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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER: 0-13994
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COMPUTER NETWORK TECHNOLOGY CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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MINNESOTA 41-1356476
(State or Other Jurisdiction of Incorporation (I.R.S. Employer Identification No.)
or Organization)
6000 NATHAN LANE NORTH, PLYMOUTH, MINNESOTA 55442
(Address of Principal Executive Offices) (Zip Code)
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(763) 268-6000
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01
par value
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of Common Stock held by non-affiliates of the
Registrant as of March 1, 2000 was approximately $601,643,000 based on a closing
price of $25.56 per share as reported by the Nasdaq National Market on such
date.
As of March 1, 2000 Registrant had 23,893,295 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Computer Network Technology Corporation's definitive Proxy
Statement for the Annual Meeting of Shareholders to be held on May 25, 2000 are
incorporated by reference into Part III of this Form 10-K.
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TABLE OF CONTENTS
PART 1
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Item 1. Business.................................................... 1
Overview.................................................. 1
Recent Accomplishments; Potential Divestiture of
Enterprise Integration Solutions Division................. 2
Networking Solutions Division............................. 2
Enterprise Integration Solutions Division................. 9
Professional Services..................................... 11
Other Product Support..................................... 11
Sales and Marketing....................................... 11
Research and Development.................................. 11
Manufacturing and Suppliers............................... 12
Competition............................................... 13
Intellectual Property Rights.............................. 13
Employees................................................. 14
Special Note Regarding Forward Looking Statements......... 14
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to Vote of Security Holders........... 16
Item 4.A Executive Officers of the Company........................... 16
PART II
Item 5. Market for the Registrant's Securities and Related
Shareholder Matters......................................... 18
Item 6. Selected Consolidated Financial Information................. 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
Item 7.A Quantitative and Qualitative Disclosures about Market
Risk........................................................ 29
Item 8. Consolidated Financial Statements and Supplementary Data.... 30
Item 9. Changes in and Disagreements with Accountants and Financial
Disclosure.................................................. 51
PART III
Item 10. Directors and Executive Officers............................ 52
Item 11. Executive Compensation...................................... 52
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 52
Item 13. Certain Relationships and Related Transactions.............. 52
PART IV
Item 14. Exhibits, Consolidated Financial Statement Schedules, and
Reports on Form 8-K......................................... 53
SIGNATURES.............................................................. 58
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PART I
ITEM 1. BUSINESS
BUSINESS
OVERVIEW
We are principally a provider of hardware and software products for storage
area networks, or SANs. A SAN is a high speed network within a business's
existing computer system that allows the business to manage its expanding data
storage needs with greater efficiency and less disruption to its overall
network. We design, manufacture, market and support a wide range of products for
critical SAN applications such as remote disk mirroring, or the real time
back-up of data to remotely located disks, and remote tape vaulting, or the
back-up of data to remotely archived tapes. Our revenues from our SAN products
were approximately $53.6 million, $31.9 million and $6.6 million for the years
ended December 31, 1999, 1998 and 1997, respectively.
We operate as two separate divisions -- the Networking Solutions Division
and the Enterprise Integration Solutions Division. Our Networking Solutions
Division sells SAN products and our established channel networking products. Our
Enterprise Integration Solutions Division develops and sells enterprise
application integration, or EAI, software that automates the integration of
computer software applications, as well as our traditional server gateways and
tools, which enable multiple desktop computers and mainframe terminals to
communicate with one another. Both divisions offer professional consulting and
support services. Information regarding segment revenues and other segment
information is included in note 13 to our consolidated financial statements
included herewith.
Our SAN products enable businesses to cost-effectively manage their
increasing storage requirements, flexibly add to and reconfigure their existing
SANs, provide faster access to greater amounts of data, protect their data more
efficiently and protect increasing amounts of data. Our SAN products consist
primarily of our UltraNet(R) and Channelink(R) families of products. We market
our SAN products directly to customers and through worldwide distributors and
original equipment manufactures, or OEMs, including Compaq, IBM and StorageTek.
We also have strategic marketing partnerships with leading storage industry
companies, including Brocade, EMC, Hitachi Data Systems, Legato and SCH.
We believe we were the first to develop, and remain a leader in, the
following SAN applications:
- SANs over wide area networks, or WANs. WANs are networks dispersed over
long distances that communicate by third party telecommunications lines.
SANs over WANs allow businesses to manage and protect data across remote
locations, in real-time if necessary, through applications such as remote
disk mirroring and remote tape vaulting.
- Fibre Channel-based SANs over WANs. Fibre Channel is a recently developed
technology that dramatically improves the speed of data input and output,
or I/O, between existing SAN storage devices and the ability to connect
additional devices to SANs.
- SANs over IP-based networks. In conjunction with EMC, we recently
introduced the first product to allow remote disk mirroring to be
deployed over private networks that are based on Internet protocol, or
IP, the standard method for data transmission over the Internet. This
product will uniquely enable businesses that use virtual private IP-based
networks, including many Internet businesses, to build SAN over WAN
applications.
Our SAN solutions operate across all business computing environments,
including open systems, servers and mainframes. Open systems and servers are
newer systems that are easy to scale, or expand, and that use hardware and
software standards not proprietary to any vendor. Mainframes are computer
systems with high processing power that have historically been used by large
businesses for storing and processing large amounts of data. Compared to
available alternatives, we believe our SAN products offer greater ability to
connect various applications and heterogeneous environments using different
interfaces, protocols and standards, and to connect and link devices in SANs
transparently, meaning with little or no alteration of other vendors' hardware
or software products.
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We believe our recent introduction of our product that enables SAN
applications over IP-based networks will benefit existing customers and expand
our reach into the rapidly growing Internet market. This product extends the
"bandwidth on demand" advantages of IP-based networks into storage applications
and allows customers to access telecommunications capacity only as needed
through a general connection, as opposed to leasing expensive dedicated lines.
In addition to cost-savings, our IP-based network product allows customers to
save the time traditionally associated with procuring leased lines. We believe
that these cost and time savings, along with the generally expected decreasing
costs of telecommunications capacity, will create high-growth opportunities for
us in remote disk mirroring and future SAN applications we enable. In addition,
as Internet companies typically generate large amounts of critical data relative
to their size, they should further increase demand for our products. Current
customers using our SAN over IP solutions include MCI Worldcom, [email protected]
and Neoforma.com.
RECENT ACCOMPLISHMENTS; POTENTIAL DIVESTITURE OF ENTERPRISE INTEGRATION
SOLUTIONS DIVISION
SAN applications over IP-based networks. In conjunction with EMC, we
recently introduced products to enable remote disk mirroring over IP-based
networks using EMC's widely used Symetrix Remote Data Facility, or SRDF,
software. SRDF software controls the complex data copy and data recovery process
used in remote disk mirroring. While our current IP solution works exclusively
with SRDF, we anticipate expanding our product offering to other vendors.
Reseller agreement with Compaq. In November 1999, Compaq 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.
StorageTek reseller agreement and asset acquisition. In November 1999, we
entered into a three-year agreement with StorageTek, under which it will resell
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 responsibility 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.
On January 3, 2000, we announced our intention to explore the divestiture
of all or part of the Enterprise Integration Solutions Division. Currently, the
Networking Solutions Division and the Enterprise Integration Solutions Division
have distinct and unrelated operations, products and core markets. We believe a
divestiture of this division will allow management of our separate divisions to
better focus on their core businesses and potentially enhance the prospects and
results of operations of each division.
We have been focusing on the relative benefits and feasibility to both
divisions of a divestiture of all or part of the Enterprise Integration
Solutions Division, the potential benefits to be obtained, and whether to
structure the divestiture as a sale or spin-off. We have engaged in discussions
with several parties concerning the sale of this division. No final decisions
regarding the feasibility, nature, timing or structure of such a transaction
have been reached and such divestiture may not occur. We will continue to invest
in our Enterprise Integration Solutions Division as we evaluate possible options
for this division over the next few months.
NETWORKING SOLUTIONS DIVISION
SAN INDUSTRY BACKGROUND
Growth in Enterprise Data
We believe several forces will continue to drive the demand for our SAN
products:
- The demand for network storage capacity is growing rapidly. The volume of
enterprise data is increasing significantly as businesses move toward
more electronic transactions, such as email, e-commerce, credit card
purchases and Web-based content distribution.
- Actual and expected declines in telecommunications costs will make remote
disk mirroring and remote tape back-up applications more cost effective
for our customers.
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- SAN applications over IP-based networks will further expand the type and
amount of data our customers will back-up and disk mirror to remote
locations, and also bring Internet companies into our customer base.
- The proliferation of the Internet has created new industries in Web
hosting, or the storing of Web-based data, for e-commerce and other
Internet companies by third parties, and data caching, or the storing of
frequently accessed Web-based data at multiple locations.
As a result of the foregoing and other factors, International Data
Corporation estimates that disk storage accessed by users grew from
approximately 10,000 terabytes, or ten thousand trillion characters, in 1994 to
approximately 116,000 terabytes in 1998. This figure is estimated to reach
approximately 1,400,000 terabytes in 2002, which reflects a compound growth rate
of 86% per year. Further, global spending on SAN-related solutions is estimated
to grow from approximately $250 million in 1998 to an estimated $2.4 billion in
2002, according to Dataquest. These increasing volumes of data are challenging
businesses to implement systems that allow users to share, access and protect
information across the enterprise.
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 numbers 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 back-up 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, where operating
computers and storage devices are at different locations, often at great
distances from one another. Consequently, solutions are required that address
the following:
- Distance -- Customers require products that support transfers over
unlimited distances. Fibre Channel supports a maximum connection distance
of 10 kilometers. Transmission across third party phone 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, T1 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.
- Seamless storage solutions -- Distance and connectivity issues prevent
remote fault-tolerant and disaster-proof storage solutions and
interconnectivity of LANs to WANs. As a result, users are required to
manually handle and transport their storage back-up tapes to off-site
locations, resulting in additional expenses and inefficient data
recovery.
- 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 back-up of only the most mission critical
data. Customers require SAN solutions that utilize less expensive
IP-based networks in order to remotely back-up greater amounts of
information and make greater use of SAN advantages.
OUR SAN SOLUTIONS
Our SAN 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 and scalability -- Our products are protocol
independent -- they can connect devices that use Fibre Channel, SCSI,
ESCON, bus and tag, T1 and TCP/IP protocols. Our products leverage
leading technologies, such as Fibre Channel, and complement our
customers' existing LAN/WAN infrastructures without burdensome hardware
and software changes. Our products allow distributed storage to be
consolidated from multiple servers to one storage device, which in turn
can be accessed by a virtually unlimited number of servers.
- IP-Based Network Solutions -- We currently enable EMC's SRDF software,
which controls the complex copy and data recovery process of data
mirroring, to operate over IP-based networks. This solution allows our
customers to capitalize on the inexpensive bandwidth on demand
capabilities of IP-based networks and improve time-to-market through
faster network deployment over existing IP infrastructures, which is
especially critical for new start-ups and Internet companies. While our
IP solution currently operates only in conjunction with EMC's product
offerings over virtual private networks, meaning private
telecommunications lines using the IP protocol, we anticipate expanding
the product offering to work with products of other storage vendors and
over the public Internet.
OUR SAN STRATEGY
We intend to build upon our position as a leading provider of networking
storage 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. Our
recent introduction of SAN applications over
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IP-based networks is an example of this strategy. We intend to build market
share by continuing to focus on areas which make SANs more useful, 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 over
virtual private networks in conjunction with EMC's SRDF software products. We
are currently developing solutions to facilitate other SAN applications,
including remote tape vaulting, as well as solutions which will operate in
conjunction with the product offerings of other storage vendors. Longer term, we
intend to develop solutions for use over the public Internet infrastructure.
Partner with SAN Industry Leaders
We have established relationships with leaders in the SAN market, including
storage vendors, storage management software providers and Fibre Channel switch
manufacturers. Our strategic partners include companies such as Brocade, Compaq,
EMC, Hitachi Data Systems, IBM, Legato, SCH 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, install, manage
and grow data centers and storage networks. We believe this value-added
professional service assists customers in installing and managing data centers
and storage networks better than they could on their own. Our product
implementation planning and turn-key installations bolster sales of our products
and allow us to generate high margin revenues.
Offer Bundled Storage and Telecommunication Solutions
Currently, we partner with telecommunications providers to offer a bundled
solution that contains our SAN solutions and a telecommunication service. It is
our intent to partner with storage service providers who will offer our products
as part of their outsourced storage solutions. This will allow our customers to
obtain end-to-end solutions from a single vendor.
OUR SAN PRODUCTS
Our SAN products include the UltraNet(R) family of storage products, and
our channel networking product known as Channelink(R).
UltraNet(R) Storage Director is a high performance switching application
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. 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 remote disk mirroring applications.
UltraNet(R) Open Systems Director is based on the same architecture as the
UltraNet(R) Storage Director. It allows large numbers of SCSI and Fibre Channel
storage devices to be shared in an open systems environment.
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UltraNet(R) Open Systems Gateway provides much of the same functionality
and performance of the UltraNet(R) Open Systems Director at a lower entry price.
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.
Channelink(R) offers connectivity over unlimited distances and is used for
remote disk mirroring and remote tape vaulting in environments using older
protocols.
APPLICATIONS FOR OUR SAN SOLUTIONS
Our SAN solutions are used for immediate, or real-time, back-up 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 back-ups by simultaneously creating up-to-the-minute images
of business-critical data on multiple back-up storage disks. Our remote disk
mirroring technology permits the back-ups 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, back-ups can be instantly made to
remote locations on disk media, including by disk mirroring, or on tape, known
as electronic tape vaulting. The benefit is secure archiving and timely
retrieval of the correct business-critical data.
OUR SAN PARTNERS
Offering customers effective SAN 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 SAN
alliances include those with key storage vendors, storage management software
providers and manufacturers of Fibre Channel products. We market our SAN
products directly through worldwide distributors and OEMs, including Compaq, IBM
and StorageTek. We also have strategic marketing partnerships with leading
storage industry companies, including Brocade, EMC, Hitachi Data Systems, Legato
and SCH. 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
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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. In the year ended December 31, 1999,
sales of our SAN products to customers using EMC's disk mirroring systems
accounted for 30% of our total product revenues and 35% of our Networking
Solutions Division product revenues. We also 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 disaster avoidance and
recovery capability and remote disk mirroring applications.
StorageTek
We recently entered into a three-year agreement with StorageTek under which
it will re-sell 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 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 on June 7, 1999. We believe the combination of our
UltraNet(R) SAN 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 NETWORKING SOLUTIONS 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.
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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 IT 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 Implementation Services
Our professional services help companies implement SAN solutions.
Implementation includes project planning, designing and documenting a detailed
network, installing SAN components, configuring SAN components, and testing the
functionality of the implemented SAN solution. Our networking equipment is at
the heart of our SANs implementations, and our long-standing partnerships with
well-known and successful storage equipment and software manufacturers place us
at the forefront of SAN technology.
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ENTERPRISE INTEGRATION SOLUTIONS DIVISION
EAI INDUSTRY BACKGROUND
Almost all businesses have made considerable investments in their
information technology infrastructure. The distributed processing infrastructure
used by large organizations typically includes mainframes, open systems and
Internet architectures. Integrating existing and open systems has historically
proved problematic for corporations seeking to leverage their investment in
existing technology. Some vendors have offered middleware products as a partial
solution to solve these time and expense problems relating to integrating legacy
and open systems. Middleware software, while providing a connection between
disparate applications, databases and transaction processing systems, has
historically suffered from a variety of shortcomings. As a result, vendors are
developing EAI products to address the historical limitations of middleware,
including products that offer decreased maintenance efforts, a reduced level of
skill required to integrate applications and a central point to control
distributed networks. EAI products also offer the value-added promise of being
able to put business knowledge and rules into an application network.
