FORM 10-Q
==============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 25, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to ________
---------------------------
COMMISSION FILE NUMBER 1-7534
--------------------------
STORAGE TECHNOLOGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 84-0593263
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2270 South 88th Street, Louisville, 80028-4309
Colorado
(Address of principal executive (Zip Code)
offices)
Registrant's Telephone Number, including area code: (303) 673-5151
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. /X/ YES / / NO
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Common stock ($.10 Par Value) - 99,833,815 shares outstanding at October 30,
1998.
<PAGE>
Form 10-Q, Page 2
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
INDEX TO FORM 10-Q
SEPTEMBER 25, 1998
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Consolidated Balance Sheet 3
Consolidated Statement of Operations 4
Consolidated Statement of Cash Flows 5
Consolidated Statement of Changes in
Stockholders' Equity 6
Notes to Consolidated Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings 24
Item 6 - Exhibits and Reports on Form 8-K 26
<PAGE>
Form 10-Q, Page 3
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In Thousands of Dollars)
09/25/98
(Unaudited) 12/26/97
----------------------
ASSETS
Current assets:
Cash and cash equivalents $ 217,792 $ 256,319
Short-term investments 77,275
Accounts receivable 657,541 627,981
Inventories (Note 2) 265,511 205,461
Deferred income tax assets 101,936 102,575
--------- ---------
Total current assets 1,242,780 1,269,611
Property, plant and equipment, at cost 304,276 305,122
Spare parts for maintenance, at cost 29,639 27,523
Deferred income tax assets 33,409 37,468
Other assets 105,155 100,293
--------- ---------
$1,715,259 $1,740,017
========= =========
LIABILITIES
Current liabilities:
Revolving credit facility (Note 3) $ 330,000
Current portion of long-term debt 1,688 $ 3,282
Accounts payable 124,770 103,483
Accrued liabilities 327,957 406,384
Income taxes payable 81,719 95,256
--------- ---------
Total current liabilities 866,134 608,405
Long-term debt 17,948 19,109
--------- ---------
Total liabilities 884,082 627,514
--------- ---------
Commitments and contingencies (Note 4)
STOCKHOLDERS' EQUITY
Common stock, $.10 par value, 150,000,000 shares
authorized; 99,863,464 shares issued at
September 25, 1998, and 108,008,082 shares
issued at December 26, 1997 (Note 6) 9,986 10,800
Capital in excess of par value 719,278 1,161,997
Retained earnings (accumulated deficit) 106,629 (39,017)
Treasury stock of 117,271 shares at
September 25, 1998, and 918,896 shares at
December 26, 1997 (2,409) (18,874)
Unearned compensation (2,307) (2,403)
--------- ---------
Total stockholders' equity 831,177 1,112,503
--------- ---------
$1,715,259 $1,740,017
========= =========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
Form 10-Q, Page 4
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(In Thousands, Except Per Share Amounts)
Quarter Ended Nine Months Ended
-------------------------------------------
09/25/98 09/26/97 09/25/98 09/26/97
-------------------------------------------
Sales revenue $405,357 $371,235 $1,127,350 $1,038,764
Maintenance revenue 165,703 153,933 470,907 442,023
------- ------- --------- ---------
Total revenue 571,060 525,168 1,598,257 1,480,787
------- ------- --------- ---------
Cost of sales 207,549 201,818 570,651 567,016
Cost of maintenance 97,239 83,565 272,272 243,323
------- ------- --------- ---------
Total cost of revenue 304,788 285,383 842,923 810,339
------- ------- --------- ---------
Gross profit 266,272 239,785 755,334 670,448
Research and product development
costs 60,880 52,445 171,800 149,403
Marketing, general, administrative
and other income and expense,
net 122,955 120,597 355,818 338,251
------- ------- --------- ---------
Operating profit 82,437 66,743 227,716 182,794
Interest income 1,975 8,807 12,345 23,693
Interest expense (2,689) (820) (5,138) (3,484)
------- ------- --------- ---------
Income before income taxes 81,723 74,730 234,923 203,003
Provision for income taxes (31,100) (20,200) (89,300) (54,900)
------- ------- --------- ---------
Net income $ 50,623 $ 54,530 $ 145,623 $ 148,103
======= ======= ========= =========
EARNINGS PER COMMON SHARE (NOTE 6)
Basic earnings per share $ 0.50 $ 0.44 $ 1.38 $ 1.21
======= ======= ========= =========
Weighted-average shares 102,178 123,189 105,242 122,890
======= ======= ========= =========
Diluted earnings per share $ 0.48 $ 0.44 $ 1.35 $ 1.19
======= ======= ========= =========
Weighted-average and dilutive
potential shares 104,723 125,196 108,030 125,104
======= ======= ========= =========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
Form 10-Q, Page 5
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(In Thousands of Dollars)
Nine Months Ended
------------------------
09/25/98 09/26/97
------------------------
OPERATING ACTIVITIES
Cash received from customers $ 1,544,947 $ 1,540,974
Cash paid to suppliers and employees (1,389,800) (1,162,562)
Interest received 12,345 22,738
Interest paid (4,182) (2,667)
Income taxes paid (92,907) (52,089)
---------- ----------
Net cash provided by operating activities 70,403 346,394
---------- ----------
INVESTING ACTIVITIES
Short-term investments, net 77,275 (216,834)
