.2 28.7 28.8
----- ----- ----- ----- -----
Total revenue................... 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- -----
Gross profit:
Product sales........................... 63.8 63.4 57.0 60.9 58.7
Service fees............................ 34.9 35.2 46.1 44.2 40.9
----- ----- ----- ----- -----
Total gross profit.............. 55.1 55.7 53.8 56.1 53.6
----- ----- ----- ----- -----
Operating expenses:
Sales and marketing..................... 34.3 31.3 27.5 28.9 24.2
Engineering and development............. 15.4 13.8 14.6 14.8 13.8
General and administrative.............. 6.2 6.1 5.5 5.8 5.2
Abandoned facility...................... -- -- 1.1 -- --
----- ----- ----- ----- -----
Total operating expenses........ 55.9 51.2 48.7 49.5 43.2
----- ----- ----- ----- -----
Income (loss) from operations............. (0.8) 4.5 5.1 6.6 10.4
Other income (expense), net............... 1.7 .4 .1 (.2) .3
----- ----- ----- ----- -----
Income from continuing operations before
income taxes............................ 0.9 4.9 5.2 6.4 10.7
----- ----- ----- ----- -----
Provision for income taxes................ 0.3 1.7 1.8 2.2 3.5
Income from continuing operations......... 0.6 3.2 3.4 4.2 7.2
----- ----- ----- ----- -----
Income (loss) from discontinued
operations, net of tax.................. (3.4) 1.4 .3 3.2 (2.4)
----- ----- ----- ----- -----
Net income (loss)......................... (2.8)% 4.6% 3.7% 7.4% 4.8%
===== ===== ===== ===== =====
</TABLE>
REVENUE
Six Months Ended July 31, 2000 and June 30, 1999
Revenue from products for the first half of 2000 totaled $59.0 million, an
increase of 39%, when compared to the first half of 1999. SAN applications for
both open systems and mainframes continued to drive our new product revenue. SAN
related product revenue for the first half of 2000 totaled $37.5 million, an
increase of 47%, when compared to the first half of 1999. Sales of channel
extension product applications for the first half of 2000 totaled $21.6 million,
an increase of 26%, when compared to the first half of 1999.
During the fourth quarter of 1999, we introduced the first product for
remote disk mirroring over IP-based networks. During the first half of 2000 we
recorded $2.4 million of IP-related product revenue. Our partner relationships
with STK and Compaq have also generated significant product revenue. During the
first half of 2000, sales of the DXE product to STK contributed $5.3 million of
product revenue, while our OEM relationship with Compaq contributed $2.1 million
of product revenue.
Service revenue for the first half of 2000 totaled $23.9 million, an
increase of 39% when compared to the first half of 1999. Professional service
revenue for the first half of 2000 totaled $4.1 million, an increase
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of 88%, when compared to the first half of 1999 as a result of increased demand
for our new professional service offerings. Traditional maintenance services
accounted for the remaining increase in revenue due to the growing installed
base of customers using our networking products.
Years Ended December 31, 1999 and 1998
Revenue from products increased 19% in 1999 to $89.2 million compared to
1998. SAN applications for both open systems and mainframes continued to drive
new product revenue during 1999. SAN product sales increased 68% in 1999 to
$53.6 million compared to 1998. Channel extension product applications declined
17% in 1999 to $35.6 million compared to 1998. We anticipate that sales of
channel extension products will continue to decline in the future, due to
product maturation.
Service revenue increased 31% in 1999 to $36.7 million, due to the growing
installed base of customers using our products. In addition, the sale of
professional services increased 203% in 1999 to $4.6 million.
Years Ended December 31, 1998 and 1997
Revenue from products increased 34% in 1998 to $75.0 million compared to
1997. SAN revenue for both open systems and mainframes continued to drive new
product revenue in 1998. SAN product applications increased 381% in 1998 to
$31.9 million from $6.6 million in 1997. Channel extension product applications
declined 13% in 1998 to $43.1 million from $49.5 million in 1997.
Service revenue increased by 17% in 1998 to $28.1 million compared to 1997,
due to the growing installed base of customers using our products. In addition,
the sale of professional services generated $1.5 million of new incremental
revenue in 1998.
General
Revenue generated from the sale of products and services outside the United
States for the six months ended July 31, 2000 totaled $21.7 million, a decrease
of 1% when compared to the same period of 1999.
Revenue from the sale of products and services outside the United States
increased in 1999 and 1998 by $10.1 million, or 30%, and $9.9 million, or 42%,
respectively, when compared to the prior year. We derived 35%, 32% and 29% of
our revenue outside the United States in 1999, 1998 and 1997, respectively. The
increase in revenue generated outside the United States is primarily
attributable to growing customer demand for SAN-related product applications.
No single customer accounted for more than 10% of our revenue during the
first six months of fiscal 2000 or during 1999, 1998 or 1997. Revenue increases
in 1999 and 1998 were attributable to increases in sales of SAN products and
additional services. Price increases for our products and services did not have
a significant impact on revenue in the first half of 2000, 1999 or 1998.
During the six months ended July 31, 2000, approximately 26%, 4% and 8% of
our product revenue was derived from businesses in the financial services,
telecommunications and information outsourcing industries, respectively. During
the year ended December 31, 1999, approximately 27%, 11% and 7% of our product
revenue was derived from businesses in the financial services,
telecommunications, and information outsourcing industries, respectively.
We derive an increasingly significant portion of our revenue from sales of
our storage networking products. As a result of product maturation, revenue
derived from traditional channel networking declined in 1999. We expect that
revenue from traditional channel networking products will continue to decline in
the future as we continue to focus more of our resources on our SAN products.
We primarily sell our storage networking products directly to end-user
customers in connection with joint marketing activities with our business
partners and OEMs. OEMs combine our products with their own products and sell
the combined products to their customers. For a new customer, the initial sales
and
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design cycle, from first contact through shipment, can vary from 90 days to 12
months or more. We expect that this cycle will continue.
We expect continued quarter-to-quarter fluctuations in revenue in both
domestic and international markets. The timing of sizable orders, because of
their relative impact on total quarterly sales, may contribute to such
fluctuations. The level of product sales reported by us in any given period will
continue to be affected by the receipt and fulfillment of sizable new orders in
both domestic and international markets.
GROSS PROFIT MARGIN
Six Months Ended July 31, 2000 and June 30, 1999
Gross profit margin from the sale of products for the first half of 2000
was 59%, compared to 61% for the first half of 1999. The decrease in the gross
margin was due to our sale of the DXE product to STK, and the UltraNet(R)
Gateway product to Compaq, both of which carry lower gross margin, but
comparable operating margin, than our Channelink(R) and UltraNet(R) products
sold through direct channels.
Gross profit margin from services for the first half of 2000 was 41%,
compared to 44%, for the first half of 1999. The decrease in gross margin was
due to new professional services employees who have been added over the past
nine months, in anticipation of future growth in professional services.
Years Ended December 31, 1999 and 1998
Gross profit margin from the sale of products was 57% in 1999, compared to
63% in 1998. The decrease in gross profit margin in 1999 compared to 1998 is
attributable to the write-off of non-SAN-related products totaling $1.4 million.
Excluding this charge, gross profit margin from the sale of products would have
been 59% in 1999. The remaining decrease in gross profit margin in 1999 is due
to an increase in UltraNet(R) product sales, which have a slightly lower gross
margin than our traditional Channelink(R) products.
Gross profit margin from service revenues in 1999 and 1998 was 46% and 35%,
respectively. The improvement in gross profit margin in 1999 compared to 1998 is
attributable to economies of scale resulting from the steadily increasing base
of our customers contracting for services and new incremental revenue from
professional services, which offers a higher gross margin than our traditional
service business.
Years Ended December 31, 1998 and 1997
Gross profit margin from the sale of products was 63% in 1998, compared to
64% in 1997. This decrease in gross profit margin was due to an increase in
UltraNet(R) product sales, which have a slightly lower gross margin than our
traditional Channelink(R) products.
Gross profit margin from service revenue was 35% in both 1998 and 1997.
OPERATING EXPENSES
Six Months Ended July 31, 2000 and June 30, 1999
Sales and marketing expense for the first half of 2000 increased by $2.8
million, or 16%, when compared to the first half of 1999. The increase in
expense resulted from higher commissions and additional headcount required to
generate the increase in revenue.
Engineering and development expense for the first half of 2000 increased by
$2.6 million, or 30%, when compared to the first half of 1999. The increase was
primarily due to continued development of our UltraNet(R) family of products
that provide customers with additional applications to satisfy their growing SAN
capabilities. During the first half of 2000, we announced SAN over standard IP
solutions, including SCSI and Fibre Channel over IP to strengthen our presence
in the IP solutions market.
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General and administrative expense for the first half of 2000 increased by
$842,000, or 24%, when compared to the first half of 1999. The increases were
due to higher costs for wages, insurance and professional fees.
Years Ended December 31, 1999 and 1998
Sales and marketing expense increased in 1999 by $2.4 million, or 7%,
compared to 1998. The increase in expense resulted from higher commissions and
additional headcount required to generate the increase in product revenue in
1999 of 19%.
Engineering and development expense increased in 1999 by $4.2 million, or
30%, compared to 1998. This increase was due to the continued development of our
UltraNet(R) family of products that provide customers with additional
applications to satisfy their growing need for SAN capabilities. Revenue related
to shipments of UltraNet(R) products increased 111% to $37.5 million in 1999
from $17.7 million in 1998.
General and administrative expense increased in 1999 by $670,000, or 11%,
compared to 1998 due to increases in insurance costs and professional fees.
Years Ended December 31, 1998 and 1997
Sales and marketing expense increased in 1998 by $4.8 million, or 17%,
compared to 1997. The increase in expense resulted from increases in headcount
and sales commissions necessary to generate increased product revenue in 1998 of
34%.
Engineering and development expense increased in 1998 by $1.9 million, or
15%, compared to 1997 due to the continued development of our UltraNet(R) family
of products. Revenues related to shipments of UltraNet(R) products increased
222% to $17.7 million in 1998 compared to $5.5 million in 1997.
General and administrative expense increased in 1998 by $1.3 million, or
26%, compared to 1997 due to increases in wages and professional fees.
SPECIAL CHARGES
Years Ended December 31, 1999, 1998 and 1997
During the fourth quarter of 1999, we recorded a $1.3 million charge for
the future costs associated with a facility that was abandoned prior to the
expiration of the lease term and a $1.4 million charge for the write-off of
non-SAN related products.
OTHER
Six Months Ended July 31, 2000 and June 30, 1999
Other income for the first half of 2000 increased by $329,000 when compared
to the first half of 1999, due to an increase in interest income resulting from
higher balances of cash and marketable securities available for investment.
We recorded a provision for income taxes for the first half of 2000 at an
effective income tax rate of 33%, compared to 34%, for the first half of 1999.
Fluctuations in our effective income tax rate are primarily due to the amount of
nondeductible foreign losses and fluctuations in the level of benefit from our
foreign sales corporation. Based on an assessment of our taxable earnings
history and prospective future taxable income, we have determined it to be more
likely than not that our net deferred tax asset will be realized in future
periods. We may be required to provide a valuation allowance for this asset in
the future if we do not generate sufficient taxable income as planned.
Years Ended December 31, 1999, 1998 and 1997
Interest income increased in 1999 by $351,000 and decreased in 1998 by $1.2
million due to fluctuations in the balances of cash and marketable securities
available for investment.
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Interest expense increased to $264,000 in 1999 from $79,000 and $57,000, in
1998 and 1997, respectively, due to an increase in capital lease obligations.
We recorded a provision for income taxes in 1999 and 1998 at an effective
rate of 34%, and in 1997 at an effective rate of 41%.
DISCONTINUED OPERATIONS
Six months Ended July 31, 2000 and June 30, 1999
Discontinued operations consisting of our Enterprise Integration Solutions
Division generated a loss after income taxes of $2.0 million in the first half
of 2000, compared to income after income taxes of $1.9 million in the first half
of 1999. The decrease in profitability is primarily attributed to a 69% decline
in revenue from sales of server gateways and tools products in the first half of
2000 to $2.1 million from $6.9 million in the first half of 1999. In addition,
maintenance revenue from our traditional server gateways and tools products
declined in the first half of 2000 to $1.8 million, from $2.7 million in the
first half of 1999, due to a drop off in the installed base of customers using
our traditional server gateways and tools products.