Dataquest estimates sales of EAI products will grow from approximately $250
million in 1998 to approximately $1.4 billion in 2002. Growth in industry sales
is expected to be driven by:
- Value of information -- increasingly businesses view information as a
strategic asset. Users require immediate access to information to provide
quality customer service and to make business decisions.
- Mergers and acquisitions -- the parties to such transactions must
integrate data processing structures to realize the cost benefits from
the transaction and the revenue benefits of cross selling to customers.
- Re-engineering -- EAI products permit rapid development of new systems so
that businesses can adapt to changing trends, like e-commerce.
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, a technology we acquired as part of our acquisition of
IntelliFrame, includes new tools that provide business logic, rules and process
work flow management for improved development and deployment of large e-commerce
and CRM applications. With InVista, our EAI solution will be able to do more
than just display information -- it will be able to suggest alternative courses
of action. For instance, InVista 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. We anticipate distributing test versions of
our EAI product incorporating InVista technology during the first half of
calendar year 2000.
9
<PAGE> 12
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 2000 is a development tool that permits legacy
applications to be linked real-time with new business applications. The product
will include InVista technology when our research and development is complete.
Enterprise/Access 2000 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 2000 provides one of the fastest ways to e-commerce by
enabling the easy reuse of existing legacy application programs. Key features of
Enterprise/Access 2000 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.
ENTERPRISE INTEGRATION SOLUTIONS BUSINESS PARTNERS
Our business partner program couples us with vendors of complementary
products and systems integrators who provide us with valuable distribution
channels.
Cap Gemini
Cap Gemini uses our Enterprise/Access 2000 product for developing corporate
intranets and extranets that require access to mainframe systems. Cap Gemini
used the Enterprise/Access product to develop a working prototype for Telecom
Italia that allows browser-based access to legacy data.
Deloitte Consulting and PricewaterhouseCoopers
We believe Deloitte Consulting's and PricewaterhouseCoopers' trained
professionals will provide a knowledgeable base of consultants to recommend and
implement our EAI products. We anticipate that these relationships will enhance
sales and provide an additional distribution and implementation channel.
Siebel Systems
Siebel, who is the world's leading supplier of CRM software, focuses on
software for field sales, customer service, telesales, telemarketing, field
service third-party resellers and Internet based e-commerce and self-service.
Siebel references our Enterprise/Access 2000 product that integrates with
Siebel's products to give users easy, real-time access to customer information
from back-office legacy applications, minicomputers and open systems.
10
<PAGE> 13
PROFESSIONAL SERVICES
We have developed a number of professional services programs to help
customers meet their business objectives on time and within budget:
Proof of Concept: We provide prototype applications to help customers
gain confidence with the selected product in the context of their own
system design.
Project Mentoring: We offer ongoing consulting support throughout a
project's lifecycle, ensuring that customers have the support they need for
a successful implementation.
System Architecture and Design: We provide large-scale system design,
including transaction definition, process diagrams and logic flows.
Development and Deployment: We provide complex, business-critical
application development as well as ongoing management of deployed
applications.
Adoption: We provide services such as architecture, design and code
review as well as implementation training.
OTHER PRODUCT SUPPORT
Both divisions offer standard maintenance contracts. 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 the products of both our divisions in the United States through a
direct sales force. We have established representative offices in Canada, the
United Kingdom, France, Germany, Australia, Japan, The Netherlands, Brazil and
Mexico. We also market the products of both divisions in the United States and
throughout the world through OEMs, systems integrators and independent
distributors.
Each division maintains its own marketing staff and direct sales force.
While the customer bases of the divisions overlap, the persons who evaluate and
authorize product purchases at customer organizations are usually different. The
Networking Solutions Division currently employs approximately 167 persons in its
marketing and sales organization, and the Enterprise Integration Solutions
Division currently employs approximately 50 persons in its marketing and sales
organization.
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 and EAI products. Each division
maintains its own research and development staff.
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.
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<PAGE> 14
Research and development expenses were equal to 16% of our total revenue in
1999, compared to 16% and 18% of total revenue in 1998 and 1997, 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 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.
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 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.
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<PAGE> 15
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 Ancor, Computerm, Crossroads, Data Switch, Gadzoox, McData,
Network Systems, StorageTek and Vixel. IBM and Cisco Systems currently compete
with us in the server gateways and tools area. Neon Systems and TSI currently
compete with our Enterprise/Access 2000 product. Neon Systems and TSI have
product suites with broader capabilities than our EAI products, although we
believe our EAI products occupy a special market niche with respect to access to
legacy systems.
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 SAN and EAI 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 and server gateways and tools
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.
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 seven patent applications filed or
in the process of being filed in the United States. 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 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 are also dependent upon a patent license agreement to manufacture our
Channelink(R) and UltraNet(R) products that use ESCON. This license expired on
December 31, 1999. We believe the license can be renewed on terms that would not
materially harm our operating results. If we are unable to renew this license,
we may be prohibited from further use of the subject technology and our
operating results and financial condition could be materially harmed.
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
13
<PAGE> 16
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 December 31, 1999, we had 691 full-time employees. On that date, 137
full-time employees provided services to both divisions and are members of our
administrative and manufacturing departments. On that date, the Networking
Solutions Division had 427 employees and the Enterprise Integration Solutions
Division had 127 employees. 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.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-K and other documents we have filed with the Securities and
Exchange Commission contain forward-looking statements, which may include
statements about our:
- anticipated receipt of orders;
- business strategy;
- timing of and plans for the introduction or phase-out of products or
services;
- enhancements of existing products or services;
- plans for hiring additional personnel;
- entering into strategic partnerships; and
- other plans, objectives, expectations and intentions contained in this
Form 10-K that are not historical facts.
When used in this prospectus, the words "may," "should," "expect," "plan,"
"anticipate," "believe," "estimate," "predict," "intend," "potential" or
"continue" and similar expressions are generally intended to identify
forward-looking statements. Because these forward-looking statements involve
risks and uncertainties, actual results could differ materially from those
expressed or implied by these forward-looking statements for a number of
reasons, including those discussed under cautionary statements included as
Exhibit 99 and elsewhere in this Form 10-K. We assume no obligation to update
any forward-looking statements. These statements are only predictions. Although
we believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements.
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<PAGE> 17
ITEM 2. PROPERTIES
FACILITIES AND PROPERTIES
Our principal administrative, manufacturing, engineering and development
functions are located in leased facilities in the Minneapolis, Minnesota suburb
of Plymouth. We also lease space in Westborough, Massachusetts, primarily for
the development and support of software products for our Enterprise Integration
Solutions Division. We lease space 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.
ITEM 3. LEGAL PROCEEDINGS
We are currently not a party to any legal proceedings that could materially
harm our business.
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<PAGE> 18
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers are as follows:
<TABLE>
<CAPTION>
NAME POSITION SERVED AGE
- ---- ------------------------------------------------- ---
<S> <C> <C>
Thomas G. Hudson.................. Chairman of the Board, President and Chief 53
Executive Officer
Gregory T. Barnum................. Chief Financial Officer, Vice President of 45
Finance and Corporate Secretary
Jeffrey A. Bertelsen.............. Corporate Controller and Treasurer 37
Richard E. Carlson................ Vice President of Manufacturing 62
William C. Collette............... Chief Technology Officer and Vice President of 56
Advanced Technology
Peter Dixon....................... Vice President of Worldwide Business Development 50
and Product Marketing
Nick V. Ganio..................... Group Vice President of Worldwide Sales, 40
Marketing and Services
Mark R. Knittel................... Group Vice President of Worldwide Product 45
Operations
Kristine E. Ochu.................. Vice President of Human Resources 38
</TABLE>
Thomas G. Hudson has served as President and Chief Executive Officer since
June 1996, as a director since August 1996 and Chairman of the Board since May
1999. From 1993 to June 1996, Mr. Hudson served as Senior Vice President of
McGraw Hill Companies, a leading information services provider, serving as
General Manager of its F.W. Dodge Division, and as Senior Vice President,
Corporate Development. From 1968 to 1993, Mr. Hudson served in a number of
management positions at IBM, most recently as Vice President Services Sector
Division. Mr. Hudson's IBM career included varied product development, marketing
and strategic responsibilities for IBM's financial services customers and
extensive international and large systems experience. Mr. Hudson is a graduate
of the University of Notre Dame and New York University. Mr. Hudson attended the
Harvard Advanced Management Program in 1990.
Gregory T. Barnum was appointed Vice President of Finance, Chief Financial
Officer and Corporate Secretary in July 1997. From September 1992 to July 1997,
Mr. Barnum served as Senior Vice President of Finance and Administration, Chief
Financial Officer and Corporate Secretary at Tricord Systems, Inc., a
manufacturer of enterprise servers. From May 1988 to September 1992, Mr. Barnum
served as the Executive Vice President, Finance, Chief Financial Officer,
Treasurer and Corporate Secretary for Cray Computer Corporation, a development
stage company engaged in the design of supercomputers. Prior to that time, Mr.
Barnum served in various accounting and financial management capacities for Cray
Research, Inc., a manufacturer of supercomputers. Mr. Barnum is a graduate of
the University of St. Thomas.
Jeffrey A. Bertelsen was appointed Corporate Controller and Treasurer in
December 1996. Mr. Bertelsen served as our Controller from March 1995 to
December 1996. From 1985 to March 1995, Mr. Bertelsen was employed by KPMG LLP,
a public accounting firm, most recently as a Senior Audit Manager. Mr. Bertelsen
is a graduate of the University of Minnesota.
Richard E. Carlson was appointed Vice President of Manufacturing in January
1992. Mr. Carlson served as Director of Manufacturing from August 1990 to
January 1992. From 1981 to 1990, Mr. Carlson was employed by Zycad Corporation,
a manufacturer of special purpose computers, and most recently served as Vice
President of Product Development and Operations. Mr. Carlson holds a bachelor of
science degree in mechanical engineering from the University of Minnesota. Mr.
Carlson retired in March of 2000.
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<PAGE> 19
William C. Collette was appointed Chief Technology Officer in December 1998
and Vice President of Advanced Technology in October 1999. Mr. Collette served
as our Vice President of Engineering from December 1995 to October 1999, and as
our Director of Future Software Development and as a Software Development
Manager from June 1993 to December 1995. From 1990 to 1993, Mr. Collette was
employed by SuperComputer Systems, Inc. as a Senior Software Engineer, where he
worked with Steve Chen to design the networking for the SS1 Supercomputer. Mr.
Collette holds a bachelors degree in business management from Metro State
University.
Peter Dixon was appointed Vice President of Worldwide Business Development
in November 1998 and Vice President of Product Marketing in October 1999. Mr.
Dixon served as our Vice President of Worldwide Distribution from March 1998 to
November 1998, Vice President of International Sales from January 1990 to March
1998, Vice President of Strategic Account Marketing from January 1989 to January
1990 and as Director of Distribution Marketing and Sales from February 1988 to
January 1989. From 1985 to 1988, Mr. Dixon served as an Account Manager with
National Advanced Systems Canada, Inc. and its predecessor, Sand Technology
Systems, Inc., companies involved in the marketing of mainframe peripherals.
Nick V. Ganio was appointed Group Vice President of Worldwide Sales,
Marketing and Services in October 1999. From November 1998 to October 1999, Mr.
Ganio served as Vice President of Worldwide Sales and also as Vice President of
Direct Sales Worldwide from April 1998 to November 1998. From September 1996 to
February 1998, Mr. Ganio served as Vice President of Worldwide Sales and
Marketing for Xyplex, Inc. From March 1987 to September 1996, Mr. Ganio held
various high-level positions with Digital Equipment Corporation, including Vice
President of Operations in Japan, Vice President and General Manager of the
Americas Networks Product business and Vice President and Executive Assistant to
the Office of President. Mr. Ganio held various sales positions with IBM from
May 1981 to February 1987. Mr. Ganio holds a bachelors degree, magna cum laude
from Bernard Baruch College.
Mark R. Knittel was appointed Group Vice President of Worldwide Product
Operations in October 1999. From May 1997 to October 1999, Mr. Knittel served as
our Vice-President of Marketing and also as our Vice President of Architecture
and Business Development from March 1997 to May 1997. From July 1977 to March
1997, Mr. Knittel was employed with IBM where he held several executive
development positions for both hardware and software networking products, as
well as multiple strategy positions. Most recently, Mr. Knittel held the
position of Director of Campus Product Marketing within the Network Hardware
Division of IBM. Mr. Knittel has a masters degree in philosophy from the
University of Chicago.
Kristine E. Ochu was appointed Vice President of Human Resources in March
1996 and served as our Director of Human Resources from May 1995 to March 1996.
From January 1994 to May 1995, Ms. Ochu was employed by Data Systems and
Management, a software development company, as Manager of Human Resources. From
1991 to 1994, Ms. Ochu was employed as a Director of Human Resources by
DataCard, Inc., a diversified high technology manufacturing company. Ms. Ochu
holds a bachelors degree in psychology and a masters degree in industrial
relations from the University of Minnesota. Ms. Ochu attended the University of
Michigan Advanced Human Resources Executive Program in 1996.
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<PAGE> 20
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S SECURITIES AND RELATED SHAREHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock is traded on the Nasdaq National Market under the symbol
"CMNT." The following table sets forth for the indicated periods the range of
high and low per share sales prices for our common stock as reported on the
Nasdaq National Market:
<TABLE>
<CAPTION>
PRICE RANGE OF
COMMON STOCK
----------------
HIGH LOW
------ ------
<S> <C> <C>
1999
First Quarter............................................. $17.56 $ 9.75
Second Quarter............................................ 30.63 13.00
Third Quarter............................................. 23.25 9.19
Fourth Quarter............................................ 27.63 7.38
1998
First Quarter............................................. $ 5.00 $ 3.69
Second Quarter............................................ 5.88 3.88
Third Quarter............................................. 6.50 3.50
Fourth Quarter............................................ 14.25 3.75
</TABLE>
As of March 13, 2000, there were 1,000 shareholders of record. The Company
estimates that approximately an additional 6,000 shareholders own stock held for
their accounts at brokerage firms and financial institutions.
DIVIDEND POLICY
We have not paid any cash dividends since our inception, and we do not
intend to pay any cash dividends in the future.