Purchase of property, plant and equipment, net (70,239) (39,824)
Other assets (9,774) 16,243
---------- ----------
Net cash used in investing activities (2,738) (240,415)
---------- ----------
FINANCING ACTIVITIES
Repurchases of common stock (Note 6) (458,270) (40,726)
Repayments of other debt (3,863) (3,513)
Proceeds from revolving credit facility 330,000
Proceeds from employee stock plans 25,744 17,373
---------- ----------
Net cash used in financing activities (106,389) (26,866)
---------- ----------
Effect of exchange rate changes on cash 197 (12,979)
---------- ----------
Increase (decrease) in cash and cash equivalents (38,527) 66,134
Cash and cash equivalents - beginning of the
period 256,319 388,401
---------- ----------
Cash and cash equivalents - end of the period $ 217,792 $ 454,535
========== ==========
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES
Net income $ 145,623 $ 148,103
Depreciation and amortization expense 91,719 86,728
Translation loss 1,052 16,432
Other adjustments to income 4,531 14,146
(Increase) decrease in accounts receivable (53,310) 37,603
(Increase) decrease in inventories (57,273) 13,233
Increase in spare parts for maintenance, net (14,605) (2,043)
Decrease in net deferred income tax asset 4,764 15,537
Increase (decrease) in accounts payable and
accrued liabilities (38,627) 29,381
Decrease in income taxes payable (13,471) (12,726)
---------- ----------
Net cash provided by operating activities $ 70,403 $ 346,394
========== ==========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
Form 10-Q, Page 6
<TABLE>
<CAPTION>
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(In Thousands of Dollars)
Retained
Capital in Earnings
Common Excess of (Accumulated Treasury Unearned
Stock Par Value Deficit) Stock Compensation Total
-------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances, December 26, 1997, as
previously reported $ 5,400 $1,161,997 $(33,617) $(18,874) $(2,403) $1,112,503
2-for-1 stock split in the form
of a stock dividend (Note 6) 5,400 (5,400)
------- --------- ------- ------- ------ ---------
Balances, December 26, 1997,
as restated 10,800 1,161,997 (39,017) (18,874) (2,403) 1,112,503
Shares issued under stock purchase
plan, and for exercises of options
(1,515,248 shares, including 808,254
shares issued from treasury) 71 14,771 16,601 31,443
Repurchases of common stock
(8,822,500 shares) (Note 6) (882) (370,403) (371,285)
Final price adjustment for
common stock repurchased
in October 1997 (Note 6) (87,030) (87,030)
Net income 145,623 145,623
Other (3) (57) 23 (136) 96 (77)
------- --------- ------- ------- ------ ---------
Balances, September 25, 1998 $ 9,986 $ 719,278 $106,629 $ (2,409) $(2,307) $ 831,177
======= ========= ======= ======= ====== =========
The accompanying notes are an integral part of the consolidated financial statements.
</TABLE>
<PAGE>
Form 10-Q, Page 7
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PREPARATION
- -----------------------------
The accompanying consolidated financial statements of Storage Technology
Corporation and its subsidiaries (StorageTek or the Company) have been prepared
in accordance with the Securities and Exchange Commission requirements for Form
10-Q. In the opinion of management, these statements reflect all adjustments
necessary for the fair presentation of results for the periods presented, and
such adjustments are of a normal, recurring nature. For further information,
refer to the consolidated financial statements and footnotes included in the
Company's Annual Report on Form 10-K for the year ended December 26, 1997.
NOTE 2 - INVENTORIES
- --------------------
Inventories consist of the following (in thousands of dollars):
09/25/98 12/26/97
-----------------------------
Raw materials $ 47,834 $ 32,607
Work-in-process 90,454 57,235
Finished goods 127,223 115,619
------- -------
$265,511 $205,461
======= =======
NOTE 3 - DEBT AND FINANCING ARRANGEMENTS
- ----------------------------------------
The Company has a $350,000,000 unsecured revolving credit facility (the
Revolver) which expires in October 2001. The credit limit available under the
Revolver will be reduced by $12,500,000 on the last day of each calendar quarter
beginning December 31, 1998. The interest rates under the Revolver depend on the
type of advance selected. The basic advance rate is not less than the London
Interbank Offered Rate (LIBOR) plus 0.625% (approximately 6.01% as of September
25, 1998). The Revolver contains certain financial and other covenants,
including restrictions on the Company's payment of cash dividends on its common
stock. As of September 25, 1998, the Company had borrowings of $330,000,000 and
had issued letters of credit for approximately $100,000 under the Revolver. The
remaining available credit under the Revolver as of September 25, 1998, was
approximately $19,900,000. The interest rate on the $330,000,000 of borrowings
under the Revolver varied from approximately 6.22% to 8.50%.
The Company has a financing agreement with a bank that provides for the sale of
promissory notes in the principal amount of up to $140,000,000 at any one time.
The agreement, which expires in January 2000, provides for commitments by the
bank to purchase promissory notes denominated in a number of foreign currencies.
The notes must be repaid only to the extent of future revenue of the Company and
obligations under the agreement are not cancelable by the Company or the bank.