Years Ended December 31, 1999 and 1998
Discontinued operations generated income after income taxes of $329,000 in
1999 compared to income after income taxes of $1.4 million in 1998. The decrease
in profitability can be attributed to a 40% decline in revenue from sales of our
server gateways and tools products in 1999 to $9.7 million from $16.1 million in
1998. In addition, traditional maintenance revenue declined to $6.3 million in
1999 from $7.6 million in 1998.
Years Ended December 31, 1998 and 1997
Discontinued operations generated income after income taxes of $1.4 million
in 1998 compared to a loss after income taxes of $2.8 million in 1997. The
increase in profitability was due a 73% increase in revenue to $30.5 million in
1998 from $17.6 million in 1997, due to the acquisition of the Internet
Solutions Division of Apertus in October 1997.
Acquisitions
On December 3, 1998, we acquired, for $2.0 million, all of the outstanding
stock of IntelliFrame, a start-up software and services company that develops
technology for integrating legacy systems with client/server systems and the
Internet. Two employees who were former shareholders of IntelliFrame are
eligible for aggregate bonus payments of up to $10.0 million through December
31, 2001 if future revenue from specified products of the Enterprise Integration
Solutions Division exceed defined targets or if certain products are sold in a
transaction that does not constitute a change of control. The potential bonus
payments increase to a maximum of $12.0 million if we engage in certain
divestitures of specified products of the division in calendar year 2000. The
employees may also be entitled to bonus payments of up to an aggregate of $8.0
million (offset by bonuses previously paid) upon certain failures to market
specified products of the division prior to December 31, 2001. To date, no bonus
payments have been made under these agreements. We do not know if any bonus
payments will become due under these agreements as a result of the divestiture
of the Enterprise Integration Solutions Division, as a transaction has not yet
been structured.
On October 24, 1997, we acquired substantially all of the assets, including
in-process research and development, of the Internet Solutions Divisions of
Apertus, a provider of EAI and server gateways and tools. The purchase price of
$16.4 million included a cash payment of $11.4 million at closing and assumption
by us of $5.0 million of liabilities and related acquisition costs. The assets
we acquired from IntelliFrame and Apertus are part of the Enterprise Integration
Solutions Division.
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Options
We have issued options for the purchase of approximately 2.8 million shares
of common stock in RealLegacy.com, Inc., our wholly owned subsidiary including
our EAI business, to our directors and the employees and officers of
RealLegacy.com, Inc. The options have an exercise price of $2.00 per share,
equal to their estimated fair market value on the date of grant, and have
individually defined terms and vesting periods.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations through the public and private
sale of equity securities, bank borrowings under lines of credit, capital and
operating equipment leases and cash generated by operations.
Cash, cash equivalents and marketable securities at July 31, 2000 totaled
$29.6 million, an increase of $13.0 million since January 31, 2000. Operations
and proceeds from the exercise of stock options provided cash for the first half
of 2000 of $20.6 million and $2.2 million, respectively. Uses of cash for the
first half of 2000 included the purchase of property and equipment and field
support spares totaling $8.3 million.
Cash, cash equivalents and marketable securities at December 31, 1999,
totaled $26.9 million, an increase of $14.5 million over 1998. Operations and
proceeds from the exercise of stock options and shares issued under the employee
stock purchase plan contributed cash in 1999 of $18.8 million and $8.6 million,
respectively. Uses of cash in 1999 included the purchase of property and
equipment and field support spares totaling $11.0 million.
Expenditures for capital equipment and field support spares have been, and
will likely continue to be, a significant capital requirement. We believe that
our current balances of cash, cash equivalents and marketable securities, when
combined with anticipated cash flows from operations, will be adequate to fund
our operating plans and meet our current anticipated aggregate capital
requirements, at least through fiscal 2000.
We believe that inflation has not had a material impact on our operations
or liquidity to date.
MARKET RISK
We have no derivative financial instruments in our cash and cash
equivalents. We mainly invest our cash and cash equivalents in investment grade,
highly liquid investments, consisting of money market instruments, bank
certificates of deposits and investments in commercial paper.
At July 31, 2000, our marketable securities include a $582,000 investment
in a Standard and Poors 500 stock price index fund and a $104,000 investment in
a NASDAQ 100 index tracking stock. These investments were purchased to directly
offset any investment gains or losses owed to participants under our executive
deferred compensation plan which has been established for selected key
employees.
We are exposed to market risks related to fluctuations in foreign exchange
rates because some sales transactions, and the assets and liabilities of our
foreign subsidiaries, are denominated in foreign currencies, primarily French
francs, the euro and British pounds sterling. As of July 31, 2000, we have
hedged a portion of our risk by purchasing forward exchange contracts for 1.2
million British pounds sterling that settle at various times through January 31,
2001.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standard No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS No. 133), effective for us
on February 1, 2001, establishes new standards for recognizing all derivatives
as either assets or liabilities and measuring those instruments at fair value.
Currently, we do not anticipate that SFAS No. 133 will have a material impact on
our financial position or results of operations.
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In December 1999, the SEC staff issued SAB 101, "Revenue Recognition in
Financial Statements." SAB 101 summarizes certain of the SEC staff's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. We are currently analyzing whether SAB 101 will have any
impact on our financial statements. SAB 101 will become effective for us during
the quarter ending January 31, 2001.
CHANGE IN FISCAL YEAR
On January 12, 2000, we changed our fiscal year end to January 31, rather
than December 31. Our January 2000 results were reported in our Report on Form
10-Q for the three month period ended April 30, 2000. Our summary January 2000
results are as follows: revenues $4.3 million; gross profit $1.3 million;
operating expenses $5.3 million; net loss from continuing operations $2.6
million; net loss from discontinued operations $1.0 million; and net loss $3.6
million. We typically incur significant losses in the first month following the
completion of a quarter because our revenue is significantly less than the
average monthly revenues we generate in any quarterly or annual period.
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Part II -- Description of Business
BUSINESS
OVERVIEW
We are a leading provider of hardware and software products and related
professional services in the rapidly growing storage networking market. We focus
primarily on helping our customers design, develop, deploy and manage SANs. We
design, manufacture, market and support a wide range of products for critical
SAN applications such as remote disk mirroring and remote tape vaulting. Revenue
from our SAN products were $6.6 million, $31.9 million and $53.6 million for the
years ended December 31, 1997, 1998 and 1999, respectively and $37.5 million for
the six months ended July 31, 2000.
Our storage networking products enable businesses to cost-effectively
manage their increasing storage requirements, connect geographically dispersed
SANs, provide continuous availability to greater amounts of data, and protect
their increasing amounts of data more efficiently. Our SAN products consist
primarily of our UltraNet(R) and Channelink(R) families of products. We market
our SAN products directly to customers through our sales force, worldwide
distributors and OEMs. Our distributors and OEM relationships include Compaq,
Hewlett Packard, and StorageTek. We also have strategic marketing partnerships
with leading storage industry and fibre switching companies, including Brocade,
EMC, Hitachi Data Systems, IBM, Legato and SCH Technologies.
Historically, we have operated through two vertically integrated divisions.
We have and continue to market our storage networking products through our
continuing operations, which we have historically referred to as our Networking
Solutions Division, which represent our core business. Our continuing operations
also market our established channel networking products, which enable computers
to transmit data over unlimited distances. Our discontinued operations, which we
have historically referred to as our Enterprise Integration Solutions Division,
develops and sells our enterprise application integration, or EAI, software that
automates the integration of computer software applications and business
workflow processes, as well as our traditional server gateways and tools, which
enable multiple desktop computers and mainframe terminals to communicate with
one another.
SELECTED RECENT DEVELOPMENTS
Divestiture of Enterprise Integration Solutions Division. Our board of
directors has determined to sell or spin-off our Enterprise Integration
Solutions Division in order to focus all of our resources on our SAN and other
storage networking products. The board has set January 31, 2001 as a target date
for completing any sale or a decision to proceed with a spin-off. Accordingly,
the financial information for this division has been accounted for as
discontinued operations.
SAN applications over IP-based networks. In February 2000, we introduced
the first products to allow storage networking applications, such as remote disk
mirroring using EMC's SRDF software, and remote tape vaulting to be deployed
over standard IP-based networks. We anticipate expanding our product offerings
to support additional SAN applications from other vendors. The recent expansion
of support of IP includes what we believe is the only working capability to
extend Fibre Channel technology and the SCSI interface over IP-based networks.
Strategic Alliance with Iron Mountain to Provide Storage Services. We
recently entered into a strategic alliance with Iron Mountain to provide
outsourced electronic tape vaulting services. Iron Mountain's Arcus Data
Security Division provides tape management expertise and well-established secure
off-site vaulting facilities. We will bundle our storage networking products and
expertise with Iron Mountain's facilities to provide a complete outsourced
remote tape vaulting service.
Partnership with Nortel Networks. We are working with Nortel Networks to
design and develop storage networking technologies using IP-based and optical
networks to meet the needs of storage and application service providers.
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STORAGE NETWORKING INDUSTRY BACKGROUND
Growth in Enterprise Data
The volume of enterprise data is increasing significantly due to the
proliferation of Internet and Web-based content distribution, digital media,
e-commerce, e-mail and data warehousing. Furthermore, the proliferation of the
Internet has created new industries in Web hosting and data caching, which has
led to an increase in the volume of enterprise data needed to be tracked and
stored.
As a result of the foregoing and other factors, International Data
Corporation, or IDC, estimates that the worldwide revenue for SAN-attached disk
storage systems will grow from $1.4 billion in 1999 to $10.9 billion in 2003, a
compound annual growth rate of 66%. Another indication of a strong demand for
our storage networking products is the growth of the Fibre Channel market. IDC
estimates the revenue for Fibre Channel hubs and switches will grow from $0.4
billion in 1999 to $4.2 billion in 2003, which reflects a compound annual growth
rate of 76%.
Limitations of Traditional Storage Solutions
The rapid escalation of the size and amount of data stored has presented
organizations with significant data management challenges and increased storage
related costs. As the volume of data stored, and the number of users that
require access to the data continue to increase, storage systems and servers are
burdened by an increased number of input/output, or I/O, transactions they must
perform. However, traditional storage architecture has inherent speed, distance,
capacity and performance constraints. For example, depending on the standards
and protocols used, the following constraints may exist:
- bandwidth, or the data transmission rate, is generally fixed at 15, 40 or
80 megabytes per second;
- distance between devices is limited to 12 to 150 meters;
- connectivity is limited to 15 storage devices;
- the lack of data management capability in SCSI devices places the burden
for management tasks on servers, thereby degrading network performance;
- if the server to which the data storage device is connected fails, the
data cannot be accessed; and
- LAN performance can be significantly degraded while the LAN is being used
for storage backup applications.
Advent of Fibre Channel
In response to the speed, distance, capacity and performance limitations of
traditional storage architectures, the Fibre Channel interface was developed in
the mid-1990s as an open standard technology specifically for high performance,
data intensive environments. Fibre Channel products offer over one gigabit per
second of bandwidth and enable the inter-connectivity of millions of storage
devices and servers. Fibre Channel also offers distance connectivity of up to 10
kilometers, a single interface for networking and I/O applications, technology
that supports a variety of traditional I/O and LAN protocols and interfaces and
the ability to support simultaneous two-way communications, which effectively
doubles bandwidth. The introduction of the Fibre Channel interface means that
SANs are becoming a viable alternative to traditional data storage architecture.
However, Fibre Channel-based SANs do not provide complete solutions for
managing large amounts of data in a distributed environment. Consequently,
solutions are required that address the following Fibre Channel limitations:
- Distance -- Customers require products that support transfers over
unlimited distances. Fibre Channel supports a maximum connection distance
of 10 kilometers. Transmission across third-party telecommunications
lines is not supported by Fibre Channel.