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<PAGE> 21
ITEM 6. SELECTED CONSOLIDATED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA:
Revenue:
Product sales......................... $104,730 $95,475 $68,787 $74,170 $60,890
Service fees.......................... 46,963 38,060 29,054 22,939 17,947
-------- ------- ------- ------- -------
Total revenue................. 151,693 133,535 97,841 97,109 78,837
-------- ------- ------- ------- -------
Cost of revenue......................... 65,968 54,828 41,691 43,112 32,572
Cost of revenue -- special charges...... 1,414(1) -- -- -- --
-------- ------- ------- ------- -------
Total cost of revenue......... 67,382 54,828 41,691 43,112 32,572
-------- ------- ------- ------- -------
Gross profit............................ 84,311 78,707 56,150 53,997 46,265
-------- ------- ------- ------- -------
OPERATING EXPENSES:
Sales and marketing................... 45,463 43,492 33,717 32,192 21,728
Engineering and development........... 24,749 20,824 17,848 14,775 11,215
General and administrative............ 6,922 6,252 4,944 5,137 5,895
Special charges....................... 901(1) 927(2) 4,934(3) 1,941(4) 2,500(5)
-------- ------- ------- ------- -------
Total operating expenses...... 78,035 71,495 61,443 54,045 41,338
-------- ------- ------- ------- -------
Income (loss) from operations........... 6,276 7,212 (5,293) (48) 4,927
-------- ------- ------- ------- -------
Other income, net....................... 110 427 1,400 2,072 1,608
Other nonrecurring income............... 667(1) -- -- -- --
-------- ------- ------- ------- -------
Income (loss) before income taxes....... $ 7,053 $ 7,639 $(3,893) $ 2,024 $ 6,535
======== ======= ======= ======= =======
Net income (loss)....................... $ 4,655 $ 4,729 $(2,314) $ 1,360 $ 4,023
======== ======= ======= ======= =======
Diluted income (loss) per share......... $ .18 $ .21 $ (.10) $ .06 $ .17
======== ======= ======= ======= =======
Diluted shares.......................... 25,818 22,572 22,702 23,557 23,443
======== ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------
1999 1998 1997 1996 1995
-------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities............................ $ 26,895 $12,362 $10,824 $35,065 $28,409
Working capital......................... 50,715 35,587 30,380 48,192 44,282
Total assets............................ 114,670 94,027 85,487 82,379 79,134
Long-term obligations................... 1,780 2,816 701 -- --
Total shareholders' equity.............. 78,472 60,558 55,607 64,161 60,506
</TABLE>
- ---------------
(1) Reflects special charges in the fourth quarter of 1999 of $1.4 million for
the write-off of non-SAN-related products, $1.3 million for an abandoned
facility, partially offset by the reversal of the remaining integration
accrual of $430,000 relating to the acquisition of the Internet Solutions
Division of Apertus Technologies, Inc. Special charges in the fourth quarter
of 1999 totaled $.06 per share after tax. Reflects other nonrecurring income
in the first quarter of 1999 of $667,000, or $.02 per share after tax, due
to recognition of a payment received in connection with the sale of our
vision product line.
(2) Reflects a special charge in the fourth quarter of 1998 of $927,000, or $.04
per share after tax, for purchased in-process research and development
associated with the acquisition of IntelliFrame. The charge associated with
the IntelliFrame acquisition was not deductible for tax purposes.
(3) Reflects special charges in the fourth quarter of 1997 of $4.9 million, or
$.13 per share after tax, for purchased in-process research and development
associated with the acquisition of the Internet Solutions Division of
Apertus Technologies, Inc. and subsequent integration charges.
(4) Reflects special charges in 1996 of $2.7 million for the write-down of
purchased technology, partially offset by a $779,000 reversal of a portion
of the 1995 management reorganization charge.
(5) Reflects a special charge in 1995 of $2.5 million for a management
reorganization.
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<PAGE> 22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are a leading provider of hardware and software products in the rapidly
growing market for SANs. We market our SAN products through our Networking
Solutions Division. The Networking Solutions Division also markets our
established channel networking products, which enable computers to transmit data
over unlimited distances. Our Networking Solutions Division is our principal
business and accounts for the majority of our revenues. Our other division, the
Enterprise Integration Solutions Division, develops and sells our EAI software
that automates the integration of computer applications, as well as our
traditional server gateways and tools, which enable multiple desktop computers
and mainframe terminals to communicate with one another.
Revenues for the year ended December 31, 1999, increased 14% to a record
$151.7 million, from 1998 revenues of $133.5 million. Excluding special charges,
net income for 1999 was $6.2 million, or $.24 per share, compared to net income
before special charges in 1998 of $5.7 million, or $.25 per share. Special
charges from the 1999 fourth quarter include the remaining payments due for an
abandoned facility, and write-off of certain non-SAN-related products, partially
offset by the reversal of the remaining integration accrual relating to the 1997
acquisition of the Internet Solutions Division of Apertus. After the charges, we
reported net income of $4.7 million, or $.18 per share, for 1999, compared to
net income of $4.7 million, or $.21 per share, for 1998. Results for 1999 before
and after special charges include recognition of a $667,000 gain, or $.02 per
share after tax, from an earlier sale of our vision product line.
Total product revenue for 1999 was $104.7 million, up 9.7% from $95.5
million in 1998. Our Networking Solutions Division saw total revenues increase
22%, driven by rising demand for our SAN product applications, which rose 68% to
$53.6 million.
Product revenues for our Enterprise Integration Solutions Division
decreased 25% in 1999 from 1998 due to a faster-than-anticipated decline in
server gateways and tools sales. However, within this division, EAI product
revenues increased 33% during 1999 to $5.8 million.
Professional service revenues for our Networking Solutions Division and
Enterprise Integration Solutions Division increased in 1999 from 1998 more than
200% to $4.6 million, and 67% to $3.9 million, respectively.
Revenues in the storage networking and enterprise integration industries
are subject to volatility -- especially near calendar quarter- and year-end when
many companies delay their purchases, which makes consistent quarter-to-quarter
performance and forecasting revenues difficult. To address this problem, our
management team has taken the following steps:
- instituting a policy that requires two-week lead times for orders;
- offering sales-force incentives to close sales earlier in the quarter;
and
- changing the end of our fiscal year to January 31.
We believe these actions will help offer more stability in
quarter-to-quarter performance and improve the visibility of revenues in future
quarters, but cannot be certain that quarterly revenues will stabilize or be
more predictable in the future.
We derive an increasingly significant portion of our revenues from sales of
our SAN products, and our EAI products if we do not divest all or part of our
Enterprise Integration Solutions Division. As a result of product maturation,
revenues derived from traditional channel networking and server gateways and
tools products have declined, and we expect that revenues from these products
will continue to decline in the future as we continue to focus more of our
resources on our SAN and EAI products.
20
<PAGE> 23
We primarily sell our SAN products directly to end-user customers in
connection with joint marketing activities with our business partners and
original equipment manufacturers, or 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 design cycle, from first contact through
shipment, can vary from 90 days to 12 months or more. We expect that this cycle
will continue.
Historically, a large percentage of our product shipments have occurred
late in each quarter. Timing of receipt of orders from customers and delays in
shipment can have a disproportionate impact on our revenues and results of
operations in any given quarter.
POTENTIAL DIVESTITURE OF ENTERPRISE INTEGRATION SOLUTIONS DIVISION
On January 3, 2000, we announced the intention to explore the divestiture
of all or part of our Enterprise Integration Solutions Division. Currently, the
Networking Solutions Division and the Enterprise Integration Solutions Division
have distinct and unrelated operations, products and core markets. We believe a
divestiture of this division will allow management of our separate divisions to
better focus on their core businesses and potentially enhance the prospects and
results of operations of each division.
We have been focusing on the relative benefits and feasibility to both
divisions of a divestiture of all or part of the Enterprise Integration
Solutions Division, the potential benefits to be obtained, and whether to
structure the divestiture as a sale or spin-off. We have engaged in discussions
with several parties concerning the sale of this division. No final decisions
regarding the feasibility, nature, timing or structure of such a transaction
have been reached, and such divestiture may not occur. We will continue to
invest in our Enterprise Integration Solutions Division as we evaluate possible
options for this division over the next few months.
ACQUISITIONS
On December 3, 1998, we acquired all of the outstanding stock of
IntelliFrame Corporation, a start-up software and services company that develops
technology for integrating legacy systems with client/ server and for the
Internet. The contract to purchase IntelliFrame's stock required payment of the
$2.0 million purchase price in two installments of $1.0 million each in January
1999 and 2000. We have made both of those payments. We allocated $927,000 of the
purchase price to in-process research and development, which was charged to
expense in 1998, because the underlying research and development project,
InVista, had not yet reached technological feasibility. InVista is a new
technology that manages business logic rules and process workflow management for
improved development and deployment of large e-commerce and customer
relationship management, or CRM, applications. Two employees who were former
shareholders of IntelliFrame will be eligible for aggregate bonus payments of up
to $10.0 million through December 31, 2001 if future revenues from our EAI
products exceed defined targets. The potential bonus payments increase to a
maximum of $12.0 million if we divest any portion of the EAI product line during
2000. The full bonus payments set forth above are conditioned upon the
employment of these individuals through July 1, 2000. To date, no bonus payments
have been made in connection with this agreement.
On October 24, 1997, we acquired substantially all of the assets, including
in-process research and development, of the Internet Solutions Division 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 amount
related to in-process research and development of approximately $2.8 million was
charged to expense in 1997 as the underlying research and development projects
had not yet reached technological feasibility. Subsequent to our acquisition of
the Internet Solutions Division of Apertus, we recorded a charge of
approximately $2.2 million in 1997 for costs incurred to integrate our
businesses, including accruals for severance, facility closures and
infrastructure integration. The remaining integration accrual of $430,000 was
reversed in the fourth quarter of 1999.
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<PAGE> 24
RESULTS OF OPERATIONS
On January 12, 2000, we changed our fiscal year to end on January 31,
rather than December 31. Our January 2000 results will be reported in our Report
on Form 10-Q filed for the first quarter of 2000, which ends on April 30. The
following tables set forth financial data 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>
NETWORKING SOLUTIONS DIVISION
-----------------------------
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Revenue:
Product sales............................................. 70.8% 72.8% 70.0%
Service fees.............................................. 29.2 27.2 30.0
----- ----- -----
Total revenue..................................... 100.0 100.0 100.0
----- ----- -----
Gross profit:
Product sales............................................. 57.0 63.4 63.8
Service fees.............................................. 47.4 36.7 35.9
----- ----- -----
Total gross profit................................ 54.2 56.1 55.4
----- ----- -----
Operating expenses:
Sales and marketing....................................... 26.9 30.5 34.1
Engineering and development............................... 14.2 13.4 15.2
General and administrative................................ 4.5 4.6 5.5
Abandoned facility........................................ 1.1 -- --
----- ----- -----
Total operating expenses.......................... 46.7 48.5 54.8
----- ----- -----
Income from operations...................................... 7.5 7.6 0.6
Other income, net......................................... 0.1 0.4 1.8
----- ----- -----
Income before income taxes.................................. 7.6 8.0 2.4
Provision for income taxes................................ 2.6 2.7 0.9
----- ----- -----
Net income.................................................. 5.0% 5.3% 1.5%
===== ===== =====
</TABLE>
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<PAGE> 25
<TABLE>
<CAPTION>
ENTERPRISE INTEGRATION
SOLUTIONS DIVISION
-----------------------
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Revenue:
Product sales............................................. 60.2% 67.2% 71.7%
Service fees.............................................. 39.8 32.8 28.3
----- ----- -----
Total revenue..................................... 100.0 100.0 100.0
----- ----- -----
Gross profit:
Product sales............................................. 88.5 83.0 83.2
Service fees.............................................. 23.1 38.8 23.8
----- ----- -----
Total gross profit................................ 62.4 68.4 66.4
----- ----- -----
Operating expenses:
Sales and marketing....................................... 45.4 39.7 36.3
Engineering and development............................... 26.2 22.8 31.5
General and administrative................................ 5.0 5.0 3.2
Purchased in-process research and development............. -- 3.0 15.6
Integration charges....................................... (1.7) -- 12.4
----- ----- -----
Total operating expenses.......................... 74.9 70.5 99.0
----- ----- -----
Loss from operations........................................ (12.5) (2.1) (32.6)
Other income (expense), net............................... 2.4 -- (0.2)
----- ----- -----
Loss before income taxes.................................... (10.1) (2.1) (32.8)
Provision (benefit) for income taxes...................... (3.5) 0.3 (13.1)
----- ----- -----
Net loss.................................................... (6.6)% (2.4)% (19.7)%
===== ===== =====
</TABLE>
The financial data set forth above and otherwise included in this Form 10-K
was prepared from consolidated financial statements that include the combined
results of operations of our Networking Solutions Division and our Enterprise
Integration Solutions Division. The Networking Solutions Division and the
Enterprise Integration Solutions Division were not accounted for, and were not
operated as, separate stand alone business entities. The financial data set
forth above and otherwise included in this Form 10-K is not necessarily
reflective of what cost structures will remain after any divestiture of all or
part of the Enterprise Integration Solutions Division and no adjustments have
been made to such information to reflect any changes in such cost structures,
including increased costs associated with reduced economies of scale.
REVENUE
Our Networking Solutions Division revenue consists of the sale and support
of products that enable our customers to build and manage SANs and our
traditional channel networking products for applications that require continuous
business availability and other applications such as remote storage, remote disk
mirroring and remote tape vaulting.
Our Enterprise Integration Solutions Division revenue consists of the
licensing, sale and support of EAI products and our traditional server gateways
and tools products, which are used for e-commerce and CRM applications.
We generally recognize revenue from product sales 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,
23
<PAGE> 26
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.
Years Ended December 31, 1999 and 1998
Revenue from Networking Solutions Division 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
applications 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 from the Networking Solutions Division increased 31% in
1999 to $36.7 million compared to 1998, due to the growing installed base of
customers using our products. In addition, the sale of professional services to
Networking Solutions Division customers increased 203% in 1999 to $4.6 million.
Revenue from Enterprise Integration Solutions Division products decreased
25% in 1999 to $15.5 million compared to 1998. To increase market share for our
Enterprise Integration Solutions Division products, we expect to incur
significant sales and marketing expenses in 2000. As a result, we expect to
incur a loss in 2000 on sales of these products and in the division as a whole.
Revenue from the sale of EAI products increased 33% in 1999 to $5.8 million due
to growing customer demand for products that integrate legacy applications with
frameworks, packaged applications or new environments, while also providing
mainframe connectivity. Revenue from the sale of server gateways and tools
products decreased 40%, or $6.5 million, in 1999 compared to 1998. We anticipate
that sales of server gateways and tools products will continue to decline in the
future due to product maturation.
Service revenue from the Enterprise Integration Solutions Division
increased 2%, or $215,000, in 1999 to $10.2 million, compared to 1998. An
increase in professional services revenue from the Enterprise Integration
Solutions Division of $1.6 million, or 67%, was offset by a 18% decline in
traditional service revenue to approximately $6.3 million due to a decrease in
the server gateways and tools installed base.
Years Ended December 31, 1998 and 1997
Revenue from Networking Solutions Division products increased 34% in 1998
to $75.0 million compared to 1997. SAN applications for both open systems and
mainframes continued to drive new product revenues in 1998. SAN product
applications increased 379% 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 from the Networking Solutions Division 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 to
Networking Solutions Division customers generated $1.5 million of new
incremental revenue in 1998.
Revenue from the sale of Enterprise Integration Solutions Division products
increased 62% in 1998 to $20.5 million compared to 1997, due to the acquisition
of the Internet Solutions Division of Apertus in the fourth quarter of 1997 and
an increase in sales of EAI products. Revenue from the sale of EAI products
increased 528% in 1998 to $4.4 million compared to 1997. Approximately 60% of
this increase in revenue from EAI product sales can be attributed to a single
transaction with a tier one systems integrator. Revenue from the sale of server
gateways and tools products increased 35% in 1998 to $16.1 million compared to
1997. This increase can be attributed to the acquisition of the Internet
Solutions Division of Apertus in the fourth quarter of 1997 and higher levels of
OEM sales.
Service revenue from the Enterprise Integration Solutions Division
increased 101% in 1998 to $10.0 million compared to 1997 due to the acquisition
of the Internet Solutions Division of Apertus in the fourth quarter of 1997.
24
<PAGE> 27
General
Revenue from the sale of products and services outside the United States
increased in 1999 and 1998 by $4.0 million, or 9%, and $16.3 million, or 57%,
respectively, when compared to the prior year. We derived 32%, 34% 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 and EAI-related product
applications.