Transaction gains and losses related to the notes are deferred and recognized as
an adjustment to the revenue supporting the note repayment. The promissory
notes, together with accrued interest, are payable in U.S. dollars within 40
days from the date of
<PAGE>
Form 10-Q, Page 8
issuance and bear interest at rates no less than the LIBOR
rate plus 0.35% (approximately 5.74% as of September 25, 1998). Under the terms
of the agreement, the Company is required to comply with certain covenants and,
under certain circumstances, may be required to maintain a collateral account,
including cash and qualifying investments, in an amount of no less than the
outstanding promissory notes. As of September 25, 1998, the Company had no
outstanding borrowings and had committed to borrowings between October 1998 and
December 1999 in the cumulative principal amount of approximately $331,120,000.
NOTE 4 - LITIGATION
- -------------------
In January 1994, Stuff Technology Partners II, a Colorado Limited Partnership
(Stuff), filed suit in Boulder County, Colorado, District Court against the
Company and certain subsidiaries. The suit alleged that the Company breached a
1990 settlement agreement that had resolved earlier litigation between the
parties. The suit sought injunctive relief and damages in the amount of
$2,400,000,000. On December 28, 1995, the court dismissed the complaint. Stuff
appealed the dismissal to the Colorado Court of Appeals. In April 1996, the
trial court stayed discovery on the Company's counterclaim for breach of the
covenant not to sue pending resolution of the appeal. In March 1997, the Court
of Appeals reversed the District Court's judgment and remanded the case to the
District Court for further proceedings. In December 1997, the Colorado Supreme
Court rejected the Company's petition seeking a reversal of this decision. A new
trial date has not been set. The case is in the discovery phase.
On June 29, 1995, Odetics, Inc. (Odetics) filed a patent infringement suit in
the U.S. District Court for the Eastern District of Virginia against the Company
alleging that the "pass-through" port in certain of the Company's tape library
products infringed U.S. Patent No. 4,779,151 (the "151 Patent"). The complaint
asked the court to impose injunctive relief, treble damages in an unspecified
amount, and an award of attorney's fees and costs. In February 1996, a jury
found that the Company's products did not infringe the 151 Patent. Odetics
appealed and in June 1997, the U.S. Court of Appeals for the Federal Circuit
reversed the District Court's ruling and remanded the case back to the District
Court for further proceedings. On March 27, 1998, a second trial was held and a
jury found that a pass-through port in certain of the Company's tape library
products willfully infringed the 151 Patent and awarded actual damages to
Odetics of $70,600,000. On July 31, 1998, the Court granted the Company's motion
for judgment as a matter of law, overturning the jury's verdict, and entered
judgment in favor of the Company. On August 10, 1998, Odetics appealed the
judgment to the U.S. Court of Appeals for the Federal Circuit, and on August 26,
1998, the Company filed a cross-appeal. These appeals are pending before the
U.S. Court of Appeals.
On December 8, 1995, Odetics filed a second patent infringement suit in the U.S.
District Court for the Eastern District of Virginia against the Company. The
complaint alleges that the "cartridge access port" in certain of the Company's
tape library products also infringes the 151 Patent. The complaint seeks
injunctive relief, treble damages in an unspecified amount, and an award of
attorney's fees and costs. This case has been stayed pending the outcome of the
case filed by Odetics on June 29, 1995, which is described above.
On October 3, 1995, certain former employees of the Company filed suit in the
U.S. District Court for the District of Colorado against the Company. The
amended suit alleges violations of the Age Discrimination in Employment Act
(ADEA) and the Employee Retirement Income Security Act (ERISA) between the
period of April 13, 1993, and December 31, 1996. On November 26, 1997, the Court
granted the plaintiffs' request to proceed as a collective action
<PAGE>
Form 10-Q, Page 9
on the ADEA claims. On November 6, 1998, the Court issued a ruling from the
bench granting the plaintiffs' request to proceed as a class on the ERISA
claims. Approximately 1,266 persons are eligible members of the ERISA class,
which includes approximately 400 persons of the ADEA class. The plaintiffs
seek, among other things, compensatory damages in an unspecified amount,
including the value of back pay and benefits; reinstatement as employees or
alternatively the value of future earnings and benefits; and exemplary or
liquidated damages. The Company has filed an answer denying both the ADEA and
ERISA claims. A trial has been set for October 1999.
The Company believes it has adequate legal defenses with respect to each of the
actions cited above and intends to vigorously defend against these actions.
However, it is reasonably possible that these actions could result in outcomes
unfavorable to the Company. The Company is also involved in various other less
significant legal actions. While the Company currently believes that the amount
of the ultimate potential loss would not be material to the Company's financial
position, the outcome of these actions is inherently difficult to predict. In
the event of an adverse outcome, the ultimate potential loss could have a
material adverse effect on the Company's financial position or reported results
of operations in a particular quarter. An unfavorable decision, particularly in
patent litigation, could require material changes in production processes and
products or result in the Company's inability to ship products or components
found to have violated third-party patent rights.
NOTE 5 - RECENTLY ISSUED ACCOUNTING STANDARDS
- ---------------------------------------------
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131, which is effective for
fiscal years beginning after December 15, 1997, establishes new disclosure
requirements for operating segments, including products, services, geographic
areas, and major customers. The Company will adopt SFAS No. 131 for the 1998
fiscal year, but does not expect the new accounting standard to have a material
impact on the Company's reported financial results.