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- Connectivity -- Customers want their existing computing systems to
communicate with one another and share data. Mainframe systems have
interface channels using the ESCON or bus and tag protocols, and open
systems use SCSI or LAN standards known as TCP/IP, or Transmission
Control Protocol/Internet Protocol. Fibre Channel switches cannot
communicate with non-Fibre Channel switches, requiring further
connectivity solutions. Protocols are a set of rules for communicating
between computers. Standards are specifications for hardware or software
that are widely used and accepted. An interface is the connection and
interaction between hardware, software and the user.
- Application availability -- Customers need to keep applications online
and running during infrastructure changes, backup, testing and unplanned
outages to remain competitive in today's business economy. Fibre Channel
by itself does not provide continuous application availability.
- Bandwidth on demand -- Dedicated high capacity telecommunications lines
that have traditionally been used with SANs, namely T1, T3 and ATM lines,
are expensive and permit remote backup of only the most mission critical
data. Customers require SAN solutions that utilize less expensive
IP-based networks in order to remotely backup greater amounts of
information and make greater use of SAN advantages. Fibre Channel does
not provide the inherent ability to transmit data over IP-based networks.
OUR STORAGE NETWORKING SOLUTIONS
Our storage networking products address the limitations of traditional
storage architecture and Fibre Channel technology in the following ways:
- SANs over unlimited distance -- Our products enable organizations to
create secure SANs without any distance limitations. This allows the
creation of SAN over WAN environments in such critical applications as
remote disk mirroring and remote tape vaulting.
- Any-to-any connectivity -- Our products are protocol independent -- they
can connect devices that use Fibre Channel, SCSI, ESCON, and bus and tag
protocols. These devices can be connected and extended over
telecommunications links including T1/E1, T3/E3 and ATM, or WAN protocols
like IP, Fibre Channel and fiber optics. We believe our products connect
with substantially all storage vendors.
- Infrastructure options -- Our products enable the use of IP, ATM, Fibre
Channel and fiber optics for expanded use of a SAN infrastructure. This
supports the growing amounts of storage created by applications like
e-commerce and increases due to user demands to access applications in a
continuous mode.
- IP-based networking solutions -- We enable remote disk mirroring using
EMC's SRDF software and tape vaulting over standard IP-based networks.
Our solutions allow our customers to capitalize on inexpensive bandwidth
on demand capabilities of IP-based networks and use under-utilized,
existing IP bandwidth, especially at low traffic times of the day, and
rely on existing IP network knowledge. We anticipate expanding SAN
application support with products from other vendors.
Our SAN solutions are used for immediate, or real-time, backup and
recovery, and support a technology known as remote disk mirroring. Disk
mirroring avoids the serious threat to businesses posed by the loss of data
between data system backups by simultaneously creating up-to-the-minute images
of business-critical data on multiple backup storage disks. Our remote disk
mirroring technology permits the backups to be transmitted to a geographically
separated location, thereby reducing the risk of natural and site-wide
disasters. This technique also permits rapid recovery of data when needed, as it
is not necessary to reload tapes.
We also enhance continuous business operations. Traditional LAN-based
storage management requires manual handling and transportation of storage to an
off-site location. While this ensures a physically-separated copy of valuable
corporate data, it requires additional time and expense for handling and
transportation. In addition, finding the right tape in a timely manner can be
difficult. By bridging the SAN over the WAN, backups can be instantly made to
remote locations on disk media, including by disk
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mirroring, or on tape, known as electronic tape vaulting. The benefit is secure
archiving and timely retrieval of the correct business-critical data.
OUR STORAGE NETWORKING STRATEGY
We intend to build upon our position as a leading provider of storage
networking solutions. Key elements of this strategy are as follows:
Extend SAN Leadership
We intend to extend our SAN leadership by continuing to broaden our product
and service offerings and by expanding our SAN solutions into new markets. An
example of this strategy is our recent introduction of Fibre Channel over ATM
WANs. We intend to build market share by continuing to focus on areas which make
storage networks more useful and accessible, such as SAN over WAN applications,
any-to-any connectivity, and IP-based network solutions. To achieve leadership,
we intend to capitalize on the remote disk mirroring and remote tape vaulting
capabilities of our products.
Expand IP-Based Network Solutions
Currently, our IP-based network solutions enable remote disk mirroring, in
conjunction with EMC's SRDF software products, and remote tape vaulting over
IP-based networks. We are currently developing solutions which will operate in
conjunction with SAN applications of other storage networking vendors.
Partner with Storage Networking Industry Leaders
We have established relationships with leaders in the storage networking
market, including storage vendors, storage management software providers and
Fibre Channel switch manufacturers. Our strategic partners include companies
such as Brocade, Compaq, EMC, Hewlett Packard, Hitachi Data Systems, IBM,
Legato, Nortel, SCH Technologies and StorageTek. We intend to strengthen our
relationships with existing strategic partners and develop relationships with
new strategic partners that offer complementary products and services. We
believe that current and future strategic relationships will facilitate the
integration of our products with our strategic partners, thereby increasing our
market share and reducing the length of our sales cycle.
Focus on Professional Services
Our professional services help customers evaluate, analyze, design, install
and manage storage networks. We believe this value-added professional service
assists customers in designing SANs, integrating SAN components and implementing
SANs better than they could on their own. Our integration services eliminate the
complexity of implementing a SAN that is scalable and compatible with customer
resources. These services bolster sales of our products and allow us to generate
high margin revenues.
Explore Additional Outsourcing Services
We offer outsourced storage networking services that complement our current
storage networking products. Our data migration service helps our customers
migrate large amounts of data from one data center or storage facility to
another during consolidation or expansion of data centers. This is a turnkey
service including personnel, equipment, software and support. We intend to
provide an outsourced electronic tape vaulting service in conjunction with Iron
Mountain. We anticipate adding other outsourced services that help drive demand
for our storage networking products.
OUR STORAGE NETWORKING PRODUCTS
Our storage networking products include the UltraNet(R) family of storage
products, and our channel networking product known as Channelink(R).
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UltraNet(R) Storage Director is a high performance switching product that
operates at the center of the SAN. It enables SANs to establish a direct
connection between storage elements and servers and share data among diverse
servers and storage systems, and networks that are local and geographically
dispersed. The switch provides connectivity among SCSI, ESCON, Fibre Channel and
WANs. Two sizes are offered -- with 6 or 12 expansion slots.
UltraNet(R) Storage Gateway provides much of the same functionality and
performance of the UltraNet(R) Storage Director at a lower entry price. The
product is targeted at small SAN applications.
UltraNet(R) Fibre Channel Switch enhances our ability to provide open
systems solutions for Fibre Channel only configurations as well as mixed
environments. Mixed environments can include SCSI server and storage systems
that require access to Fibre Channel solutions. Brocade manufactures this switch
and we resell it alone or with our SAN system solutions. This switch is
available in 8 and 16 expansion slot models.
UltraNet(R) Wave Optimizer and UltraNet(R) Wave Multiplexer increase the
bandwidth available from fiber optic lines by carrying multiple signals over a
single cable using different wave lengths (colors of light) or time slots.
Pandatel manufactures these DWDM, or dense wave division multiplexing, and TDM,
or time dimension multiplexing products.
Channelink(R) offers connectivity over unlimited distances and is used for
remote disk mirroring and remote tape vaulting in environments using older
protocols.
OUR STORAGE NETWORKING PARTNERS
Offering customers effective storage networking solutions requires
integrating diverse components, including disk and tape storage devices, storage
management software, network management products and Fibre Channel products. The
optimal package of goods and services allows a customer to reduce storage
management costs by consolidating data centers and centralizing data management.
We work with our business partners to provide customers with those benefits. Our
storage networking alliances include those with key storage vendors, storage
management software providers and manufacturers of Fibre Channel and optical
networking products. We market our SAN products directly and through worldwide
distributors and OEMs, including Compaq, Hewlett Packard and StorageTek. We also
have strategic marketing partnerships with leading storage industry and fibre
switching companies, including Brocade, EMC, Hewlett Packard, Hitachi Data
Systems, IBM, Legato and SCH Technologies. Benefits of our alliances include:
- The working relationship provides us with visibility regarding market
trends and technology requirements and allows us to contact customers
earlier in the sales cycle and ascertain their needs.
- Sales of storage systems for disk mirroring provides a ready market for
our remote disk mirroring applications.
- A platform to demonstrate our interoperability with various platforms and
integrate heterogeneous components allowing us to gain preferred provider
status with key vendors.
- The resulting customer base provides us with strong reference accounts to
further increase market penetration.
EMC
We have established a relationship with EMC for remote disk mirroring
applications. This existing relationship was recently enhanced by an agreement
to provide an exclusive package of remote disk mirroring hardware, software and
implementation service. We are offering an exclusive package of our hardware,
software and implementation services to EMC's customers. Together with EMC, we
offer complementary professional services and linked customer support
organizations. We work with EMC to provide our mutual customers with timely,
effective service. For the six months ended July 31, 2000, sales of our storage
networking products to customers using EMC's disk mirroring systems accounted
for 26% of our total product revenue. In the year ended December 31, 1999, sales
of our storage networking products to customers using EMC's disk mirroring
systems accounted for 35% of our total product revenue. We also
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market our remote disk mirroring applications with other vendors, including
Hitachi Data Systems and IBM.
IBM
IBM is one of our oldest strategic partners. We coordinate local market
activities with IBM, provide mutual assistance and prepare combined proposals.
We also partner with IBM to provide customers with outsourced disaster avoidance
and recovery capability and remote disk mirroring applications.
StorageTek
In November 1999, we entered into a three-year agreement with StorageTek
under which it resells our SAN over WAN products. In addition, we purchased
StorageTek's DXE/RDE product line for $2.5 million in cash and assumed ongoing
manufacturing and engineering responsibilities for this product line. This
acquisition will provide us with access to StorageTek's large installed base of
customers for cross-selling our SAN products. We plan to discontinue the DXE/RDE
product line in March 2001, and transition the customer base to our UltraNet(R)
and Channelink(R) products. We have certified StorageTek's tape drives with our
UltraNet(R) product and work closely with them to ensure interoperability.
Compaq
Compaq has entered into a multi-million dollar commitment to resell our SAN
products. Compaq is packaging our Fibre Channel-based SAN over WAN solutions
with their product offerings. Our UltraNet(R) Open Systems Gateway product
supports Compaq's StorageWorks Data Replication Manager over long distances. The
relationship with Compaq is significant because we believe Compaq is the largest
provider of storage today.
Brocade
Our UltraNet(R) Fibre Channel Switch, which is manufactured by Brocade,
became generally available in June 1999. We believe the combination of our
UltraNet(R) storage networking solutions and UltraNet(R) family of Fibre Channel
switches offers customers an attractive architecture for developing SAN
solutions. The industry expects complete interoperability for Fibre Channel
devices, and we believe our SAN solutions are a step in that direction.
OTHER STORAGE NETWORKING PRODUCTS
We also offer channel extension products, which are certified for use with
over 250 different devices. These products offer connectivity over unlimited
distances, free of limitations imposed by traditional standards and protocols.
These products are used for the following applications:
- Data Center Consolidation -- The consolidation of data centers in
different locations to one location; often useful after mergers or
acquisitions.
- Remote Printing/Imaging -- High-speed digital printing or imaging at
remote locations.
- Data Center Load Balancing -- Operating two or more data centers from one
site. The application is transparent to the systems and servers that are
interconnected as well as to data users, meaning users do not know that
the data is not located centrally.
Under our agreement with StorageTek, we have also assumed ongoing
manufacturing and continuing engineering responsibility for StorageTek's DXE/RDE
product line. This product line is used for similar applications as our
Channelink(R) product line and substantially all sales of such products are to
StorageTek. We plan to discontinue the DXE/RDE product line in March 2001 and
transition the customer base to our UltraNet(R) and Channelink(R) products.
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PROFESSIONAL SERVICES
SAN Assessment Services
Our SAN assessment analyzes a company's storage needs, determines a SAN
solution to meet those needs, and assists in development of a business case to
justify the SAN solution. With a SAN assessment, we assist our customers in
making their existing networks more flexible and easier to manage. This thorough
assessment assists information technology managers and corporate executives
responsible for planning and funding computer resources in making sound data
management and storage decisions.
Our reliable, repeatable SAN assessment process includes the following
phases. These phases are designed for efficient evaluation and recommendation of
an appropriate SAN infrastructure for storage.