No single customer accounted for more than 10% of our revenue in 1999, 1998
or 1997. Revenue increases in 1999 and 1998 were attributable to increases in
sales of SAN and EAI products, and additional services. Price increases for our
products and services did not have a significant impact on revenue in 1999 or
1998.
Revenues from sales to StorageTek amounted to 10% of our total revenues in
the fourth quarter of 1999. We anticipate revenues from StorageTek will account
for approximately 10% of our total revenues in the first quarter of fiscal 2000.
Networking Solutions Division revenues from Compaq totaled $1.0 million in the
fourth quarter of 1999. At this time, we are unable to forecast total Networking
Solutions Division revenues from Compaq in 2000.
During the year ended December 31, 1999, approximately 26%, 13% and 5% of
our revenues were derived from businesses in the financial services,
telecommunications, and information outsourcing industries, respectively.
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
Years Ended December 31, 1999 and 1998
Gross profit margin from the sale of Networking Solutions Division 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 Networking Solutions Division products would have been 59% in 1999.
The remaining decrease in gross profit margin in 1999 is due to an increase in
UltraNet product sales, which have a slightly lower gross margin than our
traditional Channelink(R) products.
Gross profit margin from Networking Solutions Division service revenues in
1999 and 1998 was 47% and 37%, respectively. The improvement in gross profit
margins 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.
Gross profit margin from the sale of Enterprise Integration Solutions
Division products was 89% in 1999, compared to 83% in 1998. The increase can be
attributed to higher-margin software sales accounting for a larger percentage of
total Enterprise Integration Solutions Division product revenue.
Gross profit margin from Enterprise Integration Solutions Division service
revenues in 1999 and 1998 was 23% and 39%, respectively. The decline in service
revenue gross margin in 1999 compared to 1998 was primarily due to a drop-off in
the server gateways and tools products installed base.
25
<PAGE> 28
Years Ended December 31, 1998 and 1997
Gross profit margin from the sale of Networking Solutions Division products
was 63% in 1998, compared to 64% in 1997. This decrease in gross profit margin
was due to an increase in UltraNet product sales, which have a slightly lower
gross margin than our traditional Channelink(R) products.
Gross profit margin from Networking Solution Division service revenues in
1998 and 1997 was 37% and 36%, respectively. The slight improvement in gross
profit margin is attributable to the steadily increasing base of customers
contracting for Networking Solutions Division services. In addition, new
professional services revenue generates a higher gross margin than our
traditional services business.
Gross profit margin from the sale of Enterprise Integration Solutions
Division products was 83% in 1998 and 1997.
Gross profit margin from Enterprise Integration Solution Division service
revenues in 1998 and 1997 was 39% and 24%, respectively. The improvement in
service revenue gross margin in 1998 compared to 1997 was primarily attributable
to the acquisition of the Internet Solutions Division of Apertus in the fourth
quarter of 1997.
OPERATING EXPENSES
Years Ended December 31, 1999 and 1998
Sales and marketing expense related to our Networking Solutions Division
increased in 1999 by $2.4 million, or 8%, compared to 1998. The increase in
expense resulted from higher commissions and additional headcount required to
generate the increase in Network Solutions Division product revenue in 1999 of
19%.
Engineering and development expense related to our Networking Solutions
Division increased in 1999 by $4.2 million or 30%, compared to 1998. This
increase was due to the continued development of our UltraNet family of products
that provide customers with additional applications to satisfy their growing
need for SAN capabilities. Revenues related to shipments of UltraNet products
increased 111% to $37.5 million in 1999 from $17.7 million in 1998.
Sales and marketing expense related to our Enterprise Integration Solutions
Division declined by $455,000 or 4% in 1999 compared to 1998 due to the 16%
decline in Enterprise Integration Solutions Division revenue and our initiative
in 1998 to reduce headcount and expense associated with this division.
Engineering and development expense related to our Enterprise Integration
Solutions Division decreased by $232,000 in 1999 to $6.7 million, compared to
1998. The slight decline in engineering and development expense was due to our
initiative in 1998 to reduce headcount and expense associated with this
division.
General and administrative expense for both the Networking Solutions
Division and Enterprise Integration Solutions Division combined 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 related to our Networking Solutions Division
increased in 1998 by $4.1 million, or 15%, compared to 1997. The increase in
expense resulted from an increase in Network Solutions Division product revenue
in 1998 of 34%.
Engineering and development expense related to our Networking Solutions
Division increased in 1998 by $1.6 million, or 13%, compared to 1997 due to the
continued development of our UltraNet family of products. Revenues related to
shipments of UltraNet products increased 222% to $17.7 million in 1998 compared
to $5.5 million in 1997.
26
<PAGE> 29
Sales and marketing expense and engineering and development expense related
to our Enterprise Integration Solutions Division increased in 1998 by $5.7
million, or 89%, and $1.4 million, or 25%, respectively, compared to 1997 due to
the acquisition of the Internet Solutions Division of Apertus in the fourth
quarter of 1997. In 1998, we also completed development of the
Enterprise/Connect product acquired as in-process research and development in
connection with this acquisition.
General and administrative expense for both the Networking Solutions
Division and Enterprise Integration Solutions Division combined increased in
1998 by $1.3 million, or 26%, compared to 1997 due to the additional expense
associated with the higher levels of revenue in 1998 and the acquisition of the
Internet Solutions Division of Apertus in the fourth quarter of 1997.
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. These charges were partially offset by the reversal of
the remaining integration accrual of $430,000 relating to the acquisition of the
Internet Solutions Division of Apertus.
During the fourth quarter of 1998, we recorded a $927,000 charge for
in-process research and development associated with the acquisition of
IntelliFrame. This charge was not deductible for tax purposes.
During the fourth quarter of 1997, we recorded pre-tax charges of $2.8
million for in-process research and development associated with the acquisition
of the Internet Solutions Division of Apertus and $2.2 million for severance,
facility closures and infrastructure integration subsequent to the acquisition
to integrate the businesses.
OTHER
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.
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.
During the first quarter of 1999, we recognized as other income a $667,000
payment received in connection with the sale of our vision product line. A final
payment of $1.2 million was received in March 2000 and will be recognized as
other income in our quarter ending April 30, 2000.
We recorded a provision for income taxes in 1999, 1998 and 1997 at an
effective rate of 34%, 38% and 41%, respectively. Excluding the nondeductible
charge in 1998 for purchased in-process research and development associated with
the acquisition of IntelliFrame, our effective tax rate for 1998 would have been
34%. Fluctuations in our effective tax rate are primarily due to the large
special charges that have been recorded each year, the amount of nondeductible
foreign losses and fluctuations in the level of benefit from our foreign sales
corporation. We recorded a net deferred tax asset at December 31, 1999 of $7.7
million. 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.
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<PAGE> 30
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 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, field support spares and technology assets totaling $11.3 million. We
also made a $1.0 million installment payment during the first quarter of 1999
relating to our 1998 purchase of IntelliFrame.
In the fourth quarter of 1999, we announced a three-year agreement with
StorageTek under which we will manufacture and provide continuation engineering
support for StorageTek's DXE/RDS channel extension product line, and StorageTek
will resell our UltraNet wide-area networking products. In connection with this
agreement, we purchased inventory and fixed assets from StorageTek for
approximately $2.5 million, which was paid from existing cash on-hand.
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.
NEW EUROPEAN CURRENCY
On January 1, 1999, 11 of the 15 member countries of the European Union
established fixed conversion rates between their existing currencies and the
euro, a new European currency, and adopted the euro as their common legal
currency. Either the euro or a participating country's present currency will be
accepted as legal tender from January 1, 1999 to January 1, 2002, from which
date forward only the euro will be accepted. We have a significant number of
customers located in European Union countries participating in this conversion.
The euro conversion may have competitive implications for our pricing and
marketing strategies, which could be material in nature; however, any such
impact is not known at this time. Our new business system, which became
effective January 1999, is capable of handling the new euro currency. We cannot
assure, however, that all problems related to the euro conversion will be
foreseen and corrected, or that no material disruptions of our business will
occur.
NEW ACCOUNTING PRONOUNCEMENT
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.
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 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 July 31, 2000.
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<PAGE> 31
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 will be reported in our Report on
Form 10-Q filed on the first quarter of 2000, which ends on April 30. Our
summary January 2000 results are as follows: revenues $4.8 million; gross profit
$1.2 million; operating expenses $6.7 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.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 December 31, 1999, our marketable securities include a $392,000
investment in a Standard and Poors 500 stock price index fund, which was
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. We have hedged a portion of our
risk by purchasing forward exchange contracts for 950,000 British pounds
sterling that settle at various times through February 15, 2000.
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<PAGE> 32
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1999 1998
-------- -------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 16,184 $11,786
Marketable securities..................................... 10,711 576
Receivables, net.......................................... 36,847 30,225
Inventories............................................... 14,764 19,241
Deferred tax asset........................................ 4,419 3,138
Other current assets...................................... 2,208 1,274
-------- -------
Total current assets.............................. 85,133 66,240
-------- -------
Property and equipment, net................................. 18,471 16,360
Field support spares, net................................... 4,135 3,739
Deferred tax asset.......................................... 3,236 2,517
Goodwill and other intangibles, net......................... 3,427 4,737
Other assets................................................ 268 434
-------- -------
$114,670 $94,027
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 11,696 $ 7,565
Accrued liabilities....................................... 11,714 14,527
Deferred revenue.......................................... 9,320 7,235
Current installments of obligations under capital lease... 688 326
Current installments of long-term debt.................... 1,000 1,000
-------- -------
Total current liabilities......................... 34,418 30,653
-------- -------
Obligations under capital lease, less current
installments.............................................. 1,780 1,816
Long-term debt, less current installments................... -- 1,000
-------- -------
Total liabilities................................. 36,198 33,469
-------- -------
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 23,792 at December 31, 1999 and
22,254 at December 31, 1998............................ 238 223
Additional paid-in capital................................ 68,927 54,921
Unearned compensation..................................... (838) (355)
Retained earnings......................................... 10,796 6,141
Accumulated other comprehensive income-foreign currency
translation adjustment................................. (651) (372)
-------- -------
Total shareholders' equity........................ 78,472 60,558
-------- -------
$114,670 $94,027
======== =======
</TABLE>
See accompanying notes to consolidated financial statements
30
<PAGE> 33
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
REVENUE:
Product sales............................................. $104,730 $ 95,475 $68,787
Service fees.............................................. 46,963 38,060 29,054
-------- -------- -------
Total revenue..................................... 151,693 133,535 97,841
-------- -------- -------
COST OF REVENUE:
Cost of product sales..................................... 40,199 30,935 22,472
Cost of service fees...................................... 27,183 23,893 19,219
-------- -------- -------
Total cost of revenue............................. 67,382 54,828 41,691
-------- -------- -------
GROSS PROFIT................................................ 84,311 78,707 56,150
-------- -------- -------
OPERATING EXPENSES:
Sales and marketing....................................... 45,463 43,492 33,717
Engineering and development............................... 24,749 20,824 17,848
General and administrative................................ 6,922 6,252 4,944
Purchased in-process research and development............. -- 927 2,750
Integration charges....................................... (430) -- 2,184
Abandoned facility........................................ 1,331 -- --
-------- -------- -------
Total operating expenses.......................... 78,035 71,495 61,443
-------- -------- -------
INCOME (LOSS) FROM OPERATIONS............................... 6,276 7,212 (5,293)
-------- -------- -------
OTHER INCOME (EXPENSE):
Interest income........................................... 744 393 1,553
Interest expense.......................................... (264) (79) (57)
Other, net................................................ 297 113 (96)
-------- -------- -------
Other income, net................................. 777 427 1,400
-------- -------- -------
INCOME (LOSS) BEFORE INCOME TAXES........................... 7,053 7,639 (3,893)
PROVISION (BENEFIT) FOR INCOME TAXES........................ 2,398 2,910 (1,579)
-------- -------- -------
NET INCOME (LOSS)........................................... $ 4,655 $ 4,729 $(2,314)
======== ======== =======
BASIC:
NET INCOME (LOSS) PER SHARE............................... $ .20 $ .21 $ (.10)
======== ======== =======
SHARES.................................................... 23,137 22,095 22,702
======== ======== =======
DILUTED:
NET INCOME (LOSS) PER SHARE............................... $ .18 $ .21 $ (.10)
======== ======== =======
SHARES.................................................... 25,818 22,572 22,702
======== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements
31
<PAGE> 34
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
====== ==== ======= ===== ======= ===== =======
</TABLE>
See accompanying notes to consolidated financial statements
32
<PAGE> 35
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
--------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)......................................... $ 4,655 $ 4,729 $ (2,314)
Depreciation and amortization............................. 10,791 8,856 7,384
Compensation expense...................................... 316 81 7
Purchase of in-process research and development........... -- 927 2,750
Change in deferred taxes.................................. (2,000) 82 (2,630)
Changes in operating assets and liabilities:
Receivables............................................ (6,595) 2,585 (8,337)
Inventories............................................ 4,477 (6,919) (1,493)
Other current assets................................... (934) 115 (468)
Accounts payable....................................... 4,131 (137) 3,008
Accrued liabilities.................................... 1,839 2,576 1,871
Deferred revenue....................................... 2,085 (1,972) 2,025
-------- -------- --------
Cash provided by operating activities............. 18,765 10,923 1,803
-------- -------- --------
INVESTING ACTIVITIES:
Additions to property and equipment....................... (8,443) (6,424) (7,565)
Additions to field support spares......................... (2,796) (2,358) (1,797)
Additions to purchased technology......................... (96) (538) (1,550)
Acquisition of business, net of cash provided............. -- 169 (11,412)
Proceeds from sale of vision product line................. -- -- 2,000
Purchase of marketable securities......................... (15,421) (18,054) (12,190)
Redemption of marketable securities....................... 5,286 23,512 36,374
Other..................................................... 166 51 434
-------- -------- --------
Cash provided by (used in) investing activities... (21,304) (3,642) 4,294
-------- -------- --------
FINANCING ACTIVITIES:
Payments for repurchases of common stock.................. -- (1,758) (6,688)
Repayment of long-term debt............................... (1,000) -- --
Proceeds from issuance of common stock.................... 8,570 1,645 701
Repayments of obligations under capital leases............ (327) (181) (107)
-------- -------- --------
Cash provided by (used in) financing activities... 7,243 (294) (6,094)
-------- -------- --------
Effects of exchange rate changes............................ (306) 9 (60)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents........ 4,398 6,996 (57)
Cash and cash equivalents -- beginning of year.............. 11,786 4,790 4,847
-------- -------- --------
Cash and cash equivalents -- end of year.................... $ 16,184 $ 11,786 $ 4,790
======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements
33
<PAGE> 36
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999, 1998, AND 1997
(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.
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.
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 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 July 31,
2000.
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.
34
<PAGE> 37
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 1999 and 1998 was $959,000 and $1,225,000, 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.
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 1999 and 1997
of $196,000 and $45,000, 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.