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." SOP 98-1, which is effective for
transactions in fiscal years beginning after December 15, 1998, provides
guidance on accounting for the costs of computer software developed or obtained
for internal use. The Company will adopt SOP 98-1 for the 1999 fiscal year, but
does not expect the new SOP to have a material effect on its reported financial
results.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
periods beginning after June 15, 1999, with earlier adoption encouraged. SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments and hedging activities and requires all derivatives to be recognized
as either assets or liabilities in the consolidated balance sheet, measured at
fair value. The corresponding change in fair value of the derivative will be
recorded in the earnings of the Company, net of related change in fair value of
the hedged item, or as a component of comprehensive income depending upon the
intended use and designation. The Company is currently evaluating the impact of
SFAS No. 133 on its financial statements and its plans for adopting the new
accounting standard.
<PAGE>
Form 10-Q, Page 10
NOTE 6 - COMMON STOCK
- ---------------------
In May 1998, the Company's board of directors authorized a two-for-one stock
split effective in the form of a 100% stock dividend paid on the close of
business June 26, 1998, to shareholders of record on June 5, 1998. All earnings
per common share amounts, references to common stock, and stockholders equity
amounts have been restated as if the stock dividend had occurred as of the
earliest period presented.
In connection with the 16,000,000 shares of common stock repurchased in October
1997, the Company paid $87,030,000 as a final purchase price adjustment in April
1998. During the first nine months of 1998, the Company repurchased and retired
an aggregate of 8,822,500 shares of its common stock through a combination of
privately negotiated and open market repurchase transactions. The aggregate
purchase price for those transactions was $272,365,000 after considering the
effects of a price adjustment of $98,875,000 received by the Company in October
1998. The shares repurchased during the first nine months of 1998 include
7,472,500 shares repurchased pursuant to the Company's plan to repurchase up to
$800,000,000 of its common stock which was announced in October 1997, as well as
1,350,000 shares repurchased under an existing stock repurchase program.
<PAGE>
Form 10-Q, Page 11
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SEPTEMBER 25, 1998
ALL ASSUMPTIONS, ANTICIPATIONS, EXPECTATIONS AND FORECASTS CONTAINED IN THE
FOLLOWING DISCUSSION REGARDING THE COMPANY'S FUTURE PRODUCT AND BUSINESS PLANS,
FINANCIAL RESULTS, PERFORMANCE AND EVENTS ARE FORWARD-LOOKING STATEMENTS. THE
COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY BECAUSE OF A NUMBER OF RISKS AND
UNCERTAINTIES, SOME OF THESE RISKS ARE DETAILED BELOW IN "RISK FACTORS THAT MAY
AFFECT FUTURE RESULTS" AND ELSEWHERE IN THIS FORM 10-Q.
STATEMENTS MADE HEREIN ARE ACCURATE ONLY AS OF THE DATE OF FILING THIS FORM 10-Q
WITH THE SECURITIES AND EXCHANGE COMMISSION AND MAY ONLY BE RELIED UPON AS OF
THAT DATE. THE COMPANY DISCLAIMS ANY OBLIGATION TO UPDATE INFORMATION ON
FORECASTS CONTAINED HEREIN, EXCEPT AS MAY BE OTHERWISE REQUIRED BY LAW.
GENERAL
- -------
The Company reported net income for the third quarter ended September 25, 1998,
of $50.6 million on revenue of $571.1 million, compared to net income for the
same period in 1997 of $54.5 million on revenue of $525.2 million. Net income of
$145.6 million was reported for the nine months of 1998 on revenue of $1.60
billion, compared to net income of $148.1 million for the nine months of 1997 on
revenue of $1.48 billion.
Revenue increased 9% and 8% during the third quarter and nine months of 1998,
respectively, compared to the same periods in 1997. The increase in revenue is
primarily a result of increased sales of client-server tape and disk storage
products, and online mainframe products. The increase was partially offset by a
decline in sales revenue from Nearline(R) mainframe products. Overall gross
profit margin increased to 47% during the third quarter and nine months of 1998,
respectively, compared to 46% and 45% for the same periods in 1997. This
increase was principally due to increased sales of higher-margin software
products and cost reductions achieved in the Company's manufacturing processes.
The Company's future revenue and operating results are significantly dependent
upon effectively managing several new Nearline product introductions; sustained
demand for mainframe products in their traditional markets; expanding the
Company's market presence in the client-server and network-attached storage
environments; developing new applications for its products; and expanding its
distribution channels. For the discussion of these and other risk factors, see
"Risk Factors That May Affect Future Results" below.
The Company's cash and short-term investment balances decreased $115.8 million
during the nine months of 1998 primarily due to cash payments of $458.3 million
associated with the Company's common stock repurchase programs and net
investments in property, plant and equipment of $70.2 million. These repurchases
and investments were partially funded by borrowings under the Company's
revolving credit facility of $330 million, a reduction of short-term investments
of $77.3 million, and cash generated from operating activities of $70.4 million.
<PAGE>
Form 10-Q, Page 12
The following table, stated as a percentage of total revenue, presents
Consolidated Statement of Operations information and revenue by product line,
which includes both product sales and maintenance revenue.