- SAN audit -- the audit contains a summary of business needs and an
inventory of a customer's network components and a storage capability.
- SAN analysis -- the analysis includes a profile of a customer's current
environment compared to its competitors, capacity planning, and a
projection of a customer's future needs.
- SAN recommendation -- this phase develops a detailed summary report
containing one to three recommended SAN solutions.
SAN Integration Services
Our professional services help companies implement storage networking
solutions. Implementation includes project planning, designing and documenting a
detailed network, installing SAN components, integrating SAN components, and
testing the functionality of the implemented SAN solution. Our storage
networking products are at the heart of our SAN implementations, and our
long-standing partnerships with well-known and successful storage equipment and
software manufacturers place us at the forefront of SAN technology.
PRODUCT SUPPORT
We offer standard maintenance contracts for our storage networking
products. The contracts generally have a one-year term and provide for advance
payment. Customers are offered a variety of contracts to choose from to suit
their particular needs. For instance, current options allow a customer to choose
support seven days a week, 24 hours per day, or five days per week, 11 hours a
day. Other options offer the customer the choice to select air shipment or
replacement parts, with the part being installed by the customer's staff, or on
site support with spare parts and service being provided by a local parts
distributor.
SALES AND MARKETING
We market our storage networking products in the United States through a
direct sales force. We have established representative offices in Canada, the
United Kingdom, France, Germany, Australia, Hong Kong, Japan, The Netherlands,
Brazil and Mexico. We also market the products in the United States and
throughout the world through OEMs, systems integrators and dependent
distributors.
We maintain our own marketing staff and direct sales force. On July 31,
2000, we had approximately 200 persons in our marketing and sales organization
for continuing operations.
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CUSTOMERS
Our customers include:
<TABLE>
<S> <C> <C>
FINANCIAL SERVICES TELECOMMUNICATIONS INFORMATION OUTSOURCING
American Express AT&T Technologies Comdisco Disaster Recovery Services
Bank of America British Telecom Computer Sciences Company Ltd
Barclays Sprint Electronic Data Systems
Chase Worldcom IBM Global Services
Citibank Integrated Systems Solutions Corp.
Merrill Lynch
Rabo Bank
</TABLE>
RESEARCH AND DEVELOPMENT
The markets in which we operate are characterized by rapidly changing
technology, new standards and changing customer requirements. Our long term
success in these markets depends upon our continuing ability to develop advanced
network hardware and software technologies.
To meet the future demands of our customers, we expect to:
- increase the compatibility of our products with the products made by
others;
- emphasize the flexible and modular architecture of our products to permit
the introduction of new and improved products within existing systems;
- continue to focus on providing sophisticated diagnostic support tools to
help deliver high network availability and, in the event of failure,
rapid return to service; and
- develop new products based on customer feedback and market trends.
Research and development expenses were equal to 14% of our total revenue
during the six months ended July 31, 2000, compared to 15%, 14% and 15% of total
revenue in 1997, 1998 and 1999, respectively. We intend to continue to apply a
significant portion of resources to product enhancements and new product
development for the foreseeable future. We cannot assure you that our research
and development activities will be successful.
MANUFACTURING AND SUPPLIERS
In-house manufacturing activities for our products primarily involve
quality assurance testing of subassemblies and final system assembly,
integration and quality assurance testing. We became ISO 9001 certified in 1999
and have been ISO 9002 certified since 1993.
We manufacture our products based on forecasted orders. Forecasting orders
is difficult as most shipments occur at the end of each quarter. Our customers
generally place orders for immediate delivery, not in advance of need. Customers
may generally cancel or reschedule orders without penalties. Accordingly, we
believe that backlog is generally not meaningful for purposes of predicting our
revenue for any fiscal period.
Some of our products, including Fibre Channel switches, time division
multiplexers and wave division multiplexers, are manufactured by OEMs for sale
by us. We manufacture our other products from subassemblies, parts and
components, such as integrated circuits, printed circuit boards, power supplies
and metal parts, each manufactured by others. Some items manufactured by
suppliers are made to our specific design criteria.
At December 31, 1999, we held $1.7 million of inventory for parts that our
vendors no longer manufacture. Products in which those parts are included
accounted for approximately $80.9 million of sales in 1999. We expect that this
inventory will be used in the ordinary course of our business over the next six
years. Relevant parts will have to be redesigned after the inventory is used.
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We believe that we currently have adequate supply channels. Components and
subassemblies used in our products and systems are generally available from a
number of different suppliers. However, certain OEM products, such as Fibre
Channel switches, time division multiplexers and wave division multiplexers, and
key components in our other products are purchased from a limited number of
sources. We do not anticipate any difficulty in obtaining an adequate supply of
purchased OEM products and required components. An interruption in our existing
supplier relationships or delays by some suppliers, however, could result in
production delays and harm our results of operations.
COMPETITION
Our products are sold in markets where other market participants have
significantly greater revenues and internationally known brand names. Many of
those market participants do not currently sell products similar to ours.
However, such market participants may do so in the future, and new products we
develop may compete with products sold by well-known market participants. Our
competitors in channel networking and SAN include storage system vendors and
others including Crossroads, Gadzoox, InRange, McData, Network Systems, QLogic,
StorageTek and Vixel. In addition, Cisco Systems recently acquired a company
which is developing IP-based network solutions which may have functionality
similar to our product offerings.
The markets in which we operate are characterized by rapidly changing
technology and evolving industry standards, resulting in rapid product
obsolescence and frequent product and feature introductions and improvements. We
compete with several companies that have greater engineering and development
resources, marketing resources, financial resources, manufacturing capability,
customer support resources and name recognition. As a result, our competitors
may have greater credibility with existing and potential customers. They also
may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than we can to new or
emerging technologies and changes in customer requirements. These competitive
pressures may materially harm our business.
The competitive environments of markets in which our storage networking
products are sold are not yet fully developed. Accordingly, we are not in a
position to prepare long range plans in response to unknown competitive
pressures. As these markets grow, we anticipate other companies will enter with
competing products. In addition, customers and business partners could possibly
develop and introduce competing products. We anticipate the markets will be
highly competitive.
The declining sales of channel networking products present unique
competitive pressures. We anticipate pricing pressures may increase in these
markets. Consolidation of competing vendors of these products could also have
negative consequences.
The principal competitive factors affecting our products include customer
service, flexibility, price, performance, reliability, ease of use and
functionality. In many situations, the potential customer has an installed base
of a competitor's products, which can be difficult to dislodge. IBM, Microsoft
and others can significantly influence customers and control technology in our
markets.
INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of trade secret, copyright, patent and trademark
laws, nondisclosure agreements and technical measures to establish and protect
our intellectual property rights. That protection may not preclude competitors
from developing products with features similar to our products.
We currently own three patents and have eight patent applications filed or
in the process of being filed in the United States with respect to our
continuing operations. Our pending patent applications, however, may not be
issued. We have not applied for patent protection in any foreign countries. Not
all of our unique products are patented. Our issued patents may not adequately
protect our technology from infringement or prevent others from claiming that
our technology infringes that of third parties. Failure to protect our
intellectual property could materially harm our business. We believe that patent
and copyright
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protection are less significant to our competitive position because of the rapid
pace of technological change in the markets in which our products are sold and
because of the effectiveness and quality of our support services, the knowledge,
experience and ability of our employees and the frequency of our enhancements.
We rely upon a patent license agreement to manufacture our Channelink(R)
and UltraNet(R) products that use ESCON. This license was recently renewed and
expires on December 31, 2004.
We have from time to time received, and may in the future receive,
communications from third parties asserting that our products infringe on their
patents. We believe that we possess or license all required proprietary rights
to the technology involved in our products and that our products, trademarks and
other intellectual property rights do not infringe upon the proprietary rights
of others. However, there can be no assurance that others will not claim a
proprietary interest in all or a part of the technology we use or assert claims
of infringement. Any such claim, regardless of its merits, could involve us in
costly litigation and materially harm our business.
The existence of a large number of patents in the markets in which our
products are sold, the rapid rate of issuance of new patents and short product
development cycles means it is not economically practical to determine in
advance whether a product infringes patent rights of others. We believe that,
based upon industry practice, any necessary license or rights under such patents
may be obtained on terms that would not materially harm our consolidated
financial position or results of operations. However, there can be no assurance
in this regard.
EMPLOYEES
As of July 31, 2000, we had 745 full-time employees for both divisions. On
that date, 137 full-time employees provided services to both divisions and are
members of our administrative and manufacturing departments. On that date, our
continuing operations had 486 employees in addition to those who provide
services to both divisions. We consider our ability to attract and retain
qualified employees and to motivate such employees to be essential to our future
success. Competition for highly skilled personnel is particularly intense in the
computer and data communications industry, and we cannot assure that we will
continue to attract and retain qualified employees.
LEGAL PROCEEDINGS
We are currently not a party to any legal proceedings that could materially
harm our business.
FACILITIES AND PROPERTIES
Our principal administrative, manufacturing, engineering and development
functions are located in leased facilities in the Minneapolis, Minnesota suburb
of Plymouth. We lease space for our continuing operations in Atlanta, Georgia
for development of certain products. In addition, we lease office space in
England, France, Germany, Australia, Japan, The Netherlands, Brazil and Mexico.
We also lease space for sales offices for our direct sales staff and systems
consultants in a number of locations throughout the United States and Canada. We
believe our facilities are adequate to meet our current needs. In August 2000,
we terminated a lease on surplus space in a Minneapolis suburb in exchange for a
cash payment which will be made to the landlord in the amount of $547,000 when
certain conditions have been met. The payment has been accrued on the July 31,
2000 balance sheet.
DISCONTINUED OPERATIONS -- ENTERPRISE INTEGRATION SOLUTIONS DIVISION
Our board of directors has determined to sell or spin-off our Enterprise
Integration Solutions Division in order to focus all of our resources on our SAN
and other storage networking products. The board of directors has set
January 31, 2001 as a target date for completing any sale or a decision to
proceed with a spin-off. Accordingly, the financial information for this
division has been accounted for as discontinued operations.
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OUR ENTERPRISE INTEGRATION SOLUTION
Our EAI solutions help organizations integrate legacy applications with
powerful new business applications that improve customer productivity and
customer satisfaction. Our EAI solutions preserve our customers' investment in
their computer systems, allow enterprise-wide real-time access to data, are
flexible and highly scalable. In addition to integrating existing systems, our
EAI solutions are particularly suited for developing new applications, such as:
- CRM applications -- CRM applications facilitate integration of
information collected in different areas of a company that affect
customer relations. CRM applications can instantly pull together customer
information from multiple databases.
- E-commerce applications -- Customer data integrated from a variety of
legacy environments can enhance a company's ability to interact with
suppliers and partners, sell products and provide customer service over
the Internet. Our solutions filter legacy data, translate and format it
so that it can be used with Sun Microsystem's NetDynamics and Lotus'
Domino products and other Internet tools to build effective
Internet-based sales and service applications in less time.
Further, InVista(TM), a technology we acquired as part of our acquisition
of IntelliFrame, includes new tools that provide business logic, rules and
process workflow management for improved development and deployment of large
e-commerce and CRM applications. With InVista(TM), our EAI solution is able to
do more than just display information -- it is able to suggest alternative
courses of action. For instance, InVista(TM) can recommend whether a customer
should use funds in an account to pay a credit card bill, or transfer funds to a
more favorable interest bearing account. A beta version of our InVista(TM)
product became available during the second quarter of 2000. The product will be
sold both on a standalone basis and with Enterprise/Access.
Our EAI products are marketed through a direct sales staff and through our
business partner program. An alliance with Siebel provides a comprehensive
solution to established call centers and for sales force applications. Alliances
with Cap Gemini, Deloitte Consulting and PricewaterhouseCoopers provide a
platform for each business partner to introduce our EAI products to customers by
trained specialists.