35
<PAGE> 38
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
------------------
1999 1998
------- -------
<S> <C> <C>
Inventories:
Components and subassemblies.............................. $ 8,816 $ 9,490
Work in process........................................... 3,147 4,095
Finished goods............................................ 2,801 5,656
------- -------
$14,764 $19,241
======= =======
</TABLE>
36
<PAGE> 39
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1999 1998
------- -------
<S> <C> <C>
Property and equipment:
Machinery and equipment................................... $27,494 $22,944
Office and data processing equipment...................... 20,296 16,610
Furniture and fixtures.................................... 2,403 1,698
Leasehold improvements.................................... 2,448 2,293
------- -------
52,641 43,545
Less accumulated depreciation and amortization............ 34,170 27,185
------- -------
$18,471 $16,360
======= =======
Field support spares:
Field support spares...................................... $17,139 $14,343
Less accumulated depreciation............................. 13,004 10,604
------- -------
$ 4,135 $ 3,739
======= =======
Goodwill and other intangibles:
Purchased technology...................................... $ 3,574 $ 3,478
Goodwill.................................................. 1,515 1,515
Identifiable intangibles.................................. 867 867
------- -------
5,956 5,860
Less accumulated amortization............................. 2,529 1,123
------- -------
$ 3,427 $ 4,737
======= =======
Accrued liabilities:
Compensation.............................................. $ 7,261 $ 7,687
Income taxes.............................................. 1,049 3,725
Integration............................................... -- 430
Abandoned facility........................................ 1,331 --
Other..................................................... 2,073 2,685
------- -------
$11,714 $14,527
======= =======
</TABLE>
(3) MARKETABLE SECURITIES
The Company's investments in marketable securities are summarized as
follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1999 1998
------- -------
<S> <C> <C>
Corporate debt securities......................... $10,319 $ --
Standard & Poors 500 stock price index fund....... 392 576
------- -------
$10,711 $ 576
======= =======
</TABLE>
At December 31, 1999 and 1998, available-for-sale securities consist of
investments in corporate debt securities of $10,319,000 and $0, respectively.
The amount of gross unrealized gains and losses with respect to investments in
available-for-sale securities at December 31, 1999 and 1998 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 1999,
37
<PAGE> 40
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998 and 1997 were $984,000, $8,093,000 and $26,252,000, 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 1999, 1998 and 1997 was $112,000, $0 and $0, respectively.
(4) ACQUISITIONS
INTELLIFRAME
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 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>
The Company has allocated $927,000 of the IntelliFrame purchase price to
acquired in-process research and development to reflect the value of InVista,
which was approximately 75% complete at the time of the acquisition. At the date
of acquisition, the technological feasibility of InVista had not been attained
and the technology had no alternative future use. InVista is a new technology
that manages business logic and process workflow for improved development and
deployment of large e-commerce and customer relationship management
applications. The allocation to in-process research and development was based on
the present value of the net operating cash flows to be generated by InVista
during its estimated useful life. At the time of the acquisition, the remaining
cost to complete development of InVista was estimated to be approximately
$500,000. The Company presently anticipates that a beta version of InVista will
be available in the first half of 2000.
Two employees, who were former shareholders of IntelliFrame, will be
eligible for aggregate bonus payments of up to $10,000,000 through December 31,
2001 if future revenues from the Company's EAI products exceed defined targets.
The potential bonus payments increase to a maximum of $12,000,000 if the Company
were to divest any portion of the EAI product line in 2000. The full bonus
payments set forth above are conditioned upon the employment of these
individuals through July 1, 2000. No bonus payments were made in 1999 or 1998 in
connection with this agreement.
38
<PAGE> 41
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PRO FORMA RESULTS
The following table presents the consolidated results of operations of the
Company for 1998 on an unaudited pro-forma basis as if the acquisition of
IntelliFrame took place at the beginning of the year:
<TABLE>
<CAPTION>
UNAUDITED PROFORMA
------------------
<S> <C>
Total revenue.............................................. $133,575
Net income................................................. 4,284
Diluted net income per share............................... $ .19
</TABLE>
The unaudited pro-forma results are for comparative purposes only and do
not necessarily reflect the results that would have been recorded had the
acquisition occurred at the beginning of the period presented or the results
which might occur in the future.
APERTUS
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
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>
The Company allocated $2,750,000 of the Apertus purchase price to acquired
in-process research and development to reflect the value of Enterprise/Connect
which was approximately 80% complete at the time of the acquisition. At the date
of acquisition, the technological feasibility of Enterprise/Connect had not been
attained, and the technology had no alternative future use. Enterprise/Connect
is a family of products bundled together to provide a solution for access from a
dispersed TCP/IP network to legacy based systems. The allocation to in-process
research and development was based on the present value of the net operating
cash flows to be generated by Enterprise/Connect during its estimated useful
life. At the time of the acquisition, the remaining cost to complete development
of Enterprise/Connect was estimated to be $800,000. The Company completed
development of Enterprise/Connect in 1998.
(5) INTEGRATION ACTIVITIES
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
39
<PAGE> 42
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
activities of $430,000 was reversed and has been reflected as a separate line
item in the 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 through March 2001,
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 three months ended March 31, 1999,
the Company recognized other income in the amount of $667,000 upon receipt of
its first additional payment from the sale of the vision product line. Any
additional payments received will be recognized as other income.
(6) 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, 1999 and 1998, leased capital
assets included in property and equipment were as follows:
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Office and data processing equipment........................ $3,027 $2,430
Less accumulated amortization............................... 1,098 481
------ ------
$1,929 $1,949
====== ======
</TABLE>
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 1999, 1998, and 1997, was $3,970,000, $3,122,000 and $2,765,000,
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.
40
<PAGE> 43
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) LONG TERM DEBT
Effective December 3, 1998, the Company acquired all of the outstanding
stock of IntelliFrame Corporation for $2,000,000. The first $1,000,000
installment was paid on January 4, 1999. The second $1,000,000 installment, plus
interest at the rate of 4.33%, was paid on January 3, 2000.
(8) 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 1998
and 1997, 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 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
1999, 1998 and 1997, the Company issued 90,250, 81,000 and 8,000 restricted
shares, respectively, having an aggregate weighted fair market value per share
of $16.25, $4.81 and $5.16, respectively. Compensation expense recognized for
restricted shares in 1999, 1998 and 1997 was $316,000, $81,000 and $7,000,
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.
41
<PAGE> 44
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
1999 1998 1997
------------------- ------------------- -------------------
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........ 4,972 $ 5.63 4,321 $5.42 3,368 $6.19
Granted................................. 1,689 18.40 1,269 6.08 1,689 4.85
Reissued................................ -- -- -- -- 310 4.94
Exercised............................... (1,540) 5.54 (219) 4.66 (20) 3.80
Canceled................................ (443) 10.79 (399) 5.33 (1,026) 6.91
------ ----- ------
Outstanding at end of year.............. 4,678 $ 9.76 4,972 $5.63 4,321 $5.42
====== ===== ======
Exercisable at end of year.............. 1,901 $ 6.31 2,388 $5.71 1,707 $5.90
====== ===== ======
Weighted-average fair value of grants
during the year....................... $12.68 $4.48 $2.77
</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>
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 1999, 1998 and 1997 were 86,972, 153,163 and 163,637,
respectively.
The fair value of each purchase right granted in 1999, 1998 and 1997 was
$6.38, $1.57 and $1.66, respectively.
42
<PAGE> 45
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
1999 1998 1997
------ ------ -------
<S> <C> <C> <C>
Net income (loss):
As reported...................................... $4,655 $4,729 $(2,314)
Pro forma........................................ $ (795) $2,580 $(3,826)
Net income (loss) per share:
As reported
Basic......................................... $ .20 $ .21 $ (.10)
Diluted....................................... $ .18 $ .21 $ (.10)
Pro forma
Basic......................................... $ (.03) $ .12 $ (.17)
Diluted....................................... $ (.03) $ .11 $ (.17)
</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 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>
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Risk free interest rate............................. 5.64% 5.26% 6.42%
Expected life....................................... 5.23 8.41 8.14
Expected volatility................................. 79.66% 67.50% 39.30%
</TABLE>
43
<PAGE> 46
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) 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>
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
======= ====== =====
1998:
Basic.................................... $ 4,729 22,095 $ .21
Dilutive effect of employee stock
purchase awards and options........... -- 477 --
------- ------ -----
Diluted.................................. $ 4,729 22,572 $ .21
======= ====== =====
1997:
Basic.................................... $(2,314) 22,702 $(.10)
Dilutive effect of employee stock
purchase awards and options........... -- -- --
------- ------ -----
Diluted.................................. $(2,314) 22,702 $(.10)
======= ====== =====
</TABLE>
(10) INCOME TAXES
The components of income (loss) 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>
1999 1998 1997
------- ------ -------
<S> <C> <C> <C>
Income (loss) before income taxes:
U.S. ........................................ $ 5,459 $5,548 $(3,517)
Foreign...................................... 1,594 2,091 (376)
------- ------ -------
Total................................... $ 7,053 $7,639 $(3,893)
======= ====== =======
Income tax provision:
Current:
U.S. ..................................... $ 2,676 $2,041 $ (592)
Foreign................................... 507 681 119
State..................................... 891 511 (170)
------- ------ -------
Total current........................... 4,074 3,233 (643)
------- ------ -------
Deferred:
U.S. ..................................... (1,320) (289) (741)
State..................................... (356) (34) (195)
------- ------ -------
Total deferred.......................... (1,676) (323) (936)
------- ------ -------
Total income tax expense (benefit)............. $ 2,398 $2,910 $(1,579)
======= ====== =======
</TABLE>
44
<PAGE> 47
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
1999 1998 1997
----- ---- -----
<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............ 5.0 4.2 (6.2)
Foreign sales corporation.......................... (6.8) (6.5) (6.7)
Meals and entertainment............................ 1.2 1.9 1.9
In-process research and development................ -- 4.1 --
Change in valuation allowance...................... -- -- 5.5
Other.............................................. .6 .4 (1.1)
----- ---- -----
Total................................................ 34.0% 38.1% (40.6)%
===== ==== =====
</TABLE>
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, 1999 and 1998 was as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1999 1998
------- ------
<S> <C> <C>
Deferred tax assets:
Inventory............................................... $ 1,896 $1,261
Acquired intangibles.................................... 1,121 1,163
Accrued compensation.................................... 1,040 1,009
Property and equipment.................................. 1,061 888
Reserves for bad debts and sales returns................ 496 838
Foreign net operating loss carryforwards................ 410 410
Federal and state tax credits........................... 1,148 373
Federal and state net operating loss carryforwards...... 813 --
Abandoned facility...................................... 512 --
Other................................................... 711 709
------- ------
Total gross deferred tax assets......................... 9,208 6,651
Valuation allowance..................................... (1,007) (410)
------- ------
Net deferred tax assets......................... 8,201 6,241
------- ------
Deferred tax liabilities:
Purchased technology.................................... (263) (364)
Other................................................... (283) (222)
------- ------
Total gross deferred tax liabilities.................... (546) (586)
------- ------
Net deferred tax assets......................... $ 7,655 $5,655
======= ======
</TABLE>
The Company recorded a valuation allowance at December 31, 1999 of
$1,007,000 for the tax benefits associated with certain losses incurred from
foreign operations of $410,000 and from its Enterprise Integration Solutions
Division of $597,000. Stock option exercises generated a net operating loss
carryforward for the Company's Enterprise Integration Solutions Division in
1999. The valuation allowance related to this net operating loss carryforward of
$597,000 will be recorded as additional paid-in capital in the future when
realization of the benefit becomes more likely than not. At December 31, 1999,
the Company had net operating loss and credit carryforwards available for
federal tax purposes of
45
<PAGE> 48
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
(11) 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 1999, 1998, and 1997 was $420,000,
$1,673,000, and $43,000 respectively.
(12) 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.
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
1999, 1998 and 1997 was $470,000, $570,000 and $380,000, respectively.
(13) SEGMENT INFORMATION
The Company has two reportable segments consisting of its Networking
Solutions and Enterprise Integration Solutions Divisions. The Networking
Solutions Division provides products and services that offer high speed open
systems connectivity, access to legacy data and guaranteed data integrity for
applications such as remote storage and disk mirroring. The Enterprise
Integration Solutions Division provides products and services that integrate
legacy systems with client/server and internet technologies, including
e-commerce and customer relationship management applications. The Company's two
reportable segments are strategic business units that offer different products
and services. They are managed separately because each business requires
different technology and market strategies.
46
<PAGE> 49
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The accounting policies for the two reportable segments are the same as
those described in the summary of significant accounting policies. The Company
evaluates performance based on operating profit or loss before special charges
and income taxes.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
-------------------------------
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
Revenue:
Networking Solutions...................................... $125,989 $103,022 $80,195
Enterprise Integration Solutions.......................... 25,704 30,513 17,646
-------- -------- -------
Total............................................. $151,693 $133,535 $97,841
======== ======== =======
Income (Loss) from Operations:
Networking Solutions...................................... $ 10,814 $ 7,857 $ 458
Enterprise Integration Solutions.......................... (3,637) 282 (817)
Special charges........................................... (901) (927) (4,934)
-------- -------- -------
Total............................................. $ 6,276 $ 7,212 $(5,293)
======== ======== =======
Depreciation and Amortization:
Networking Solutions...................................... $ 9,520 $ 7,251 $ 6,200
Enterprise Integration Solutions.......................... 1,271 1,605 1,184
-------- -------- -------
Total............................................. $ 10,791 $ 8,856 $ 7,384
======== ======== =======
Expenditures for Long -- Lived Assets:
Networking Solutions...................................... $ 10,799 $ 8,689 $ 9,893
Enterprise Integration Solutions.......................... 536 631 1,019
-------- -------- -------
Total............................................. $ 11,335 $ 9,320 $10,912
======== ======== =======
Total Assets (end of year):
Networking Solutions...................................... $ 76,194 $ 64,336 $60,980
Enterprise Integration Solutions.......................... 11,581 17,329 13,683
Corporate................................................. 26,895 12,362 10,824
-------- -------- -------
Total............................................. $114,670 $ 94,027 $85,487
======== ======== =======
Revenue:
United States............................................. $102,543 $ 88,365 $69,015
United Kingdom............................................ 15,220 15,805 7,090
France.................................................... 4,348 5,479 1,849
Other..................................................... 29,582 23,886 19,887
-------- -------- -------
Total............................................. $151,693 $133,535 $97,841
======== ======== =======
Long -- Lived Assets (end of year):
United States............................................. $ 24,759 $ 23,208 $20,508
United Kingdom............................................ 1,009 1,058 835
Other..................................................... 265 570 277
-------- -------- -------
Total............................................. $ 26,033 $ 24,836 $21,620
======== ======== =======
</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 1999, 1998 or 1997.
47
<PAGE> 50
COMPUTER NETWORK TECHNOLOGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) NONCASH FINANCING AND INVESTING ACTIVITIES AND SUPPLEMENTAL CASH FLOW
INFORMATION
Cash payments for interest expense in 1999, 1998, and 1997 were $222,000,
$79,000, and $57,000, respectively.
Cash payments for income taxes, net of refunds received, in 1999, 1998 and
1997 were $2,116,000, $331,000 and $986,000, respectively.
During 1999, 1998, and 1997, the Company entered into capital lease
obligations for equipment valued at $653,000, $1,441,000 and $989,000,
respectively.
(15) 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.
48
<PAGE> 51
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, 1999 and
1998, 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, 1999 and
1998, 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.
/s/ KPMG LLP
Minneapolis, Minnesota
January 21, 2000
49
<PAGE> 52
REPORT OF MANAGEMENT
The accompanying consolidated financial statements, including the notes
thereto, and other financial information presented in the Annual Report on Form
10-K were prepared by management, which is responsible for their integrity and
objectivity. The financial statements have been prepared in accordance with
generally accepted accounting principles and include amounts that are based upon
our best estimates and judgments.