Quarter Ended Nine Months Ended
----------------------------------------
09/25/98 09/26/97 09/25/98 09/26/97
----------------------------------------
Revenue:
Nearline products 61.8% 66.8% 62.7% 65.7%
Online products 27.1 21.5 26.0 22.6
Network and other products 11.1 11.7 11.3 11.7
----- ----- ----- -----
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue 53.4 54.3 52.7 54.7
----- ----- ----- -----
Gross profit 46.6 45.7 47.3 45.3
Research and product development
costs 10.7 10.0 10.8 10.1
Marketing, general, administrative
and other income and expense, net 21.5 23.0 22.3 22.9
----- ----- ----- -----
Operating profit 14.4 12.7 14.2 12.3
Interest income, net (0.1) 1.5 0.5 1.4
----- ----- ----- -----
Income before income taxes 14.3 14.2 14.7 13.7
Provision for income taxes (5.4) (3.8) (5.6) (3.7)
----- ----- ----- -----
Net income 8.9% 10.4% 9.1% 10.0%
===== ===== ===== =====
REVENUE
- -------
NEARLINE PRODUCTS
Revenue from the Company's Nearline products remained unchanged in the third
quarter of 1998 and increased 3% for the nine months of 1998, as compared to the
same periods in 1997, as increased sales of TimberWolf(TM), a family of
OPENstorage(TM) tape libraries designed for client-server attachment, was offset
by a decrease in sales revenue from earlier generation Nearline products, as
well as decreased sales revenue from TimberLine(R) 9490, a 36-track cartridge
subsystem; and RedWood(R) SD-3, a high-capacity cartridge subsystem. The
decrease in TimberLine and RedWood sales revenue was primarily due to pricing
pressures and delays in customer purchase decisions associated with the
evaluation of new tape solutions currently under development by the Company, as
well as a continuation of the shift in customer storage requirements.
The rate of revenue growth in the Company's mainframe tape products has slowed
as customers shift their storage requirements from the mainframe to the
client-server and network-attached environments. Future revenue growth for
Nearline products is dependent upon the continued success of TimberWolf in the
client-server market and the successful introduction of new tape products. The
Virtual Storage Manager (VSM), a mainframe data storage management solution
designed to improve performance, cartridge utilization, and overall storage
management in the mainframe environment, is currently in the beta test and early
ship phase with initial revenue contribution anticipated in the fourth quarter
of 1998. The 9840, a high-performance tape drive designed for both the mainframe
and client-server environments is also in the beta test and early ship phase
with initial revenue contribution anticipated in the fourth quarter of 1998. The
Company's financial results in both the fourth quarter of 1998 and during 1999
will be significantly dependent on the successful introduction of both VSM and
the
<PAGE>
Form 10-Q, Page 13
9840. The introduction of both VSM and the 9840 involves integrating complex
designs, manufacturing processes, and collaborating with suppliers of key
components. The failure of a key component, a design flaw, or an inability to
obtain sufficient components, could cause a delay in the introduction of VSM or
the 9840, or result in increased manufacture or warranty costs and have an
adverse effect on financial results in the fourth quarter of 1998 or in 1999.
The transition to these new products may impact sales of the Company's existing
mainframe Nearline products as customers evaluate these new tape solutions.
There can be no assurance that the Company will be successful in managing the
introduction of VSM and the 9840.
ONLINE PRODUCTS
Revenue from the Company's online products increased 37% and 24% in the third
quarter and nine months of 1998, respectively, compared to the same periods in
1997, due to increased sales of mainframe products under the Company's OEM
agreement with International Business Machines Corp. (IBM); as well as increased
sales of the Company's products targeted for the client-server environment.
Approximately 20% of the Company's total revenue during the third quarter and
nine months of 1998, respectively, was derived from sales of online mainframe
storage products to IBM. There can be no assurance that sales to IBM will
continue at current volumes in future periods as IBM is not subject to any
long-term volume purchase commitments. Further, the Company anticipates it will
continue to experience pricing pressure in future periods due to scheduled price
decreases provided for under the terms of the agreement. See "Risk Factors That
May Affect Future Results - Dependence on IBM," for further discussion of the
risks associated with the OEM agreement.
Success in the client-server disk storage market is critical to the Company's
plans for future revenue growth. While sales of client-server disk products have
increased in the first nine months of 1998, the Company must gain further
acceptance for its disk products in an intensely competitive market and
successfully develop cost-effective, high-volume distribution channels for these
products in order to accelerate the revenue growth in this market. There can be
no assurance that the Company will be successful in its client-server disk
initiative.
NETWORK AND OTHER PRODUCTS
Revenue from network and other products increased 4% in the third quarter and
nine months of 1998, respectively, compared to the same periods in 1997,
primarily due to an increase in software revenue and maintenance revenue
associated with third party products. Revenue from network products was largely
unchanged in the third quarter and nine months of 1998, as compared to the same
periods in 1997.
Future revenue growth from network products is dependent upon the Company's
ability to successfully implement its storage area network (SAN) strategy during
the next year. The SAN strategy integrates both storage and networking products
to create an open storage utility. Growth will require, among other things,
timely development and introduction of new SAN solutions and development of
effective distribution channels for these products.
<PAGE>
Form 10-Q, Page 14
GROSS PROFIT
- ------------
Overall gross profit margins increased to 47% in the third quarter and nine
months of 1998, respectively, compared to 46% and 45% for the same periods in
1997.
Gross profit on product sales increased to 49% in the third quarter and nine
months of 1998, compared to 46% and 45% for the third quarter and nine months of
1997, respectively. This increase is primarily a result of increased sales of
higher-margin software products and cost reductions achieved in the Company's
manufacturing processes. The increase in gross profit as a percent of sales was
partially offset by a shift in sales from higher-margin mainframe products to
lower-margin client-server products, and a shift from higher-margin direct sales
channels to lower-margin indirect sales channels.