OUR ENTERPRISE INTEGRATION SOLUTIONS PRODUCTS
Enterprise/Access is a development tool that permits legacy applications to
be linked real-time with new business applications. The product is used with our
InVista(TM) offering. Enterprise/Access uses a "zero coding" approach, i.e., it
captures application screens, analyzes the interaction between the legacy system
and the user, builds a model of the legacy application, and establishes all of
the necessary data paths, transformations and logic for integrating the legacy
application with the new front-end application. As a result of "zero coding,"
Enterprise/Access provides one of the fastest ways to e-commerce by enabling the
easy reuse of existing legacy application programs. Key features of
Enterprise/Access include:
- no changes to our customers' existing applications software environment;
- a graphical user interface, which promotes rapid implementation;
- three-tier architecture for mainframe, server and client workstations,
which enhance scalability and transparency; and
- centralized management to administer, monitor and troubleshoot
large-scale deployments.
Enterprise/Connect uses TCP/IP to connect existing systems to open systems
and to implement solutions for connecting mainframes to the Internet. This
product is a complete package of applications providing mainframe connectivity
via standard Web browsers, which are the standard interface on Internet
applications. The browsers, based on the Java programming language, function as
the universal window for access to mainframe terminal, file transfer and print
services. We may divest our server gateways and tools assets, including
Enterprise/Connect, in a transaction separate from the divestiture of our other
EAI assets.
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Part III - Financial Statements
COMPUTER NETWORK TECHNOLOGY CORPORATION
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report................................ 24
Consolidated Balance Sheets as of December 31, 1998 and
1999, and July 31, 2000 (unaudited)....................... 25
Consolidated Statements of Operations for the years ended
December 31, 1997, 1998 and 1999 and the six months ended
June 30, 1999 (unaudited) and July 31, 2000 (unaudited)... 26
Consolidated Statements of Shareholders' Equity and
Comprehensive Income for the years ended December 31,
1997, 1998 and 1999, the one month transition period ended
January 31, 2000 (unaudited) and the six months ended July
31, 2000 (unaudited)...................................... 27
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999 and the six months ended
June 30, 1999 (unaudited) and July 31, 2000
(unaudited)............................................... 28
Notes to Consolidated Financial Statements.................. 29
</TABLE>
23
<PAGE> 24
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Computer Network Technology Corporation:
We have audited the accompanying consolidated balance sheets of Computer
Network Technology Corporation and subsidiaries as of December 31, 1998 and
1999, and the related consolidated statements of operations, shareholders'
equity and comprehensive income, and cash flows for each of the years in the
three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 referred to above
present fairly, in all material respects, the financial position of Computer
Network Technology Corporation and subsidiaries as of December 31, 1998 and
1999, and the results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 1999 in conformity with
generally accepted accounting principles.
KPMG LLP
Minneapolis, Minnesota
January 21, 2000, except as to the
effect of matters discussed in note
4, which is as of September 12,
2000.
24
<PAGE> 25
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31
------------------ JULY 31,
1998 1999 2000
------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $11,786 $ 16,184 $ 18,191
Marketable securities..................................... 576 10,711 11,389
Receivables, net.......................................... 23,678 29,517 33,977
Inventories............................................... 17,914 14,425 18,389
Net current assets of discontinued operations............. 3,555 5,089 1,910
Deferred tax asset........................................ 2,328 3,415 3,415
Other current assets...................................... 972 1,776 2,656
------- -------- --------
Total current assets............................... 60,809 81,117 89,927
------- -------- --------
Property and equipment, net................................. 14,815 17,529 23,001
Field support spares, net................................... 3,310 3,879 3,939
Deferred tax asset.......................................... 1,221 2,070 2,070
Goodwill and other intangibles, net......................... 1,948 1,222 1,015
Net non-current assets of discontinued operations........... 5,298 4,645 3,659
Other assets................................................ 195 192 787
------- -------- --------
$87,596 $110,654 $124,398
======= ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 7,136 $ 11,408 $ 11,474
Accrued liabilities....................................... 12,100 10,010 15,817
Deferred revenue.......................................... 5,660 8,296 12,573
Current installments of obligations under capital lease... 326 688 1,279
------- -------- --------
Total current liabilities.......................... 25,222 30,402 41,143
------- -------- --------
Obligations under capital lease, less current
installments.............................................. 1,816 1,780 2,366
------- -------- --------
Total liabilities.................................. 27,038 32,182 43,509
------- -------- --------
Shareholders' equity:
Undesignated preferred stock, authorized 965 shares; none
issued and outstanding.................................. -- -- --
Series A Junior Participating Preferred Stock, authorized
35 shares; none issued and outstanding.................. -- -- --
Common stock, $.01 par value; authorized 100,000 shares;
issued and outstanding 22,254 at December 31, 1998,
23,792 at December 31, 1999 and 24,151 at July 31,
2000.................................................... 223 238 242
Additional paid-in capital................................ 54,921 68,927 71,554
Unearned compensation..................................... (355) (838) (924)
Retained earnings......................................... 6,141 10,796 11,054
Accumulated other comprehensive income-foreign currency
translation adjustment.................................. (372) (651) (1,037)
------- -------- --------
Total shareholders' equity......................... 60,558 78,472 80,889
------- -------- --------
$87,596 $110,654 $124,398
======= ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
25
<PAGE> 26
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31 --------------------
------------------------------- JUNE 30, JULY 31,
1997 1998 1999 1999 2000
------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUE:
Product sales.............................. $56,127 $ 74,969 $ 89,248 $42,588 $59,040
Service fees............................... 24,068 28,052 36,741 17,149 23,908
------- -------- -------- ------- -------
Total revenue...................... 80,195 103,021 125,989 59,737 82,948
------- -------- -------- ------- -------
COST OF REVENUE:
Cost of product sales...................... 20,344 27,441 38,411 16,661 24,407
Cost of service fees....................... 15,658 18,175 19,798 9,567 14,118
------- -------- -------- ------- -------
Total cost of revenue.............. 36,002 45,616 58,209 26,228 38,525
------- -------- -------- ------- -------
GROSS PROFIT................................. 44,193 57,405 67,780 33,509 44,423
------- -------- -------- ------- -------
OPERATING EXPENSES:
Sales and marketing........................ 27,504 32,255 34,626 17,238 20,051
Engineering and development................ 12,384 14,236 18,456 8,838 11,475
General and administrative................. 4,944 6,252 6,922 3,467 4,309
Abandoned facility......................... -- -- 1,331 -- --
------- -------- -------- ------- -------
Total operating expenses........... 44,832 52,743 61,335 29,543 35,835
------- -------- -------- ------- -------
INCOME (LOSS) FROM OPERATIONS................ (639) 4,662 6,445 3,966 8,588
------- -------- -------- ------- -------
OTHER INCOME (EXPENSE):
Interest income............................ 1,553 393 744 226 667
Interest expense........................... (57) (79) (264) (102) (175)
Other, net................................. (96) 113 (370) (232) (271)
------- -------- -------- ------- -------
Other income (expense), net........ 1,400 427 110 (108) 221
------- -------- -------- ------- -------
Income from continuing operations before
income taxes............................... 761 5,089 6,555 3,858 8,809
Provision for income taxes................... 312 1,730 2,229 1,312 2,907
------- -------- -------- ------- -------
Income from continuing operations............ 449 3,359 4,326 2,546 5,902
------- -------- -------- ------- -------
Income (loss) from discontinued operations,
net of tax................................. (2,763) 1,370 329 1,937 (2,019)
------- -------- -------- ------- -------
NET INCOME (LOSS)............................ $(2,314) $ 4,729 $ 4,655 $ 4,483 $ 3,883
======= ======== ======== ======= =======
BASIC INCOME (LOSS) PER SHARE:
Continuing operations...................... $ .02 $ .15 $ .19 $ .11 $ .25
======= ======== ======== ======= =======
Discontinued operations.................... $ (.12) $ .06 $ .01 $ .09 $ (.08)
======= ======== ======== ======= =======
Net income (loss).......................... $ (.10) $ .21 $ .20 $ .20 $ .16
======= ======== ======== ======= =======
Shares..................................... 22,702 22,095 23,137 22,773 24,020
======= ======== ======== ======= =======
DILUTED INCOME (LOSS) PER SHARE:
Continuing operations...................... $ .02 $ .15 $ .17 $ .10 $ .23
======= ======== ======== ======= =======
Discontinued operations.................... $ (.12) $ .06 $ .01 $ .08 $ (.08)
======= ======== ======== ======= =======
Net income (loss).......................... $ (.10) $ .21 $ .18 $ .17 $ .15
======= ======== ======== ======= =======
Shares..................................... 22,702 22,572 25,818 25,649 26,152
======= ======== ======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements
26
<PAGE> 27
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER
---------------- PAID-IN UNEARNED RETAINED COMPREHENSIVE
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS INCOME TOTAL
------- ------ ---------- ------------ -------- ------------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996.................... 23,408 $234 $60,372 $ -- $ 3,726 $ (171) $64,161
------- ---- ------- ------- ------- ------- -------
Shares issued pursuant to the employee stock
purchase plan, restricted stock plan and
exercise of stock options.................... 192 2 741 (42) -- -- 701
Repurchase of common stock.................... (1,405) (14) (6,674) -- -- -- (6,688)
Compensation expense.......................... -- -- -- 7 -- -- 7
Comprehensive loss:
Net loss..................................... -- -- -- -- (2,314) -- (2,314)
Translation adjustment, net of tax effect of
$0......................................... -- -- -- -- -- (260) (260)
-------
Total comprehensive loss...................... -- -- -- -- -- -- (2,574)
------- ---- ------- ------- ------- ------- -------
Balance, December 31, 1997.................... 22,195 $222 $54,439 $ (35) $ 1,412 $ (431) $55,607
------- ---- ------- ------- ------- ------- -------
Shares issued pursuant to the employee stock
purchase plan, restricted stock plan and
exercise of stock options.................... 454 5 2,041 (401) -- -- 1,645
Tax benefits from employee stock
transactions................................. -- -- 195 -- -- -- 195
Repurchase of common stock.................... (395) (4) (1,754) -- -- -- (1,758)
Compensation expense.......................... -- -- -- 81 -- -- 81
Comprehensive income:
Net income................................... -- -- -- -- 4,729 -- 4,729
Translation adjustment, net of tax effect of
$0......................................... -- -- -- -- -- 59 59
-------
Total comprehensive income.................... -- -- -- -- -- -- 4,788
------- ---- ------- ------- ------- ------- -------
Balance, December 31, 1998.................... 22,254 $223 $54,921 $ (355) $ 6,141 $ (372) $60,558
------- ---- ------- ------- ------- ------- -------
Shares issued pursuant to the employee stock
purchase plan, restricted stock plan and
exercise of stock options.................... 1,538 15 9,354 (799) -- -- 8,570
Tax benefits from employee stock
transactions................................. -- -- 4,652 -- -- -- 4,652
Compensation expense.......................... -- -- -- 316 -- -- 316
Comprehensive income:
Net income................................... -- -- -- -- 4,655 -- 4,655
Translation adjustment, net of tax effect of
$0......................................... -- -- -- -- -- (279) (279)
-------
Total comprehensive income.................... -- -- -- -- -- -- 4,376
------- ---- ------- ------- ------- ------- -------
Balance, December 31, 1999.................... 23,792 $238 $68,927 $ (838) $10,796 $ (651) $78,472
------- ---- ------- ------- ------- ------- -------
(unaudited)
Shares issued pursuant to the employee stock
purchase plan, restricted stock plan and
exercise of stock options.................... 33 -- 507 (341) -- -- 166
Tax benefits from employee stock
transactions................................. -- -- -- -- -- -- --
Compensation expense.......................... -- -- -- 49 -- -- 49
Comprehensive income:
Net loss..................................... -- -- -- -- (3,625) -- (3,625)
Translation adjustment, net of tax effect of
$0......................................... -- -- -- -- -- 49 49
-------
Total comprehensive loss...................... -- -- -- -- -- -- (3,576)
------- ---- ------- ------- ------- ------- -------
Balance, January 31, 2000..................... 23,825 $238 $69,434 $(1,130) $ 7,171 $ (602) $75,111
------- ---- ------- ------- ------- ------- -------
(unaudited)
Shares issued pursuant to the employee stock
purchase plan, restricted stock plan and
exercise of stock options.................... 326 4 2,120 111 -- -- 2,235
Tax benefits from employee stock
transactions................................. -- -- -- -- -- -- --
Compensation expense.......................... -- -- -- 95 -- -- 95
Comprehensive income:
Net income................................... -- -- -- -- 3,883 -- 3,883
Translation adjustment, net of tax effect of
$0......................................... -- -- -- -- -- (435) (435)