Computer Network Technology Corporation maintains an effective system of
internal accounting control. We believe this system provides reasonable
assurance that transactions are executed in accordance with management
authorization and are appropriately recorded in order to permit preparation of
financial statements in conformity with generally accepted accounting principles
and to adequately safeguard, verify, and maintain accountability of assets. The
concept of reasonable assurance is based on the recognition that the cost of a
system of internal control should not exceed the benefits derived.
KPMG LLP, independent certified public accountants, is retained to audit
the Company's financial statements. Their accompanying report is based on audits
conducted in accordance with generally accepted auditing standards.
The Audit Committee of the Board of Directors is composed of four outside
directors and is responsible for recommending the independent accounting firm to
be retained for the coming year, subject to shareholder approval. The Audit
Committee meets periodically and privately with the independent accountants, as
well as with management, to review accounting, auditing, internal accounting
controls, and financial reporting matters.
/s/ Thomas G. Hudson
Chairman of the Board,
President and Chief
Executive Officer
/s/ Gregory T. Barnum
Chief Financial Officer,
Vice President of Finance and
Corporate Secretary
50
<PAGE> 53
QUARTERLY FINANCIAL DATA
(UNAUDITED)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
----------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER(1) QUARTER QUARTER QUARTER(2)
---------- ------- ------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1999
Revenue............................................... $36,913 $37,856 $41,069 $35,855
Gross profit.......................................... 21,814 22,283 23,651 16,563
Income (loss) from operations......................... 3,462 2,771 4,065 (4,022)
Net income (loss)..................................... 2,697 1,786 2,749 (2,577)
Net income (loss) per share:
Basic............................................... .12 .08 .12 (.11)
Diluted............................................. .11 .07 .11 (.11)
1998
Revenue............................................... $31,166 $33,466 $33,010 $35,893
Gross profit.......................................... 18,634 19,517 18,884 21,672
Income from operations................................ 522 1,259 2,610 2,821
Net income............................................ 369 870 1,799 1,691
Net income per share:
Basic............................................... .02 .04 .08 .08
Diluted............................................. .02 .04 .08 .07
</TABLE>
- -------------------------
(1) The 1999 first quarter includes other nonrecurring income of $667,000, or
.02 per share after tax, due to recognition of a payment received in
connection with the sale of our vision product line.
(2) The 1999 fourth quarter includes special charges of $1.4 million for the
write-off of non-SAN related products, $1.3 million for an abandoned
facility, partially offset by the reversal of the remaining integration
accrual of $430,000 relating to the acquisition of the Internet Solutions
Division of Apertus Technologies, Inc. Special charges in the fourth quarter
of 1999 totaled $.06 per share after tax. The 1998 fourth quarter includes a
special charge of $927,000 or $.04 per share after tax for acquired
in-process research and development.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
51
<PAGE> 54
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information set forth under the captions "Election of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance" in the definitive
Proxy Statement for the Annual Meeting of Shareholders to be held on May 25,
2000, to be filed with the Securities and Exchange Commission (the "Commission")
on or before April 29, 2000, is incorporated herein by reference. For
information concerning the executives officers, see Item 4.A. of this Annual
Report on Form 10K.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the captions "Summary Compensation Table",
"Option Tables", "Employment Agreements", "Election of Directors - Compensation
of Directors", "Internal Revenue Code Section 162(m)" and "Comparative Stock
Price Performance" in the definitive Proxy Statement for the Annual Meeting of
Shareholders to be held on May 25, 2000, to be filed with the Commission on or
before April 29, 2000, is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the captions "Security Ownership of Certain
Beneficial Owners and Management" in the definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 25, 2000, to be filed with the
Commission on or before April 29, 2000, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
52
<PAGE> 55
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.
(A) 1. CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES OF REGISTRANT
Consolidated Statements of Operations for the Years Ended December 31,
1999, 1998 and 1997
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Shareholders' Equity and Comprehensive Income
for the Years Ended December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the Years Ended December 31,
1999, 1998 and 1997
Notes to Consolidated Financial Statements
Independent Auditors' Report
(A) 2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULE OF REGISTRANT
Independent Auditors' Report on Consolidated Financial Statement Schedule
Schedule II: Valuation and Qualifying Accounts for the Years Ended
December 31, 1999, 1998 and 1997.
All other schedules are omitted as the required information is
inapplicable or is presented in the consolidated financial statements or
related notes thereto.
53
<PAGE> 56
SCHEDULE II
COMPUTER NETWORK TECHNOLOGY CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO
BEGINNING COSTS & OTHER BALANCE AT
DESCRIPTION OF PERIOD EXPENSES ACCOUNT DEDUCTIONS END OF PERIOD
----------- ---------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1999
Allowance for doubtful accounts and
sales returns........................ $1,225 519 -- (785) $ 959
Year ended December 31, 1998
Allowance for doubtful accounts and
sales returns........................ $2,979 690 -- (2,444) $1,225
Year ended December 31, 1997
Allowance for doubtful accounts and
sales returns(1)..................... $ 899 121 2,354 (395) $2,979
</TABLE>
- -------------------------
(1) In connection with its acquisition of the Internet Solutions Division of
Apertus Technologies, Inc. the Company recorded an allowance for doubtful
accounts and sales returns in the amount of $2,354.
54
<PAGE> 57
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Shareholders
Computer Network Technology Corporation:
Under the date of January 21, 2000, we reported on the consolidated balance
sheets of Computer Network Technology Corporation and subsidiaries as of
December 31, 1999 and 1998, 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, as contained
in the 1999 annual report on Form 10-K. These consolidated financial statements
and our report thereon are included in the annual report on Form 10-K for the
year 1999. In connection with our audits of the aforementioned consolidated
financial statements, we also have audited the related financial statement
schedule as listed in the accompanying index. This financial statement schedule
is the responsibility of the Company's management. Our responsibility is to
express an opinion on the financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Minneapolis, Minnesota
January 21, 2000
55
<PAGE> 58
(A) 3. EXHIBITS
The Company undertakes to furnish to any shareholder so requesting a copy
of any of the following exhibits upon payment to the Company of the reasonable
costs incurred by the Company in furnishing any such exhibit.
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<S> <C>
2A. Agreement for Sale of Shares among Computer Network
Technology Corporation and each of Scott Opitz and Alexsandr
Elkin dated December 3, 1998. (Incorporated by reference to
Exhibit 2.1 to current report on Form 8-K dated December 3,
1998.)
2B. Asset Purchase Agreement by and between CNT Acquisition I
Corporation, Computer Network Technology Corporation and
Apertus Technologies Inc. dated October 24, 1997.
(Incorporated by reference to Exhibit 2.1 to current report
on Form 8-K dated October 24, 1997.)
3A. Second Restated Articles of Incorporation of the Company.
(Incorporated by reference to Exhibits 3(i)-1 and 3(i)-2 to
current report on Form 8-K dated May 25, 1999.)
3B. By-laws of the Company (Incorporated by reference to Exhibit
3(ii)-1 to current report on Form 8-K dated May 25, 1999.)
4.1 Rights Agreement between the Company and Chase Mellon
Shareholder Services, L.L.C., as Rights Agent including the
form of Rights Certificate and the Summary of Rights to
Purchase Preferred Shares. (Incorporated by reference to
Exhibit 1 to Form 8-A dated July 29, 1998.)
4.2 Form of Common Stock Certificate. (Incorporated by reference
to Exhibit 4.2 to Form S-3 Registration Statement No.
333-80841.)
10A. Lease Agreement dated November 30, 1990 by and between TOLD
Development Company, a general partnership, and Computer
Network Technology Corporation. (Incorporated by reference
to Exhibit 10C Form S-2 Registration Statement No.
33-41985.)
10B. Computer Network Technology Corporation 401(k) Salary
Savings Plan effective January 1, 1991. (Incorporated by
reference to Exhibit 10B to Form S-3 Registration Statement
No. 333-80841.)(1)
10C. Subscription Agreements of Kanematsu Electronics Ltd. and
Kanematsu USA Inc. dated October 22, 1990. (Incorporated by
reference to Exhibit 10G Form S-2 Registration Statement No.
33-41985.)
10D. Amended 1992 Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 99 Form S-8 Registration Statement No.
333-80793.)(1)
10E. Amended 1992 Stock Award Plan. (Incorporated by reference to
Exhibit 99 Form S-8 Registration Statement No.
333-80791.)(1)
10F. 1999 Non-Qualified Stock Award Plan. (Incorporated by
reference to Exhibit 99 Form S-8 Registration Statement No.
333-86315.)(1)
10G. Trademark License executed October 8, 1999 between Compaq
Computer Corporation and Computer Network Technology
Corporation. (Incorporated by reference to Exhibit 99.2 to
current report on Form 8-K dated October 13, 1999.)
10H. March 10, 1994 Incentive Stock Option Agreements.
(Incorporated by reference to Exhibit 28.2 Form S-8
Registration Statement No. 33-83266.)(1)
10I. March 10, 1994 Non-Qualified Stock Option Agreements.
(Incorporated by reference to Exhibit 28.3 Form S-8
Registration Statement No. 33-83266.)(1)
10J. Building Lease by and between Opus Northwest, L.L.C., and
Computer Network Technology Corporation. (Incorporated by
reference to Exhibit 10A Form 10Q for the quarterly period
ended September 30, 1998.)
</TABLE>
56
<PAGE> 59
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<S> <C>
10K. Employment Agreement by and between the Company and Thomas
G. Hudson as amended. (Incorporated by reference to Exhibit
10Z Form 10-Q for the quarterly period ended June 30,
1996.)(1)
10L. Lease Agreement between Teachers Realty Corporation and
Computer Network Technology Corporation. (Incorporated by
reference to Exhibit 10AA Form 10-Q for the quarterly period
ended June 30, 1996.)
10M. Description of Success Sharing Bonus Plan. (Incorporated by
reference to Exhibit 10Y Form 10-K for the year ended
December 31, 1997.)(1)
10N. Employment Agreement by and between the Company and Mark
Knittel. (Incorporated by reference to Exhibit 10AA Form
10-K for the year ended December 31, 1997.)(1)
10O. Executive Deferred Compensation Plan. (Incorporated by
reference to Exhibit 10P to Form 10-K for the year ended
December 31, 1998.)(1)
10P. Form of Non-Qualified Stock Option Agreement dated May 13,
1999 for certain officers. (Incorporated by reference to
Exhibit 10R-1 to Form S-3 Registration Statement No.
333-80841.)(1)
10Q. Form of Incentive Stock Option Agreement dated May 13, 1999
for certain officers. (Incorporated by reference to Exhibit
10S-1 to Form S-3 Registration Statement No. 333-80841.)(1)
10R. Employment Agreement dated December 3, 1998 by and between
Scott Optiz and IntelliFrame Corporation. (Incorporated by
reference to Exhibit 10.3 to Form 8-K dated December 3,
1998.)
10S. Employment Agreement dated December 3, 1998 by and between
Alexansandr Elkin and IntelliFrame Corporation.
(Incorporated by reference to Exhibit 10.4 to Form 8-K dated
December 3, 1998.)
10T. Employment/Non-Compete Agreement by and between the Company
and Nick V. Ganio. (Incorporated by reference to Exhibit 10Q
to Form 10-K for the Year Ended December 31, 1998.)(1)
10U. 1997 Restricted Stock Plan. (Incorporated by reference to
Exhibit 99 to Form S-8 Registration Statement No.
333-59951.)(1)
21. Subsidiaries of the Registrant.(2)
23. Independent Auditors' Consent.(2)
27. Financial Data Schedule(2)
99. Cautionary Statements(2)
</TABLE>
- ---------------
(1) Management contracts or compensatory plans or arrangements with the Company.
(2) Filed herewith.
(B) REPORTS ON FORM 8-K
The Company filed a current report on Form 8-K dated October 13, 1999. The
report covered a contract entered into with Compaq Computer Corporation and a
press release related thereto.
57
<PAGE> 60
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COMPUTER NETWORK TECHNOLOGY CORPORATION
Dated: March 27, 2000 By: /s/ THOMAS G. HUDSON
------------------------------------
Thomas G. Hudson, President and
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<C> <S> <C>
/s/ THOMAS G. HUDSON President and Chief Executive Officer March 27, 2000
- --------------------------------------------- (Principal Executive Officer) and
Thomas G. Hudson Director
/s/ GREGORY T. BARNUM Vice President of Finance, Chief March 27, 2000
- --------------------------------------------- Financial Officer and Secretary
Gregory T. Barnum (Principal Financial Officer)
/s/ JEFFREY A. BERTELSEN Corporate Controller and Treasurer March 27, 2000
- --------------------------------------------- (Principal Accounting Officer)
Jeffrey A. Bertelsen
/s/ PATRICK W. GROSS Director March 27, 2000
- ---------------------------------------------
Patrick W. Gross
/s/ ERWIN A. KELEN Director March 27, 2000
- ---------------------------------------------
Erwin A. Kelen
/s/ LAWRENCE PERLMAN Director March 27, 2000
- ---------------------------------------------
Lawrence Perlman
/s/ JOHN A. ROLLWAGEN Director March 27, 2000
- ---------------------------------------------
John A. Rollwagen
</TABLE>
58
<PAGE> 61
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<S> <C>
2A. Agreement for Sale of Shares among Computer Network
Technology Corporation and each of Scott Opitz and Alexsandr
Elkin dated December 3, 1998. (Incorporated by reference to
Exhibit 2.1 to current report on Form 8-K dated December 3,
1998.)
2B. Asset Purchase Agreement by and between CNT Acquisition I
Corporation, Computer Network Technology Corporation and
Apertus Technologies Inc. dated October 24, 1997.
(Incorporated by reference to Exhibit 2.1 to current report
on Form 8-K dated October 24, 1997.)
3A. Second Restated Articles of Incorporation of the Company.
(Incorporated by reference to Exhibits 3(i)-1 and 3(i)-2 to
current report on Form 8-K dated May 25, 1999.)
3B. By-laws of the Company. (Incorporated by reference to
Exhibit 3(ii)-1 to current report on Form 8-K dated May 25,
1999.)
4.1 Rights Agreement between the Company and Chase Mellon
Shareholder Services, L.L.C., as Rights Agent including the
form of Rights Certificate and the Summary of Rights to
Purchase Preferred Shares. (Incorporated by reference to
Exhibit 1 to Form 8-A dated July 29, 1998.)
4.2 Form of Common Stock Certificate. (Incorporated by reference
to Exhibit 4.2 to Form S-3 Registration Statement No.
333-80841.)
10A. Lease Agreement dated November 30, 1990 by and between TOLD
Development Company, a general partnership, and Computer
Network Technology Corporation. (Incorporated by reference
to Exhibit 10C Form S-2 Registration Statement No.
33-41985.)
10B. Computer Network Technology Corporation 401(k) Salary
Savings Plan effective January 1, 1991. (Incorporated by
reference to Exhibit 10B to Form S-3 Registration Statement
No. 333-80841.)(1)
10C. Subscription Agreements of Kanematsu Electronics Ltd. and
Kanematsu USA Inc. dated October 22, 1990. (Incorporated by
reference to Exhibit 10G Form S-2 Registration Statement No.
33-41985.)
10D. Amended 1992 Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 99 Form S-8 Registration Statement No.
333-80793.)(1)
10E. Amended 1992 Stock Award Plan. (Incorporated by reference to
Exhibit 99 Form S-8 Registration Statement No.
333-80791.)(1)
10F. 1999 Non-Qualified Stock Award Plan. (Incorporated by
reference to Exhibit 99 Form S-8 Registration Statement No.
333-86315.)(1)
10G. Trademark License executed October 8, 1999 between Compaq
Computer Corporation and Computer Network Technology
Corporation. (Incorporated by reference to Exhibit 99.2 to
current report on Form 8-K dated October 13, 1999.)