Gross profit on maintenance revenue decreased to 41% and 42% in the third
quarter and nine months of 1998, respectively, compared to 46% and 45% for the
same periods in 1997. The decline is principally attributable to lower margins
associated with the Company's consulting services business which generally
carries lower margins than the traditional maintenance business.
The markets for most of the Company's products are subject to intense price
competition. The Company anticipates that price competition for its Nearline
products will continue to be a major factor as it expands its presence in the
client-server storage market and as customers evaluate new mainframe Nearline
products currently planned for introduction in the fourth quarter of 1998. The
Company anticipates that the product sales margins for its online mainframe
products will decline in future periods due to scheduled price reductions under
the terms of the OEM agreement with IBM. In addition, the Company anticipates
the price competition in the client-server market will continue in the future.
The Company's ability to sustain or improve product sales margins is
significantly dependent upon its ability to continue to reduce manufacturing
costs in all of its product lines as well as increasing sales of higher-margin
software products. Product sales margins also may be affected by inventory
reserves and writedowns resulting from rapid technological changes and delays in
gaining market acceptance for new products. Maintenance margins may be adversely
affected in the future as a result of increased competition and lower margins
associated with the Company's consulting services business.
RESEARCH AND PRODUCT DEVELOPMENT
- --------------------------------
Research and product development expenditures increased 16% and 15% in the third
quarter and nine months of 1998, respectively, compared to the same periods in
1997. The increased investment in new product development activities during the
third quarter and nine months of 1998 was partially offset by funding received
from Compaq Computer Corp. (Compaq) for certain research and product development
activities for client-server data storage solutions and networking products, and
from IBM for enhancements to the Company's mainframe online products. The
Company's research and product development expenditures are expected to continue
to increase in the fourth quarter of 1998 and in 1999 as a result of the
significant product development activities currently underway in all of the
Company's products. The Company also currently anticipates a decline of
approximately $40 million in the level of annual research and product
development funding received from third-parties in 1999, as compared to 1998.
The expected increase in research and product development expense as a result of
the
<PAGE>
Form 10-Q, Page 15
decreased funding, could be partially offset due to reduced spending as the
Company is consolidating various research and product development efforts.
MARKETING, GENERAL, ADMINISTRATIVE AND OTHER
- --------------------------------------------
Marketing, general, administrative and other income and expense (MG&A) increased
2% and 5% in the third quarter and nine months of 1998, respectively, compared
to the same periods in 1997. The increase is primarily a result of increased
investment in internal business and financial information systems. The increase
was partially offset by reduced accruals for employee bonus and profit-sharing
payments in 1998, as compared to 1997, as the Company did not attain certain
goals in the first nine months of 1998. MG&A for the third quarter and nine
months of 1997 also included gains realized on the sale of accounts receivable
of approximately $10.5 million and $22.6 million, respectively. The Company
anticipates that MG&A expense will increase in 1999 as the Company expands its
direct distribution channels for its mainframe storage products and solutions.
INTEREST INCOME AND EXPENSE
- ---------------------------
Interest income decreased 78% and 48% in the third quarter and nine months of
1998, respectively, compared to the same periods in 1997, primarily because of a
decrease in cash available for investment. Interest expense increased 228% and
47% in the third quarter and nine months of 1998, as compared to the same
periods in 1997, due to an increase in short-term borrowings under the Company's
revolving credit agreement. The decrease in interest income and increase in
interest expense was largely due to the cash requirements related to the
Company's stock repurchase program. See Note 6 of NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS for further discussion of the Company's common stock
repurchase programs.
INCOME TAXES
- ------------
The Company's effective tax rate increased from 27% for the third quarter of
1997 to 38% for the third quarter of 1998 as the Company has recognized
substantially all of its remaining net deductible temporary differences, tax
credit carryforwards and net operating loss carryforwards in the United States.
The Company's remaining deferred income tax asset valuation allowance of
approximately $22.9 million as of September 25, 1998, relates principally to net
deductible temporary differences and net operating loss carryforwards associated
with the Company's foreign subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
WORKING CAPITAL
The Company's cash and short-term investments balances decreased $115.8 million
during the nine months of 1998 primarily due to cash payments of $458.3 million
associated with the Company's common stock repurchase programs and net
investments in property, plant and equipment of $70.2 million. These repurchases
and investments were partially funded through borrowings of $330 million under
the Company's revolving credit facility, a reduction of short-term investments
of $77.3 million, and cash generated from operating activities of $70.4 million.
<PAGE>
Form 10-Q, Page 16
In connection with the 16 million shares of common stock repurchased in October
1997, the Company paid $87.0 million as a final purchase price adjustment in
April 1998. During the first nine months of 1998, the Company purchased and
retired an aggregate of 8.8 million shares of its common stock through a
combination of privately negotiated and open market repurchase transactions. The
aggregate purchase price for those transactions was $272.4 million after
considering the effects of a price adjustment of $98.9 million received by the
Company in October 1998. The shares repurchased during the first nine months of
1998 include 7.5 million shares repurchased pursuant to the Company's plan to
repurchase up to $800 million of its common stock which was announced in October
1997, as well as 1.3 million shares repurchased under an existing stock
repurchase program.