-------
Total comprehensive income.................... -- -- -- -- -- -- 3,448
------- ---- ------- ------- ------- ------- -------
Balance, July 31, 2000........................ 24,151 $242 $71,554 $ (924) $11,054 $(1,037) $80,889
======= ==== ======= ======= ======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements
27
<PAGE> 28
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31 --------------------
-------------------------------- JUNE 30, JULY 31,
1997 1998 1999 1999 2000
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)........................ $ (2,314) $ 4,729 $ 4,655 $ 4,483 $ 3,883
Discontinued operations.................. 2,763 (1,370) (329) (1,937) 2,019
Depreciation and amortization............ 6,200 7,414 9,083 4,370 5,216
Compensation expense..................... -- 58 219 106 25
Change in deferred taxes................. (452) 506 (1,936) -- --
Changes in operating assets and
liabilities:
Receivables........................... (6,772) 872 (5,872) 2,233 (5,197)
Inventories........................... (1,219) (6,815) 3,489 2,559 341
Other current assets.................. (265) 127 (804) (769) (875)
Accounts payable...................... 3,347 (78) 4,272 980 2,217
Accrued liabilities................... (777) 4,179 2,563 (1,862) 9,685
Deferred revenue...................... 2,492 (1,528) 2,636 2,229 2,653
-------- -------- -------- ------- --------
Net cash provided by continuing
operations.......................... 3,003 8,094 17,976 12,392 19,967
Net cash provided by (used in)
discontinued operations............. (1,200) 2,829 789 (1,887) 613
-------- -------- -------- ------- --------
Cash provided by operating
activities..................... 1,803 10,923 18,765 10,505 20,580
-------- -------- -------- ------- --------
INVESTING ACTIVITIES:
Additions to property and equipment...... (6,650) (6,345) (8,262) (4,249) (7,500)
Additions to field support spares........ (1,693) (2,198) (2,727) (1,089) (847)
Additions to purchased technology........ (1,550) (185) -- -- --
Discontinued operations -- acquisition of
business.............................. (11,412) 169 -- -- --
Discontinued operations -- proceeds from
sale of vision product line........... 2,000 -- -- -- --
Discontinued operations -- additions to
long-term assets...................... (1,237) (547) (507) (91) (110)
Purchase of marketable securities........ (12,190) (18,054) (15,421) (97) (2,748)
Redemption of marketable securities...... 36,374 23,512 5,286 -- --
Other.................................... 652 6 327 89 (599)
-------- -------- -------- ------- --------
Cash provided by (used in)
investing activities........... 4,294 (3,642) (21,304) (5,437) (11,804)
-------- -------- -------- ------- --------
FINANCING ACTIVITIES:
Payments for repurchases of common
stock................................. (6,688) (1,758) -- -- --
Discontinued operations -- repayment of
debt.................................. -- -- (1,000) (1,000) --
Proceeds from issuance of common stock... 701 1,645 8,570 6,218 2,235
Repayments of obligations under capital
leases................................ (107) (181) (327) (69) (549)
-------- -------- -------- ------- --------
Cash provided by (used in)
financing activities........... (6,094) (294) 7,243 5,149 1,686
-------- -------- -------- ------- --------
Effects of exchange rate changes........... (60) 9 (306) (341) (245)
-------- -------- -------- ------- --------
Net increase (decrease) in cash and cash
equivalents.............................. (57) 6,996 4,398 9,876 10,217
Cash and cash equivalents -- beginning of
period................................... 4,847 4,790 11,786 11,786 7,974
-------- -------- -------- ------- --------
Cash and cash equivalents -- end of
period................................... $ 4,790 $ 11,786 $ 16,184 $21,662 $ 18,191
======== ======== ======== ======= ========
</TABLE>
See accompanying notes to consolidated financial statements
28
<PAGE> 29
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1998, AND 1999
(INFORMATION AS OF JULY 31, 2000 AND FOR THE SIX MONTHS ENDED
JUNE 30, 1999 AND JULY 31, 2000 IS UNAUDITED)
(TABULAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE DATA)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Computer Network Technology Corporation is a leading worldwide provider of
high-performance Storage Area Networking (SAN) solutions, Enterprise Application
Integration (EAI) tools, and world class services.
DISCONTINUED OPERATIONS
The Company has determined that it will proceed with a divestiture of its
Enterprise Integration Solutions Division. Accordingly, the Enterprise
Integration Solutions Division has been accounted for as discontinued operations
in the accompanying financial statements.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Computer Network Technology Corporation and its subsidiaries (together, the
Company). All significant intercompany balances and transactions are eliminated
in consolidation.
INTERIM FINANCIAL STATEMENTS
The accompanying unaudited financial statements as of July 31, 2000 and for
the six months ended June 30, 1999 and July 31, 2000 have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal, recurring
accruals) considered necessary for a fair presentation have been included.
Results for the interim period are not necessarily indicative of results for an
entire year.
On January 12, 2000, the Company changed its fiscal year end to January 31,
from December 31. The Company believes that the six months ended June 30, 1999
provide a meaningful comparison to the first half of fiscal 2000. There are no
factors, of which the Company is aware, seasonal or otherwise, that would impact
the comparability of information or trends, if results for the six months ended
July 31, 1999 were presented in lieu of results for the six months ended June
30, 1999.
REVENUE RECOGNITION
Revenue from product sales is generally recognized by the Company upon
shipment or signed customer acceptance depending on the terms of the contract or
purchase order. Revenue from software sales is recognized in accordance with
American Institute of Certified Public Accountants Statement of Position (SOP)
97-2, "Software Revenue Recognition", and SOP 98-9, "Modification of SOP 97-2,
Software Revenue Recognition With Respect to Certain Transactions". Service fees
are recognized as revenue when earned, which is generally on a straight-line
basis over the contracted service period. Deferred revenue primarily consists of
the unearned portion of service agreements billed in advance to customers.
In December 1999, the SEC staff issued Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" (SAB 101). SAB 101 summarizes
certain of the SEC staff's view in applying
29
<PAGE> 30
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
generally accepted accounting principles to revenue recognition in financial
statements. The Company is currently analyzing whether SAB 101 will have any
impact on its financial statements. SAB 101 is effective for the Company for the
quarter ending January 31, 2001.
CASH EQUIVALENTS
The Company considers investments in highly liquid debt securities having
an initial maturity of three months or less to be cash equivalents.
MARKETABLE SECURITIES
If significant, unrealized gains and losses on available-for-sale
securities are excluded from earnings and are reflected as a separate component
of shareholders' equity. Unrealized gains and losses on trading securities are
included in earnings.
INVENTORIES
Inventories are stated at the lower of cost (determined on a first in,
first out basis) or market.
PROPERTY AND EQUIPMENT
Property and equipment owned by the Company is carried at cost and
depreciated using the straight-line method over three to eight years. Leasehold
improvements are amortized using the straight-line method over the terms of the
respective leases. Expenditures for repairs and maintenance are charged to
expense as incurred.
FIELD SUPPORT SPARES
Field support spares are carried at cost and depreciated using the
straight-line method over three years.
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of purchase price over the fair value of net
assets acquired and is amortized using the straight-line method over periods
ranging from five to twenty years. Purchased technology and other identifiable
intangible assets are carried at cost and amortized using the straight-line
method over periods ranging from two to seven years.
The Company assesses the potential impairment of its goodwill and other
intangible assets based on anticipated cash flows from operations.
ALLOWANCE FOR RETURNS AND CREDIT LOSSES
An allowance is made for potential returns and uncollectible accounts based
on current and historical experience. The allowance for returns and credit
losses at December 31, 1998 and 1999 was $1,225,000 and $959,000, respectively.
ENGINEERING AND DEVELOPMENT
The Company accounts for engineering and development costs in accordance
with Statement of Financial Accounting Standards No. 86 "Accounting for the
Costs of Computer Software to be Sold, Leased or Otherwise Marketed" (SFAS No.
86). The Company has expensed all engineering and development costs to date, as
costs which meet the capitalization criteria outlined in SFAS No. 86 have not
been significant.
30
<PAGE> 31
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FOREIGN CURRENCY
The financial statements of the Company's international subsidiaries have
been translated into U.S. dollars in accordance with the provisions of Statement
of Financial Accounting Standards No. 52 "Foreign Currency Translation" (SFAS No
52). Under SFAS No. 52, assets and liabilities are translated into U.S. dollars
at year-end exchange rates, while equity accounts are translated at historical
rates. Income and expenses are translated at the average exchange rates during
the year. The resulting translation adjustments are recorded as a separate
component of shareholders' equity.
The Company is exposed to market risks related to fluctuations in foreign
exchange rates because some sales transactions, and the assets and liabilities
of its foreign subsidiaries, are denominated in foreign currencies. As of
December 31, 1999, the Company has hedged a portion of its risk by purchasing
forward exchange contracts for 950,000 British pounds sterling that settle at
various times through February 15, 2000. Gains and losses from transactions
denominated in foreign currencies and forward exchange contracts are included in
net income (loss).
The Company recognized foreign currency transaction losses in 1997 and 1999
of $45,000 and $196,000, respectively. The Company recognized a foreign currency
transaction gain in 1998 of $110,000.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the expected future
tax consequences of temporary differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases.
STOCK COMPENSATION PLANS
The Company accounts for its stock based compensation awards in accordance
with Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" (APB No. 25) and provides the footnote disclosures required by
Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based
Compensation" (SFAS No. 123).
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
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,
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 these estimates.
NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed based on the weighted average
number of common shares outstanding, while diluted net income (loss) per share
is computed based on the weighted average number of common shares outstanding
plus potential dilutive shares of common stock. Potential dilutive shares of
common stock include stock options which have been granted to employees and
directors and awards under the employee stock purchase plan.
31
<PAGE> 32
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMPREHENSIVE INCOME
Comprehensive income consists of the Company's net income (loss) and
foreign currency translation adjustment and is presented in the consolidated
statement of shareholders' equity and comprehensive income.
(2) COMPONENTS OF SELECTED BALANCE SHEET ACCOUNTS
<TABLE>
<CAPTION>
DECEMBER 31
------------------ JULY 31,
1998 1999 2000
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Inventories:
Components and subassemblies.............................. $ 9,125 $ 8,661 $ 11,486
Work in process........................................... 3,984 3,109 3,301
Finished goods............................................ 4,805 2,655 3,602
------- ------- --------
$17,914 $14,425 $ 18,389
======= ======= ========
Property and equipment:
Machinery and equipment................................... $20,909 $25,415 $ 29,662
Office and data processing equipment...................... 15,136 18,761 22,073
Furniture and fixtures.................................... 1,547 2,221 3,283
Leasehold improvements.................................... 2,090 2,264 1,398
------- ------- --------
39,682 48,661 56,416
Less accumulated depreciation and amortization............ 24,867 31,132 33,415
------- ------- --------
$14,815 $17,529 $ 23,001
======= ======= ========
Field support spares:
Field support spares...................................... $13,584 $16,311 $ 18,264
Less accumulated depreciation............................. 10,274 12,432 14,325
------- ------- --------
$ 3,310 $ 3,879 $ 3,939
======= ======= ========
Goodwill and other intangibles:
Purchased technology...................................... $ 1,665 $ 1,665 $ 1,665
Goodwill.................................................. 866 866 866
------- ------- --------
2,531 2,531 2,531
Less accumulated amortization............................. 583 1,309 1,516
------- ------- --------
$ 1,948 $ 1,222 $ 1,015
======= ======= ========
Accrued liabilities:
Compensation.............................................. $ 5,889 $ 5,949 $ 8,426
Income taxes.............................................. 3,725 1,049 2,550
Abandoned facility........................................ -- 1,331 937
Other..................................................... 2,486 1,681 3,904
------- ------- --------
$12,100 $10,010 $ 15,817
======= ======= ========
</TABLE>
32
<PAGE> 33
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) MARKETABLE SECURITIES
The Company's investments in marketable securities are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1998 1999
------- -------
<S> <C> <C>
Corporate debt securities......................... $ -- $10,319
Standard & Poors 500 stock price index fund....... 576 392
------- -------
$ 576 $10,711
======= =======
</TABLE>
At December 31, 1998 and 1999, available-for-sale securities consist of
investments in corporate debt securities of $0 and $10,319,000, respectively.