10H. March 10, 1994 Incentive Stock Option Agreements.
(Incorporated by reference to Exhibit 28.2 Form S-8
Registration Statement No. 33-83266.)(1)
10I. March 10, 1994 Non-Qualified Stock Option Agreements.
(Incorporated by reference to Exhibit 28.3 Form S-8
Registration Statement No. 33-83266.)(1)
10J. Building Lease by and between Opus Northwest, L.L.C., and
Computer Network Technology Corporation. (Incorporated by
reference to Exhibit 10A Form 10Q for the quarterly period
ended September 30, 1998.)
</TABLE>
59
<PAGE> 62
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<S> <C> <C>
10K. Employment Agreement by and between the Company and Thomas
G. Hudson as amended. (Incorporated by reference to Exhibit
10Z Form 10-Q for the quarterly period ended June 30,
1996.)(1)
10L. Lease Agreement between Teachers Realty Corporation and
Computer Network Technology Corporation. (Incorporated by
reference to Exhibit 10AA Form 10-Q for the quarterly period
ended June 30, 1996.)
10M. Description of Success Sharing Bonus Plan. (Incorporated by
reference to Exhibit 10Y Form 10-K for the year ended
December 31, 1997.)(1)
10N. Employment Agreement by and between the Company and Mark
Knittel. (Incorporated by reference to Exhibit 10AA Form
10-K for the year ended December 31, 1997.)(1)
10O. Executive Deferred Compensation Plan. (Incorporated by
reference to Exhibit 10P to Form 10-K for the year ended
December 31, 1998.)(1)
10P. Form of Non-Qualified Stock Option Agreement dated May 13,
1999 for certain officers. (Incorporated by reference to
Exhibit 10R-1 to Form S-3 Registration Statement No.
333-80841.)(1)
10Q. Form of Incentive Stock Option Agreement dated May 13, 1999
for certain officers. (Incorporated by reference to Exhibit
10S-1 to Form S-3 Registration Statement No. 333-80841.)(1)
10R. Employment Agreement dated December 3, 1998 by and between
Scott Optiz and IntelliFrame Corporation. (Incorporated by
reference to Exhibit 10.3 to Form 8-K dated December 3,
1998.)
10S. Employment Agreement dated December 3, 1998 by and between
Alexansandr Elkin and IntelliFrame Corporation.
(Incorporated by reference to Exhibit 10.4 to Form 8-K dated
December 3, 1998.)
10T. Employment/Non-Compete Agreement by and between the Company
and Nick V. Ganio. (Incorporated by reference to Exhibit 10Q
to Form 10-K for the Year Ended December 31, 1998.)(1)
10U. 1997 Restricted Stock Plan. (Incorporated by reference to
Exhibit 99 to Form S-8 Registration Statement No.
333-59951.)(1)
21. Subsidiaries of the Registrant.(2)
23. Independent Auditors' Consent.(2)
27. Financial Data Schedule(2)
99. Cautionary Statements(2)
</TABLE>
- ---------------
(1) Management contracts or compensatory plans or arrangements with the Company.
(2) Filed herewith.
60
<PAGE> 1
EXHIBIT 21
COMPUTER NETWORK TECHNOLOGY CORPORATION
SUBSIDIARIES OF THE REGISTRANT
CNT International Ltd.
- Incorporated under the English Companies Act
- d/b/a CNT International Ltd. and CNTI
CNT France S.A.
- Incorporated under French law
- d/b/a CNT France S.A. and CNTF
Computer Network Technology GmbH
- Incorporated under German law
CNTFS Corporation
- Incorporated under Virgin Islands law
CNTware Vernetzungssysteme GmbH
- Incorporated under German law
Computer Network Technology (Asia Pacific) Pty. Ltd.
- Incorporated under Australian law
- d/b/a CNT A/P
CNT China Limited
- Incorporated under Hong Kong law
CNT Japan K.K.
- Incorporated under Japanese law
RealLegacy.com, Inc. (formerly known as CNT Acquisition I Corporation)
- Incorporated under Minnesota law
IntelliFrame Corporation
- Incorporated under Pennsylvania law
Computer Network Technology do Brasil Ltda.
- Incorporated under Brazillian law
<PAGE> 1
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Computer Network Technology Corporation:
We consent to incorporation by reference in the Registration Statements (No.
33-6862, 33-28367, 33-42750, 33-41596, 33-48944, 33-48954, 33-68356, 33-68372,
33-83262, 333-80841, 333-88209, 333-86315, 333-80791, 333-80793, 33-83264,
333-59951, 333-31851, 333-31853, 333-59949, 333-59947 and 33-83266) of Computer
Network Technology Corporation on Form S-8 and Form S-3 of our reports dated
January 21, 2000, relating to the consolidated balance sheets of Computer
Network Technology Corporation and subsidiaries as of December 31, 1999 and 1998
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, and the related financial statement schedule,
which reports appear in the December 31, 1999 annual report on Form 10-K of
Computer Network Technology Corporation.
/s/ KPMG LLP
Minneapolis, Minnesota
March 27, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF COMPUTER NETWORK TECHNOLOGY CORPORATION AS
OF AND FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 16,184
<SECURITIES> 10,711
<RECEIVABLES> 37,806
<ALLOWANCES> 959
<INVENTORY> 14,764
<CURRENT-ASSETS> 85,133
<PP&E> 52,641
<DEPRECIATION> 34,170
<TOTAL-ASSETS> 114,670
<CURRENT-LIABILITIES> 34,418
<BONDS> 1,780
0
0
<COMMON> 238
<OTHER-SE> 78,234
<TOTAL-LIABILITY-AND-EQUITY> 114,670
<SALES> 104,730
<TOTAL-REVENUES> 151,693
<CGS> 40,199
<TOTAL-COSTS> 67,382
<OTHER-EXPENSES> 24,749<F1>
<LOSS-PROVISION> 519
<INTEREST-EXPENSE> 264
<INCOME-PRETAX> 7,053
<INCOME-TAX> 2,398
<INCOME-CONTINUING> 4,655
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,655
<EPS-BASIC> .20<F2>
<EPS-DILUTED> .18
<FN>
<F1>AMOUNT PRESENTED REPRESENTS ENGINEERING AND DEVELOPMENT EXPENSE.
<F2>AMOUNT PRESENTED REPRESENTS BASIC EPS.
</FN>
</TABLE>
<PAGE> 1
EXHIBIT 99
CAUTIONARY STATEMENTS
WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE FOR A
NUMBER OF REASONS, WHICH COULD CAUSE OUR STOCK PRICE TO FLUCTUATE
Our quarterly revenues and operating results have varied significantly in
the past and are likely to vary significantly in the future due to a number of
factors, any of which may cause our stock price to fluctuate. The primary
factors that may affect our quarterly financial performance include the
following:
- fluctuations in demand for our products and services;
- the timing of customer orders, which are often grouped toward the end of
a quarter, particularly large orders from our significant customers and
whether any orders are cancelled;
- product mix among our SAN, channel networking, EAI and server gateway and
tools products;
- our traditionally long sales cycle, which can range from 90 days to 12
months or more;
- our ability to develop, introduce, ship and support new products and
product enhancements;
- the fact that our products are usually only part of an overall solution
that our customers may have problems implementing or obtaining the
required components or services from other vendors;
- the rate of adoption of SANs as an alternative to existing data storage
and management systems;
- the rate of adoption of EAI products and related solutions;
- announcements and new product introductions by our competitors and
deferrals of customer orders in anticipation of new products, services or
product enhancements introduced by us or our competitors;
- decreases over time in the prices at which we can sell our products;
- our ability to obtain sufficient supplies of components, including
limited sourced components, at reasonable prices, or at all;
- communication costs and the availability of communication lines;
- increases in the prices of the components we purchase;
- our ability to attain and maintain production volumes and quality levels
for our products; and
- increased expenses, particularly in connection with our strategy to
continue to expand our relationships with key strategic partners.
Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely, in some future period, that
our operating results may be below expectations of public market analysts or
investors. Because most of our expenses are fixed in the short-term or incurred
in advance of anticipated revenue, we may not be able to decrease our expenses
in a timely manner to offset any unexpected shortfall in revenue.
WE RECENTLY INCURRED LOSSES AND MAY NOT BE ABLE TO MAINTAIN PROFITABILITY
We experienced losses of $2.3 million for the year ended December 31, 1997,
and $2.6 million in the fourth quarter of 1999. In addition, we may incur losses
during the first quarter of 2000. Although we were profitable in 1999, taken as
a whole, we cannot be certain that we will be able to sustain historical or
projected growth rates or that we will realize sufficient revenues to maintain
profitability. Also, we are depending on our new SAN products and, if we do not
divest all or part of our Enterprise Integration Solutions Division, our EAI
products for a significant portion of future revenues, especially as revenues
from our traditional channel networking and server gateways and tools products
continue to decline. Our new product revenues must increase more rapidly than
our revenues related to our traditional products
<PAGE> 2
decline. Moreover, if we divest our Enterprise Integration Solutions Division,
our SAN revenues will have to increase significantly to maintain current revenue
levels and to offset overhead costs that are currently shared by our two
divisions. We expect to incur significant product development, sales and
marketing and administrative expenses in connection with the introduction of new
products, and, as a result, we will need to generate significant revenue
increases to achieve and maintain profitability. We may not be able to sustain
or increase profitability.
OUR FUTURE REVENUES AND OPERATING RESULTS ARE DIFFICULT TO PREDICT BECAUSE
OF OUR LIMITED OPERATING EXPERIENCE IN OUR PRESENT MARKETS
We have recently expanded into the SAN and EAI markets. In addition, we
expect that a significant portion of our future revenues will be derived from
our SAN products, and, if we do not divest all or part of our Enterprise
Integration Solutions Division, our EAI products. Our limited operating
experience, combined with the evolving nature of the markets in which we sell
our products, reduces our ability to accurately forecast our quarterly and
annual revenue. Further, if we divest our Enterprise Integration Solutions
Division, our revenue base will become less diversified and could be subject to
increased volatility. Moreover, we plan our operating expenses based in part on
our revenue projections. Because most of our expenses are fixed in the
short-term or incurred in advance of anticipated revenue, we may not be able to
decrease our expenses in a timely manner to offset any unexpected shortfall in
revenue.
WE HAVE LIMITED PRODUCT OFFERINGS AND DEPEND ON THE WIDESPREAD MARKET
ACCEPTANCE OF OUR EXISTING AND NEW PRODUCTS
We derive a substantial portion of our net revenues from a limited number
of existing products. Specifically, for the year ended December 31, 1999, we
derived approximately 57% of our product revenues from our SAN and EAI products.
We expect that net revenues from our SAN products, and, if we do not divest all
or part of our Enterprise Integration Solution Division, our EAI products will
account for a substantial and growing portion of our total net revenues for the
foreseeable future. Following any such divestiture, we will be substantially
more dependent on SAN product revenues. Further, we expect net revenues from our
channel networking and server gateways and tools products to continue to
decline. As a result, for the foreseeable future, we will continue to be subject
to the risk of a dramatic decrease in net revenues if demand for our newest
products, particularly our SAN products, declines. Therefore, widespread market
acceptance of these products is critical to our future success. These products
have been recently introduced. Accordingly, the demand for, and market
acceptance of, these products is uncertain.
Factors that may affect the market acceptance of our products, some of
which are beyond our control, include the following:
- growth of the SAN, EAI and related products markets;
- performance, quality, price and total cost of ownership of our existing
products;
- continued development of technologies that allow our SAN products to
function over WANs and over IP-based networks;
- availability, price, quality and performance of competing products and
technologies; and
- successful development of our relationships with new and existing
customers and strategic partners.
IF WE ARE UNABLE TO RENEW A LICENSE THAT EXPIRED ON DECEMBER 31, 1999, WE
COULD LOSE SIGNIFICANT REVENUES
A license related to the inclusion of a component in our Channelink(R) and
UltraNet(R) products that use ESCON expired on December 31, 1999. ESCON is the
enterprise serial connection protocol and interface used on IBM mainframes. We
are in negotiations concerning the renewal of this license, and if we are unable
to renew this license, we may be prohibited from further use of the subject
technology and
2
<PAGE> 3
our operating results and financial condition would be harmed. In 1999,
Channelink(R) and UltraNet(R) products that use this component represented
approximately 50% of our product revenues.
WE MAY DIVEST ALL OR PART OF OUR ENTERPRISE INTEGRATION SOLUTIONS DIVISION
On January 3, 2000, we announced our intention to explore the divestiture
of all or part of our Enterprise Integration Solutions Division. We have not
finalized any plans relating to this divestiture and there are significant risks
associated with a divestiture. Our revenues could decline after any such
divesture, which could reduce our profitability if our operating expenses as a
percentage of our remaining revenues increase. Further, we may be obligated to
continue to provide significant operating capital to this business unit prior to
and after divestiture, which would further reduce our available working capital.
We may also be required to provide transitional services for a limited period of
time to such an entity. Providing such services may not be profitable and could
distract management's attention from our targeted markets. We may also refer
future business opportunities to this divested business unit, which may preclude
us from realizing benefits, financial and otherwise, associated with such
opportunities. A spin-off transaction may also result in our being subject to a
corporate tax if we were to engage in significant business combinations during a
two-year period following the spin-off. Accordingly, the potential adverse tax
consequences of a spin-off may effectively prohibit subsequent transactions that
could be advantageous to shareholders.
OUR FAILURE TO DIVEST ALL OR PART OF OUR ENTERPRISE INTEGRATION SOLUTIONS
DIVISION COULD HURT OUR OPERATING RESULTS
Any final divestiture of all or part of the Enterprise Integration
Solutions Division is subject to many factors beyond our control. These factors
include future near-term profitability of the division, structuring a
transaction acceptable to us, and, where applicable, financing acceptable to
potential buyers, or acceptable conditions in the capital markets to consummate
a spin-off of all or part of the Enterprise Integration Solutions Division to
our shareholders. Prior to divesture, we will face continuing demands on our
corporate resources in order to maintain the growth and viability of the
Enterprise Integration Solutions Division's business. These demands could reduce
the resources available for development of our core SAN products. Failure to
divest all or part of the Enterprise Integration Solutions Division within a
reasonable time also may impair the long-term viability of the division, which
could impair our operating results.
OUR HISTORICAL FINANCIAL INFORMATION WILL NOT BE REFLECTIVE OF OUR RESULTS
AFTER ANY DIVESTITURE OF ALL OR PART OF THE ENTERPRISE INTEGRATION SOLUTIONS
DIVISION
The historical financial statements included in this Form 10-K include the
combined results of operations of our Networking Solutions Division and our
Enterprise Integration Solutions Division. The Networking Solutions Division and
the Enterprise Integration Solutions Division were not accounted for, and were
not operated as, separate stand alone business entities. As a result, the
historical financial statements are not reflective of what cost structures will
remain after any divestiture of all or part of the Enterprise Integration
Solutions Division and no adjustment has been made to the information included
in this Form 10-K to reflect any changes in such cost structures, including
increased costs associated with reduced economies of scale.
OUR CHANGE OF FISCAL YEAR MAY NOT RESULT IN MORE PREDICTABLE QUARTERLY
EARNINGS
Historically, our quarterly operating results have depended on our
performance in the later part of each quarter, when a large percentage of our
product shipments typically occur. This fluctuation has made consistent
quarter-to-quarter performance and revenue forecasting difficult. We have
adopted a number of measures to address this issue, including changing our
fiscal year end to January 31, rather than December 31. We cannot be certain
that changing our fiscal year or adopting other measures will result in product
shipments occurring more evenly during each quarter, resulting in consistent
quarter-to-quarter performance or improving revenue forecasts.