The current ratio decreased to 1.4 as of September 25, 1998, from 2.1 as of
December 26, 1997, primarily due to cash and short-term investments utilized to
fund the stock repurchase programs. Inventory increased $60.1 million from
December 26, 1997, to September 25, 1998, primarily due to increased inventory
levels for Nearline and online products. Accounts receivable increased $29.6
million from December 26, 1997, to September 25, 1998, primarily as a result of
the implementation of new financial information systems and administrative
processes.
AVAILABLE FINANCING LINES
The Company has a $350 million unsecured revolving credit facility (the
Revolver) which expires in October 2001. The credit limit available under the
Revolver will be reduced by $12.5 million on the last day of each calendar
quarter beginning December 31, 1998. The interest rates under the Revolver
depend on the type of advance selected. The basic advance rate is not less than
the London Interbank Offered Rate (LIBOR) plus 0.625% (approximately 6.01% as of
September 25, 1998). The Revolver contains certain financial and other
covenants, including restrictions on the Company's payment of cash dividends on
its common stock. As of September 25, 1998, the Company had borrowings of $330
million and had issued letters of credit for approximately $100,000 under the
Revolver. The remaining available credit under the Revolver as of September 25,
1998, was approximately $19.9 million. The interest rate on the $330 million of
borrowings under the Revolver varied from approximately 6.22% to 8.50%.
The Company has a financing agreement with a bank that provides for the sale of
promissory notes in the principal amount of up to $140 million at any one time.
The agreement, which expires in January 2000, provides for commitments by the
bank to purchase promissory notes denominated in a number of foreign currencies.
The notes must be repaid only to the extent of future revenue of the Company and
obligations under the agreement are not cancelable by the Company or the bank.
Transaction gains and losses related to the notes are deferred and recognized as
an adjustment to the revenue supporting the note repayment. The promissory
notes, together with accrued interest, are payable in U.S. dollars within 40
days from the date of issuance and bear interest at rates no less than the LIBOR
rate plus 0.35% (approximately 5.74% as of September 25, 1998). Under the terms
of the agreement, the Company is required to comply with certain covenants and,
under certain circumstances, may be required to maintain a collateral account,
including cash and qualifying investments, in an amount of no less than the
outstanding promissory notes. As of September 25, 1998, the Company had no
outstanding borrowings and had committed to borrowings between October 1998 and
December 1999 in the cumulative principal amount of approximately $331.1
million.
<PAGE>
Form 10-Q, Page 17
The Company intends to continue to commit substantial working capital to
research and product development projects, the rollout of new products, and may,
from time to time, as market and business conditions warrant, invest in or
acquire complementary businesses, products or technologies. The Company believes
it has adequate working capital and financing capabilities to meet its
anticipated operating and capital requirements for the next 12 months. Over the
longer term, the Company may choose to fund these activities through the
issuance of additional equity or debt financing. The issuance of equity or
convertible debt securities could result in dilution to the Company's
stockholders. There can be no assurance that such additional financing, if
required, can be completed on terms acceptable to the Company.
TOTAL DEBT-TO-CAPITALIZATION
The Company's total debt-to-capitalization ratio increased from 2% at December
26, 1997, to 30% at September 25, 1998, primarily due to short-term borrowings
of $330 million under the Company's Revolver, coupled with a decrease in
stockholders' equity as a result of the Company's common stock repurchases. See
"Liquidity and Capital Resources - Working Capital" above, for further
description of the Company's common stock repurchase programs. See Note 6 of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for further discussion of the
Company's common stock repurchase programs.
INTERNATIONAL OPERATIONS
- ------------------------
During the third quarter and nine months of 1998, approximately 36% of the
Company's revenue was generated from international operations, as compared to
approximately 33% and 34% for the third quarter and nine months of 1997,
respectively. The Company also sells its products through certain domestic
indirect distribution channels that have end-user customers located outside the
U.S. The Company expects that it will generate a significant portion of its
revenue from international operations in the future. The majority of the
Company's international operations involve transactions denominated in the local
currencies of countries within Western Europe; principally Germany, France and
the United Kingdom; Japan; Canada and Australia. An increase in the exchange
value of the U.S. dollar reduces the value of revenue and profits generated by
the Company's international operations. As a result, the Company's operating and
financial results can be materially affected by fluctuations in foreign currency
exchange rates. In an attempt to mitigate the impact of foreign currency
fluctuations, the Company employs a hedging program which utilizes foreign
currency options and forward exchange contracts. See "Market Risk
Management/Foreign Currency Exchange Risk" below.
The Company is subject to the risks of conducting business outside the United
States, including changes in, or impositions of, legislative or regulatory
requirements and trade protection measures, tariffs, quotas, difficulty in
obtaining export licenses, different tax structures, foreign currency exchange
rate risks and other factors outside the Company's control. Further, the
Company's international business may be affected by changes in demand
resulting from localized economic, political and market conditions. There can
be no assurances that one or more of the foregoing factors will not have a
material adverse effect on the Company's business or financial results in the
future.