The amount of gross unrealized gains and losses with respect to investments in
available-for-sale securities at December 31, 1998 and 1999 was not significant.
The Company realized no significant gains or losses with respect to
available-for-sale securities during the three-year period ended December 31,
1999. Proceeds from the sale of available-for-sale securities in 1997, 1998 and
1999 were $26,252,000, $8,093,000 and $984,000, respectively. At December 31,
1999, the Company's investments in available for sale securities have
contractual maturities of six months or less.
The Company's trading securities consist of a mutual fund investment that
seeks to provide a return corresponding to the Standard & Poors 500 stock price
index. The Company intends to use any gain or loss from this investment to
directly offset the investment gain or loss owed to participants under the
Company's executive deferred compensation plan. The amount of unrealized holding
gains (losses) with respect to trading securities included in net income (loss)
for 1997, 1998 and 1999 was $0, $0 and $112,000, respectively.
(4) DISCONTINUED OPERATIONS
The Company has determined that it will proceed with a divestiture of its
Enterprise Integration Solutions Division. Accordingly, the Enterprise
Integration Solutions Division has been accounted for as a discontinued
operation in the accompanying financial statements. The Enterprise Integration
Solutions Division develops and sells EAI software that automates the
integration of computer software applications, and business workflow processes,
as well as our traditional server gateways and tools, which enable multiple
desktop computers and mainframe terminals to communicate with one another.
Management estimates that the disposition of this business segment will not
result in a loss. Summary financial information for the discontinued operations
was as follows:
Condensed Consolidated Statements of Operations of Discontinued Operations:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31 SIX MONTHS ENDED
--------------------------- -------------------
JUNE 30, JULY 31,
1997 1998 1999 1999 2000
------- ------- ------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenue........................................ $17,646 $30,514 $25,704 $15,032 $ 8,065
======= ======= ======= ======= =======
Income (loss) before income taxes.............. $(4,654) $ 2,550 $ 498 $ 2,934 $(3,014)
Provision (benefit) for income taxes........... (1,891) 1,180 169 997 (995)
------- ------- ------- ------- -------
Net income (loss) from discontinued
operations................................... $(2,763) $ 1,370 $ 329 $ 1,937 $(2,019)
======= ======= ======= ======= =======
</TABLE>
Certain general and administrative, facility and information technology
infrastructure costs that had previously been allocated to and reported in the
operating results of the Enterprise Integration Solutions Division have been
reallocated to continuing operations.
33
<PAGE> 34
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Condensed Consolidated Statements of Net Assets of Discontinued Operations:
<TABLE>
<CAPTION>
DECEMBER 31
----------------- JULY 31,
1998 1999 2000
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Receivables, net............................................ $ 6,547 $ 7,330 $ 4,633
Other current assets........................................ 2,439 1,775 1,379
Goodwill and other intangibles, net......................... 2,789 2,205 1,791
Other long-term assets...................................... 3,509 2,440 1,869
------- ------- -------
Total assets........................................... 15,284 13,750 9,672
------- ------- -------
Debt........................................................ 2,000 1,000 --
All other liabilities....................................... 4,431 3,016 4,103
------- ------- -------
Net assets of discontinued operations.................. $ 8,853 $ 9,734 $ 5,569
======= ======= =======
</TABLE>
APERTUS - DISCONTINUED OPERATIONS
Effective October 24, 1997, the Company acquired substantially all of the
assets (including in-process research and development) and assumed certain
liabilities of the Internet Solutions Division of Apertus Technologies
Incorporated (Apertus), a provider of Internet-to-mainframe connectivity
products and Web access to legacy applications. The purchase price totaled
$16,429,000 including a cash payment of $11,412,000 and assumption of $5,017,000
of liabilities and related acquisition costs. The acquisition was accounted for
as a purchase and the consolidated financial statements of the Company include,
as part of discontinued operations, the results of Apertus since October 24,
1997. The purchase price was allocated to the fair value of the assets and
liabilities acquired as follows:
<TABLE>
<S> <C>
Current assets.............................................. $10,488
Property and equipment...................................... 1,000
Other assets................................................ 672
Identifiable intangibles and goodwill....................... 1,519
In-process research and development......................... 2,750
Current liabilities......................................... (5,017)
-------
Cash paid................................................... $11,412
=======
</TABLE>
INTELLIFRAME - DISCONTINUED OPERATIONS
Effective December 3, 1998, the Company acquired all of the outstanding
stock of IntelliFrame Corporation (IntelliFrame), a start-up software and
services company which develops technology for legacy systems integration with
client/server and Internet technologies. The purchase price of $2,000,000 was
paid in two installments of $1,000,000 each in January 1999 and 2000. The
acquisition was accounted for as a purchase and the consolidated financial
statements of the Company include, as part of discontinued operations, the
results of IntelliFrame since December 3, 1998. The purchase price was allocated
to the fair value of the assets and liabilities acquired as follows:
<TABLE>
<S> <C>
Net tangible assets......................................... $ 148
Identifiable intangibles and goodwill....................... 1,295
In-process research and development......................... 927
Deferred tax liability...................................... (370)
------
Cash paid................................................... $2,000
======
</TABLE>
34
<PAGE> 35
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Two employees, who were former shareholders of IntelliFrame, a company we
acquired, will be eligible for aggregate bonus payments of up to $10,000,000
through December 31, 2001 if future revenue from specified products of the
Enterprise Integration Solutions Division exceed defined targets or if certain
products are sold in a transaction that does not constitute a change in control.
The potential bonus payments increase to a maximum of $12,000,000 if the Company
were to divest certain specified products of the division in calendar year 2000.
The employees may also be entitled to bonus payments of up to an aggregate of
$8.0 million (offset by bonuses previously paid) upon certain failures to market
specified products of the division prior to December 31, 2001. No bonus payments
were made in 1998 or 1999 in connection with this agreement.
INTEGRATION ACTIVITIES -- DISCONTINUED OPERATIONS
Subsequent to the acquisition of Apertus in 1997, the Company decided to
consolidate certain operations and recorded a charge of $2,184,000 for costs
incurred to integrate existing businesses, including accruals for severance,
facility closures and infrastructure integration. During the three months ended
December 31, 1999, the Company determined that it would not complete a
previously planned consolidation of facilities in the United Kingdom. As a
result, the remaining accrual for integration activities of $430,000 was
reversed and included in results from discontinued operations in the
accompanying 1999 consolidated statement of operations.
In December 1997, the Company sold the assets and technologies relating to
the vision line of products acquired from Apertus for $2,000,000 in cash, plus
additional payments ranging from $1,500,000 to $2,000,000, depending upon the
vision product line achieving a defined future revenue target. The Company did
not recognize any gain or loss upon receipt of the initial $2,000,000 cash
payment. During the six months ended June 30, 1999 and July 31, 2000, the
Company received additional payments, from the sale of the vision product line
of $667,000 and $1,210,000, respectively, which were recognized as income and
included in results from discontinued operations. There are no additional
payments to be received from the sale of the vision product line.
(5) LEASES
The Company leases all office and manufacturing space and certain equipment
under noncancelable capital and operating leases. Building leases have terms
ranging from one to 16 years. At December 31, 1998 and 1999, leased capital
assets included in property and equipment were as follows:
<TABLE>
<CAPTION>
PROPERTY AND EQUIPMENT: 1998 1999
----------------------- ------ ------
<S> <C> <C>
Office and data processing equipment........................ $2,430 $3,027
Less accumulated amortization............................... 481 1,098
------ ------
$1,949 $1,929
====== ======
</TABLE>
35
<PAGE> 36
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments, excluding executory costs such as real
estate taxes, insurance and maintenance expense, by year and in the aggregate
are as follows:
<TABLE>
<CAPTION>
MINIMUM LEASE
COMMITMENTS
--------------------
YEAR ENDING DECEMBER 31 CAPITAL OPERATING
----------------------- ------- ---------
<S> <C> <C>
2000....................................................... $ 878 $ 4,618
2001....................................................... 878 3,792
2002....................................................... 715 2,659
2003....................................................... 405 2,387
2004....................................................... -- 2,370
Thereafter................................................. -- 13,920
------ -------
Total minimum lease payments............................... 2,876 29,746
Less minimum sublease income............................... -- 849
------ -------
Net minimum lease payments................................. 2,876 $28,897
=======
Less amounts representing interest at rates ranging from
5.69% to 9.77%........................................... 408
------
Present value of minimum capital lease payments............ 2,468
Less current installments.................................. 688
------
Obligations under capital lease, less current
installments............................................. $1,780
======
</TABLE>
Rent expense under noncancelable operating leases, exclusive of executory
costs, for 1997, 1998, and 1999, was $2,765,000, $3,122,000 and $3,970,000,
respectively. The Company recently moved into a new leased facility for its
principal office and manufacturing operations. During the three months ended
December 31, 1999, the Company recognized a $1,331,000 charge for the future
costs associated with a facility that was abandoned prior to expiration of the
lease term.
(6) SHAREHOLDERS' EQUITY
COMMON STOCK REPURCHASE
On March 10, 1997 the Company's board of directors authorized the
repurchase of up to 2,000,000 shares of the Company's common stock. During 1997
and 1998, the Company repurchased 1,799,900 shares of its common stock for
$8,446,000 pursuant to this authorization. No shares were repurchased in 1999.
RIGHTS PLAN
On July 24, 1998 the Company's board of directors adopted a shareholders
rights plan pursuant to which rights were distributed as a dividend at the rate
of one preferred share purchase right for each outstanding share of common stock
of the Company. The rights will expire on July 23, 2008 unless extended, earlier
redeemed or exchanged by the Company.
STOCK OPTIONS AND RESTRICTED STOCK
The Company maintains stock option and restricted stock plans (the Plans)
which provide for the grant of stock options, restricted stock and stock based
awards to officers, other employees, consultants, and independent contractors as
determined by the compensation committee of the board of directors. A maximum of
7,430,000 shares of common stock are issuable under the terms of the Plans, of
which no more than 930,000 shares may be issued as restricted stock or other
stock based awards. As of
36
<PAGE> 37
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1999, there were 673,659 shares of common stock available for
future grants under these plans.
Restricted stock issued under the Plans is recorded at fair market value on
the date of grant and generally vest over a two to four year period. Vesting for
some grants may be accelerated if certain performance criteria are achieved.
Compensation expense is recognized over the applicable vesting period. During
1997, 1998 and 1999, the Company issued 8,000, 81,000 and 90,250 restricted
shares, respectively, having an aggregate weighted fair market value per share
of $5.16, $4.81 and $16.25, respectively. Compensation expense recognized for
restricted shares in 1997, 1998 and 1999 was $7,000, $81,000 and $316,000,
respectively.
All stock options granted under the Plans have an exercise price equal to
fair market value on the date of grant, vest and become exercisable over
individually defined periods, generally four years, and expire ten years from
the date of grant. During 1999, stock options for 800,000 shares were granted at
an exercise price of $21.88 that vest and become exercisable after six years,
except that vesting with respect to 50% of the options will accelerate in the
event the average closing sales price of the Company's common stock exceeds 150%
of the exercise price for a period of sixty consecutive trading days. Vesting
with respect to 100% of the options will accelerate if the average closing sales
price of the Company's common stock exceeds 200% of the exercise price for a
period of sixty consecutive trading days.