3
<PAGE> 4
OUR SUCCESS DEPENDS ON THE DEMAND FOR OUR PRODUCTS
We depend on the demand for and success of our products. Potential
customers who have invested substantial resources in their existing data storage
and management systems may be reluctant or slow to adopt a new approach, like
SANs. Moreover, potential EAI customers may decide to adopt entirely new systems
that eliminate the need for an EAI product. Our success in generating net
revenues in these areas will depend on, among other things, our ability to:
- educate potential customers, strategic partners and end users about the
benefits of our products and related technologies;
- maintain and enhance our relationships with leading strategic partners;
and
- predict and base our products on standards that ultimately become
industry standards.
In addition, the continued growth of the market for SANs and related
products may depend in part on the continued decrease in the price of related
services and components, such as telecommunication lines and switches. Any
increase in the price of these related services and components would likely
cause this market to grow at a reduced rate. Further, SANs are often implemented
in connection with deployment of new storage systems and servers. Accordingly,
our future success is also substantially dependent on the market for new storage
systems and servers.
Finally, if we divest all or part of our Enterprise Integration Solutions
Division, we will be even more dependent on SAN-related revenues, which will
continue to be subject to the risks discussed above.
IF OUR RELATIONSHIPS WITH STRATEGIC PARTNERS ARE UNSUCCESSFUL OR
TERMINATED, OUR PRODUCT REVENUES COULD DECLINE
We market our products in connection with a few significant storage
vendors, including EMC, Hitachi Data Systems and IBM. In the year ended December
31, 1999, sales of our SAN products to customers using EMC's disk mirroring
systems accounted for 30% of our total product revenues. As a result, our
success depends substantially on our ability to manage and expand our
relationships with EMC and other storage vendors, to initiate relationships with
new strategic partners that will recommend our products and the success of our
strategic partners' products. In addition, we rely to a significant extent on
the continued recommendation of our products by our strategic partners. To the
extent that our strategic partners do not recommend our products, or to the
extent that they recommend products offered by our competitors, our business
will be harmed.
Additionally, we have only a limited number of sales people devoted to the
sale of our EAI products. We have chosen to rely on the efforts of our strategic
partners to assist us in these sales efforts. To the extent these strategic
partners are unable to sell these products, are unable to implement systems
using our products or recommend our competitor's products, our future revenues
could be substantially affected.
We may not be able to manage and expand our relationships with strategic
partners successfully, and they may not market our products successfully.
Moreover, our relationships with strategic partners are not in writing, have no
minimum purchase commitments and can be terminated or changed at any time. Our
failure to manage and expand our relationships with our significant strategic
partners, our failure to develop relationships with new strategic partners or
the failure of our strategic partners to market our products could substantially
reduce our net revenues and seriously harm our business.
OUR INDUSTRIES ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND WE MUST KEEP
PACE WITH THE CHANGES TO SUCCESSFULLY COMPETE
The markets for our products are characterized by rapidly changing
technology, evolving industry standards and the frequent introduction of new
products and enhancements. Our future success depends in large part on our
ability to enhance our existing products and to introduce new products on a
timely basis to meet changes in customer preferences and evolving industry
standards. We cannot be certain that we will be successful in developing,
manufacturing and marketing new products or product enhancements that
4
<PAGE> 5
respond to such changes in a timely manner and achieve market acceptance. We
also cannot be certain that we will be able to develop the underlying core
technologies necessary to create new products and enhancements.
Additionally, changes in technology and consumer preferences could
potentially render our current products noncompetitive or obsolete. If we are
unable, for technological or other reasons, to develop new products or enhance
existing products in a timely manner in response to technological and market
changes, our business, results of operations and financial condition would be
harmed.
WE ARE SUBSTANTIALLY DEPENDENT ON THE FINANCIAL SERVICES,
TELECOMMUNICATIONS AND INFORMATION OUTSOURCING INDUSTRIES
During the year ended December 31, 1999 approximately 26%, 13% and 5% of
our product revenues were derived from businesses in financial services,
telecommunications, and information outsourcing industries, respectively. The
erosion of our relationships with our customers in these industries, or the
erosion of demand for SAN and EAI products in these industries generally, would
harm our financial condition and operating results.
WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS FOR KEY COMPONENTS
We depend upon a limited number of suppliers for several key components
used in the manufacture of our products. In the future, we may experience
shortages of, or difficulties in acquiring, these components. If we are unable
to buy these components, then we will not be able to manufacture our products on
a timely basis.
We use rolling forecasts based on anticipated product orders to determine
our component requirements. Lead times for materials and components that we
order vary significantly and depend on factors such as specific supplier
requirements, contract terms and current market demand for such components. As a
result, our component requirement forecasts may not be accurate. If we
overestimate our component requirements, then we may have excess inventory,
which would increase our costs. If we underestimate our component requirements,
then we may have inadequate inventory, which could interrupt our manufacturing
and delay delivery of our products to our customers. Either of these occurrences
would negatively impact our business and operating results.
THE COMPETITION IN OUR MARKETS MAY LEAD TO REDUCED SALES OF OUR PRODUCTS,
REDUCED PROFITS OR REDUCED MARKET SHARE
The markets for our products are competitive and are likely to become even
more competitive. Increased competition could result in pricing pressures,
reduced sales, reduced margins, reduced profits, reduced market share or the
failure of our products to achieve or maintain market acceptance. Our products
face competition from multiple sources, including the ability of some of our
customers to design solutions to the problems targeted by our products. Many of
our competitors and potential competitors have longer operating histories,
greater name recognition, access to larger customer bases or substantially
greater resources than we have. As a result, they may be able to respond more
quickly than we can to new or changing opportunities, technologies, standards or
customer requirements. For all of the foregoing reasons, we may not be able to
compete successfully against our current and future competitors.
WE MAY ENGAGE IN FUTURE ACQUISITIONS THAT DILUTE OUR SHAREHOLDERS AND CAUSE
US TO INCUR DEBT OR ASSUME CONTINGENT LIABILITIES
As part of our strategy, we expect to review opportunities to buy other
businesses or technologies that would complement our current products and
services, expand the breadth of our markets, enhance our
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technical capabilities, or otherwise offer growth opportunities. In the event of
any future purchases, we could:
- spend significant amounts of cash;
- issue stock that would dilute our current shareholders' percentage
ownership;
- incur amortization expense related to goodwill and other intangible
assets; or
- incur debt or assume liabilities.
These purchases also involve numerous risks, including:
- problems combining the purchased operations, technologies, personnel or
products;
- unanticipated costs;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with suppliers,
customers or strategic partners;
- risks associated with entering markets in which we have no or limited
prior experience;
- potential loss of key employees of acquired or merged organizations; and
- the growth rates of any acquired company may be less than those projected
by analysts or anticipated by markets, which could have a depressive
effect on our stock price.
We cannot assure you that we will be able to successfully integrate any
businesses, products, technologies or personnel related to organizations that we
might acquire or merge with in the future.
UNDETECTED SOFTWARE OR HARDWARE ERRORS COULD INCREASE OUR COSTS AND DELAY
PRODUCT INTRODUCTION
Networking products frequently contain undetected software or hardware
errors when first introduced or as new versions are released. Our products are
complex and errors may be found from time to time in our products, including new
or enhanced products. In addition, our products are combined with products from
other vendors. As a result, when problems occur, it may be difficult to identify
the source of the problem. These problems may cause us to incur significant
warranty and repair costs, divert the attention of our engineering personnel
from our product development efforts and cause significant customer relations
problems. Moreover, the occurrence of hardware and software errors, whether
caused by our or another vendor's products, could delay or prevent the
development of the markets in which we compete.
THE LOSS OF KEY EXECUTIVE OR EXPERIENCED PERSONNEL OR THE INABILITY TO HIRE
AND RETAIN ADDITIONAL PERSONNEL WITH EXPERTISE IN THE SAN AND EAI INDUSTRIES
COULD NEGATIVELY IMPACT SALES AND DELAY PRODUCT INTRODUCTION
We are dependent on Thomas G. Hudson, our Chairman, President and Chief
Executive Officer. In addition, we rely upon the continued contributions of our
key management, engineering and sales and marketing personnel, many of whom
would be difficult to replace quickly. We also believe that our success depends
to a significant extent on the ability of our management to operate effectively,
both individually and as a group. Many members of our management team have only
recently joined us. The loss of any one of our key employees could adversely
affect our sales or delay the development or marketing of existing or future
products.
We believe our future success will depend also in part upon our ability to
attract and retain highly skilled and qualified managerial, engineering, sales
and marketing, and finance and operations personnel. Competition for these
personnel is intense. In the past, we have experienced difficulty in hiring
qualified personnel with expertise in the SAN and EAI industries, and there can
be no assurance that we will be successful in attracting and retaining these
individuals in the future. The inability to attract or retain qualified
personnel in the future or delays in hiring required personnel, particularly
engineers and sales personnel, could delay the development and introduction of
and negatively impact our ability to sell our
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products. In addition, companies in our industry whose employees accept
positions with competitors frequently claim that their competitors have engaged
in unfair hiring practices. We cannot assure you that we will not receive such
claims in the future as we seek to hire qualified personnel or that such claims
will not result in costly litigation. We could incur substantial costs in
defending ourselves against these claims, regardless of their merits.
WE MUST CONTINUE TO IMPROVE OUR OPERATIONAL SYSTEMS AND CONTROLS TO MANAGE
FUTURE GROWTH
We plan to continue to expand our operations to pursue existing and
potential market opportunities. We expect that this growth will place a
significant demand on our management and our operational resources. In order to
manage growth effectively, we must implement and improve our operational
systems, procedures and controls and train our employee base. Accordingly, we
cannot assure you that:
- we will be able to effectively manage the expansion of our operations;
- our key employees will be able to work together effectively as a team to
successfully manage our growth;
- we will be able to hire, train and manage our employee base;
- we will be able to properly integrate our acquisitions;
- our systems, procedures or controls will be adequate to support our
operations; and
- our management will be able to achieve the rapid execution necessary to
fully exploit the market opportunity for our products and services.
Our inability to manage growth effectively could harm our business.
WE PLAN TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES, WHICH WILL SUBJECT
US TO ADDITIONAL BUSINESS RISKS
International markets accounted for approximately 32% of our revenues in
1999. We plan to expand our international sales activities, and therefore our
success will become increasingly dependent on our performance in international
markets. Our international sales growth in these and other countries will be
limited if we are unable to establish relationships with international
distributors, establish additional foreign operations, expand international
sales channel management, hire additional personnel and develop relationships
with international service providers. Even if we are able to successfully expand
international operations, we cannot be certain that we will be able to maintain
or increase international market demand for our products. Our international
operations, are subject to a number of risks, including:
- supporting multiple languages;
- recruiting sales and technical support personnel with the skills to
support our products;
- increased complexity and costs of managing international operations;
- protectionist laws and business practices that favor local competition;
- dependence on local vendors;
- multiple, conflicting and changing governmental laws and regulations;
- longer sales cycles;
- difficulties in collecting accounts receivable, converting foreign
currency to dollars and remitting funds to the United States;
- difficulties enforcing our legal rights;
- reduced or limited protections of intellectual property rights; and
- political and economic instability.
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None of our products include screen displays or user documentation in any
language other than the English language. Our future prospects in international
markets may require us to develop multiple language versions of our products and
support documentation. The lack of such documentation could cause prospective
customers to select other products. In addition, the development of such
products and documentation could be costly and time consuming.
Because a significant portion of our international revenues are denominated
in foreign currencies, primarily French francs, the euro and British pounds
sterling, an increase in the value of the U.S. dollar relative to these
currencies could make our products more expensive and thus less competitive in
foreign markets.
WE HAVE APPLIED FOR AND RECEIVED A LIMITED NUMBER OF PATENTS AND WE MAY BE
UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY AFFECT OUR
ABILITY TO COMPETE
Historically, we have not pursued patents on all our intellectual property.
Traditionally, we have relied, and currently continue to rely, on a combination
of patent, copyright, trademark and trade secret laws and restrictions on
disclosure to protect our intellectual property rights. We also enter into
confidentiality or license agreements with substantially all our employees,
consultants and corporate partners, and control access to and distribution of
our software, documentation and other proprietary information. We have four
patents in process and have three existing patents. In addition, while we intend
to more vigorously pursue patent protection for our intellectual property in the
future, unauthorized parties may attempt to copy or otherwise obtain and use our
products or technology. Monitoring unauthorized use of our products is
difficult, and we cannot be certain that the steps we have taken will prevent
unauthorized use of our technology, particularly in foreign countries where the
laws may not protect our proprietary rights as fully as in the United States or
where legal authorities in foreign countries do not vigorously enforce existing
laws.
We have from time to time received, and may in the future receive,
communications from parties asserting patent rights against us that relate to
certain of our products. Although we believe that we possess 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 third parties, we cannot assure you that others will
not claim a proprietary interest in all or part of our technology or assert
claims of infringement. All such claims, regardless of their merits, could
expose us to costly litigation and could substantially harm our operating
results.
OTHERS MAY BRING INFRINGEMENT CLAIMS AGAINST US, WHICH COULD BE
TIME-CONSUMING AND EXPENSIVE TO DEFEND
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. Although we are not
currently involved in any intellectual property litigation, we may be a party to
litigation in the future to protect our intellectual property or as a result of
an alleged infringement of others' intellectual property. These claims and any
resulting lawsuits could subject us to significant liability for damages and
invalidation of our proprietary rights. These lawsuits, regardless of their
success, would likely be time-consuming and expensive to resolve and would
divert management time and attention. Any potential intellectual property
litigation also could force us to do one or more of the following:
- stop selling, incorporating or using our products or services that use
the challenged intellectual property;
- obtain a license from the owner of the infringed intellectual property
right allowing us to sell or use the relevant technology, which license
may not be available on reasonable terms, or at all; and
- redesign those products or services that use such technology.
In addition to the related costs of the foregoing actions, if we are forced
to take any of these actions, we may be unable to manufacture and sell the
related products, which would reduce our revenues.
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OUR PRODUCTS MUST COMPLY WITH EVOLVING INDUSTRY STANDARDS AND GOVERNMENT
REGULATIONS
The market for our products is characterized by the need to support
industry standards as they emerge, evolve and achieve acceptance. To remain
competitive, we must continue to introduce new products and product enhancements
that meet these industry standards. For example, all components of a SAN must
utilize a limited number of defined standards in order to work with existing
computer systems. Our products comprise only a part of the entire storage area
network and we depend on the companies that provide other components of the
storage area network, many of whom are significantly larger than we are, to
support the industry standards as they evolve. Also, our EAI products must
provide compatibility with major hardware and software platform standards in
order to be useful to our customers. The failure of these providers to support
these industry standards could adversely affect the market acceptance of our
products. In addition, in the United States, our products must comply with
various regulations and standards defined by the Federal Communications
Commission and Underwriters Laboratories. Internationally, products that we
develop will also be required to comply with standards established by
authorities in various countries. Failure to comply with existing or evolving
industry standards or to obtain timely domestic or foreign regulatory approvals
or certificates could materially harm our business.
WE DO NOT PLAN TO PAY CASH DIVIDENDS
We have never paid cash dividends and do not anticipate paying any cash
dividends in our foreseeable future. We intend to retain future earnings, if
any, to finance the growth and expansion of our business and for general
corporate purposes. Loan agreements and other contracts that we might enter into
in the future could prevent us from paying dividends.
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