A summary of the status of the Company's outstanding stock options and
related changes for each of the years in the three year period ended December
31, 1999 is presented below:
<TABLE>
<CAPTION>
1997 1998 1999
------------------- ------------------- -------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
------- ------ --------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year........ 3,368 $6.19 4,321 $5.42 4,972 $ 5.63
Granted................................. 1,689 4.85 1,269 6.08 1,689 18.40
Reissued................................ 310 4.94 -- -- -- --
Exercised............................... (20) 3.80 (219) 4.66 (1,540) 5.54
Canceled................................ (1,026) 6.91 (399) 5.33 (443) 10.79
------ ----- ------
Outstanding at end of year.............. 4,321 $5.42 4,972 $5.63 4,678 $ 9.76
====== ===== ======
Exercisable at end of year.............. 1,707 $5.90 2,388 $5.71 1,901 $ 6.31
====== ===== ======
Weighted-average fair value of grants
during the year....................... $2.77 $4.48 $12.68
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- ------------------------
WEIGHTED-
AVERAGE
REMAINING WEIGHTED- WEIGHTED-
CONTRACTUAL AVERAGE AVERAGE
RANGE OF NUMBER LIFE EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING (IN YEARS) PRICE EXERCISABLE PRICE
--------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$ 3.50 - $ 4.99.......................... 1,487 7.0 $ 4.56 774 $ 4.56
$ 5.00 - $ 7.99.......................... 1,363 6.7 $ 5.88 915 $ 5.92
$ 8.00 - $14.99.......................... 937 8.5 $12.40 132 $ 9.84
$15.00 - $26.00.......................... 891 9.4 $21.60 80 $21.88
----- -----
4,678 1,901
===== =====
</TABLE>
37
<PAGE> 38
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REALLEGACY.COM, INC. STOCK OPTIONS (UNAUDITED)
We have issued options for the purchase of approximately 2.8 million shares
of common stock in RealLegacy.com, Inc., our wholly owned subsidiary including
our EAI business, to our directors and the employees and officers of
RealLegacy.com, Inc. The options have an exercise price of $2.00 per share equal
to their estimated fair market value on the date of grant, and have individually
defined terms and vesting periods.
EMPLOYEE STOCK PURCHASE PLAN
The 1992 Employee Stock Purchase Plan (the Purchase Plan) allows eligible
employees an opportunity to purchase an aggregate of 1,100,000 shares of the
Company's common stock at a price per share equal to 85% of the lesser of the
fair market value of the Company's common stock at the beginning or the end of
each six month purchase period. Under the terms of the Purchase Plan, no
participant may acquire more than 5,000 shares of the Company's common stock or
more than $2,500 in aggregate fair market value of common stock (as defined)
during any six month purchase period. Common shares sold to employees under the
Purchase Plan in 1997, 1998 and 1999 were 163,637, 153,163 and 86,972,
respectively.
The fair value of each purchase right granted in 1997, 1998 and 1999 was
$1.66, $1.57 and $6.38, respectively.
STOCK COMPENSATION
The Company has elected to continue to account for its plans in accordance
with APB No. 25. Accordingly, no compensation cost related to stock option
grants or shares sold to employees under the Employee Stock Purchase Plan has
been recognized in the Company's financial statements. Had compensation cost for
the Company's stock-based compensation plans been recognized consistent with the
fair value method of SFAS No. 123, the Company's net income (loss) and net
income (loss) per basic and diluted share would have been reduced to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1998 1999
------- ------ ------
<S> <C> <C> <C>
Net income (loss):
As reported...................................... $(2,314) $4,729 $4,655
Pro forma........................................ $(3,826) $2,580 $ (795)
Net income (loss) per share:
As reported
Basic......................................... $ (.10) $ .21 $ .20
Diluted....................................... $ (.10) $ .21 $ .18
Pro forma
Basic......................................... $ (.17) $ .12 $ (.03)
Diluted....................................... $ (.17) $ .11 $ (.03)
</TABLE>
The pro forma disclosures presented above do not reflect the full impact of
stock based compensation on the Company's reported results under the recognition
provisions of SFAS No. 123 because compensation expense is reflected over the
vesting period of the award and compensation expense for awards granted prior to
January 1, 1995 are not considered.
In determining the compensation cost of stock option grants and shares sold
to employees under the employee stock purchase plan, as specified by SFAS No.
123, the fair value of each award has been
38
<PAGE> 39
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
estimated on the date of grant using the Black-Scholes option pricing model. The
weighted average assumptions used in these calculations are summarized below:
<TABLE>
<CAPTION>
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Risk free interest rate............................. 6.42% 5.26% 5.64%
Expected life....................................... 8.14 8.41 5.23
Expected volatility................................. 39.30% 67.50% 79.66%
</TABLE>
(7) NET INCOME (LOSS) PER SHARE
The components of net income (loss) per basic and diluted share are as
follows:
<TABLE>
<CAPTION>
WEIGHTED
NET INCOME AVERAGE SHARES PER SHARE
(LOSS) OUTSTANDING AMOUNT
---------- -------------- ---------
<S> <C> <C> <C>
1997:
Basic.................................... $(2,314) 22,702 $(.10)
Dilutive effect of employee stock
purchase awards and options........... -- -- --
------- ------ -----
Diluted.................................. $(2,314) 22,702 $(.10)
======= ====== =====
1998:
Basic.................................... $ 4,729 22,095 $ .21
Dilutive effect of employee stock
purchase awards and options........... -- 477 --
------- ------ -----
Diluted.................................. $ 4,729 22,572 $ .21
======= ====== =====
1999:
Basic.................................... $ 4,655 23,137 $ .20
Dilutive effect of employee stock
purchase awards and options........... -- 2,681 (.02)
------- ------ -----
Diluted.................................. $ 4,655 25,818 $ .18
======= ====== =====
</TABLE>
39
<PAGE> 40
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) INCOME TAXES
The components of income from continuing operations before income taxes and
income tax expense (benefit) for each of the years in the three-year period
ended December 31, 1999 consists of the following:
<TABLE>
<CAPTION>
1997 1998 1999
------- ------ -------
<S> <C> <C> <C>
Income from continuing operations before income
taxes:
U.S. ........................................ $ 763 $4,251 $ 6,356
Foreign...................................... (2) 838 199
------- ------ -------
Total................................... $ 761 $5,089 $ 6,555
======= ====== =======
Income tax provision:
Current:
U.S. ..................................... $ 685 $ 693 $ 3,356
Foreign................................... -- 277 60
State..................................... 79 254 749
------- ------ -------
Total current........................... 764 1,224 4,165
------- ------ -------
Deferred:
U.S. ..................................... (358) 453 (1,525)
State..................................... (94) 53 (411)
------- ------ -------
Total deferred.......................... (452) 506 (1,936)
------- ------ -------
Total income tax expense....................... $ 312 $1,730 $ 2,229
======= ====== =======
</TABLE>
The reconciliation of the statutory federal tax rate and the effective tax
rate for each of the years in the three-year period ended December 31, 1999 is
as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----- ---- ----
<S> <C> <C> <C>
Statutory tax rate.................................... 34.0% 34.0% 34.0%
Increase (decrease) in taxes resulting from:
State taxes, net of federal tax benefit............. 1.3 4.0 3.4
Foreign sales corporation........................... (35.0) (6.3) (5.3)
Meals and entertainment............................. 11.8 1.2 1.1
Change in valuation allowance....................... 28.1 -- --
Other............................................... .8 1.1 .8
----- ---- ----
Total................................................. 41.0% 34.0% 34.0%
===== ==== ====
</TABLE>
40
<PAGE> 41
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the Company's deferred tax assets and (liabilities) as of December
31, 1998 and 1999 was as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1998 1999
------ -------
<S> <C> <C>
Deferred tax assets:
Inventory............................................... $ 993 $ 1,556
Accrued compensation.................................... 808 847
Property and equipment.................................. 848 869
Reserves for bad debts and sales returns................ 258 135
Foreign net operating loss carryforwards................ 410 410
Federal and state tax credits........................... 373 1,083
Federal and state net operating loss carryforwards...... -- 118
Abandoned facility...................................... -- 512
Other................................................... 491 648
------ -------
Total gross deferred tax assets......................... 4,181 6,178
Valuation allowance..................................... (410) (410)
------ -------
Net deferred tax assets......................... 3,771 5,768
------ -------
Deferred tax liabilities:
Other................................................... (222) (283)
------ -------
Total gross deferred tax liabilities.................... (222) (283)
------ -------
Net deferred tax assets......................... $3,549 $ 5,485
====== =======
</TABLE>
The Company recorded a valuation allowance at December 31, 1998 and 1999 of
$410,000 for the tax benefits associated with certain losses incurred from
foreign operations. At December 31, 1999, the Company had net operating loss and
credit carryforwards available for federal tax purposes of approximately
$1,558,000 and $483,000, respectively, which will expire during the years 2001
through 2019.
The Company has assessed its taxable earnings history and prospective
future taxable income. Based on this assessment, management has determined that
it is more likely than not that its net deferred tax assets will be realized in
future periods. The Company may be required to provide a valuation allowance for
this asset in the future if it does not generate sufficient taxable income as
planned.
(9) SUCCESS SHARING BONUS PLAN
The Company's Success Sharing Bonus Plan provides a formula for
determination of cash bonus payments to eligible employees based on a defined
percentage of a participant's qualifying base compensation multiplied by the CNT
Performance Factor (CPF). The CPF is derived from a matrix formulated by the
board of directors with axes consisting of defined levels of revenue growth and
pre-tax profit.
The success sharing bonus expense for 1997, 1998, and 1999 was $43,000,
$1,673,000, and $420,000 respectively.
(10) 401(k) AND DEFERRED COMPENSATION PLANS
The Company has a 401(k) salary savings plan which covers substantially all
of its employees. The Company matches 100% of a participant's annual plan
contributions up to an annual maximum per participant of $1,500 which vests over
a four year period.
41
<PAGE> 42
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has also established an executive deferred compensation plan
for selected key employees which allows participants to defer a substantial
portion of their compensation each year. The Company matches 20% of a
participant's annual plan contributions up to an annual maximum per participant
of $10,000. Matching contributions vest over a four year period from the later
of July 1, 1997 or the participant's date of hire. In addition, the Company
provides participants with an annual earnings credit based on the investment
indexes selected by the participant prior to the start of each plan year.
The Company's expense under the 401(k) and deferred compensation plans for
1997, 1998 and 1999 was $380,000, $570,000 and $470,000, respectively.
(11) SEGMENT INFORMATION
Information with respect to the Company's foreign operations is summarized
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
-------------------------------
1997 1998 1999
------- -------- --------
<S> <C> <C> <C>
Revenue:
United States............................................. $56,750 $ 69,655 $ 82,494
United Kingdom............................................ 6,243 9,596 13,402
France.................................................... 1,763 5,479 4,348
Other..................................................... 15,439 18,291 25,745
------- -------- --------
Total............................................. $80,195 $103,021 $125,989
======= ======== ========
Long -- Lived Assets (end of year):
United States............................................. $16,272 $ 18,454 21,464
United Kingdom............................................ 781 1,049 901
Other..................................................... 265 570 265
------- -------- --------
Total............................................. $17,318 $ 20,073 $ 22,630
======= ======== ========
</TABLE>
Revenue has been attributed to the country where the end-user customer is
located.
No single customer accounted for more than 10% of the Company's total
revenue in 1997, 1998 or 1999.
(12) NONCASH FINANCING AND INVESTING ACTIVITIES AND SUPPLEMENTAL CASH FLOW
INFORMATION
Cash payments for interest expense in 1997, 1998, and 1999 were $57,000,
$79,000, and $222,000, respectively.
Cash payments for income taxes, net of refunds received, in 1997, 1998 and
1999 were $986,000, $331,000 and $2,116,000, respectively.
During 1997, 1998, and 1999, the Company entered into capital lease
obligations for equipment valued at $989,000, $1,441,000 and $653,000,
respectively.
(13) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair values
of financial instruments:
The carrying amount for cash and cash equivalents, marketable securities,
accounts receivable and long-term obligations approximates fair value because of
the short maturity of those instruments.
42
<PAGE> 43
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COMPUTER NETWORK TECHNOLOGY CORPORATION
Dated: September 21, 2000 By: /s/ Gregory T. Barnum
-----------------------------------
Name: Gregory T. Barnum
Title: Chief Financial Officer
43
<PAGE> 44
EXHIBIT INDEX
--------------------------------------------------------------------------------
EXHIBIT DESCRIPTION
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
12.1 Statement Regarding Computation of Ratios for the Year
Ended December 31, 1999 and Prior Years
--------------------------------------------------------------------------------
23.1 Consent of KPMG LLP
--------------------------------------------------------------------------------
44