<PAGE>
Form 10-Q, Page 18
MARKET RISK MANAGEMENT/FOREIGN CURRENCY EXCHANGE RISK
- -----------------------------------------------------
The market risk inherent in the Company's financial instruments relates
primarily to changes in foreign currency exchange rates. To mitigate the impact
of foreign currency fluctuations, the Company seeks opportunities to reduce
exposures through financing activities and utilizes foreign currency options and
forward exchange contracts to further reduce any remaining exposures. All
foreign currency options and forward exchange contracts are authorized and
executed pursuant to the Company's policies. Foreign currency options and
forward exchange contracts that are designated as, and qualify as, hedging
transactions are subject to hedge accounting treatment. The Company does not
hold or issue financial instruments, foreign currency options or forward
exchange contracts for trading purposes.
The Company has a financing agreement with a bank which provides for commitments
by the bank to purchase promissory notes denominated in a number of foreign
currencies. Transaction gains and losses related to the notes are deferred and
recognized as an adjustment to the revenue supporting the note repayment. See
"Liquidity and Capital Resources - Available Financing Lines" above for further
discussions of the financing agreement.
The Company periodically utilizes foreign currency options, generally with
maturities of less than one year, to hedge a portion of its exposure to
exchange-rate fluctuations in connection with anticipated revenue from its
international operations. Gains and losses associated with the options are
deferred and recognized as an adjustment to the underlying revenue transactions.
To the extent an option is terminated or ceases to be effective as a hedge, any
gains and losses as of that date are deferred and recognized as an adjustment to
the underlying revenue transaction.
The Company also utilizes forward exchange contracts, generally with maturities
of less than two months, to hedge its exposure to exchange-rate fluctuations in
connection with anticipated monetary assets and liabilities held in foreign
currencies and anticipated revenues from its international operations. The
carrying amounts of these forward foreign exchange contracts equal their fair
value as the contracts are adjusted at each balance sheet date for changes in
exchange rates. Gains and losses on the forward contracts used to hedge monetary
assets and liabilities are recognized as incurred within MG&A on the
Consolidated Statement of Operations as adjustments to the foreign exchange
gains and losses on the translation of net monetary assets.
A hypothetical 10% adverse movement in foreign exchange rates applied to the
Company's foreign currency exchange rate sensitive instruments held as of
December 26, 1997, and as of September 25, 1998, would result in a hypothetical
loss of approximately $26.6 million and $55.3 million, respectively. The
increase in the hypothetical loss during the nine months of 1998 is primarily
due to an increase in committed borrowings under the financing agreement
mentioned above. These hypothetical losses do not take into consideration the
Company's underlying international operations. The Company anticipates that any
hypothetical loss associated with the Company's foreign currency exchange rate
sensitive instruments would be offset by gains associated with its underlying
international operations.
<PAGE>
Form 10-Q, Page 19
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
- -------------------------------------------
NEW PRODUCTS, MARKETS AND DISTRIBUTION CHANNELS
The Company's results of operations and competitive strength depend upon its
ability to successfully develop, manufacture, market and deliver innovative new
products and product enhancements. Short product life cycles are inherent to the
high-technology markets in which the Company operates. The Company must devote
significant resources to research and product development projects and
effectively manage the transition to new products. Developing new products and
product enhancements is complex and involves uncertainties. The Company's
results could be adversely affected in the event of delays in product
development, manufacturing, or if customers delay their purchase decisions in
anticipation of new product introductions. In addition, product transitions make
the process of production and inventory planning more difficult as the Company
must accurately anticipate product mix and configuration demands, and accurately
forecast inventory levels. The Company has experienced product development
delays in the past that adversely affected the Company's financial results and
competitive position. There can be no assurances that the Company will be able
to successfully manage the risks inherent in the product development and
transition of new products in the future.
The Company currently has two new Nearline products, VSM and 9840, in the beta
test and early ship phase with initial revenue contribution anticipated in the
fourth quarter of 1998. The Company's financial results in both the fourth
quarter of 1998 and during 1999 are significantly dependent on the successful
introduction of VSM and the 9840. The introduction of both VSM and the 9840
involves integrating complex designs, manufacturing processes, and collaborating
with suppliers of key components. The failure of a key component, a design flaw,
or an inability to obtain sufficient components, could cause a delay in the
introduction of VSM or the 9840, or result in increased manufacture or warranty
costs and have an adverse effect on financial results in the fourth quarter of
1998 or in 1999. The transition to these new products may impact sales of the
Company's existing mainframe Nearline products as customers evaluate these new
tape solutions.
The Company historically has generated a significant portion of its revenue and
operating profits from mainframe products. The rate of revenue growth in the
Company's mainframe tape products has slowed as customers shift their storage
requirements from the mainframe to the client-server environment. The Company's
future financial results are significantly dependent upon the continued success
of the TimberWolf tape family in the client-server market and significantly
increasing the Company's presence in the client-server disk market. The Company
must also establish new cost-effective distribution channels in order to be
successful in the client-server market. There can be no assurances that the
Company will be successful in these activities.
The Company's increasing dependence on indirect distribution channels, such as
OEMs, value-added resellers and value-added distributors, will make production
and inventory planning more complex. In the event an indirect partner adjusts
their ordering pattern, establishes a new relationship with a competitor, or
experiences financial difficulties, the Company's operating and financial
results may be adversely affected. See "Dependence on IBM," below, for a
discussion of specific issues associated with the Company's distribution of its
mainframe online products.
<PAGE>
Form 10-Q, Page 20
DEPENDENCE ON IBM
Approximately 20% of the Company's total revenue during the third quarter and
nine months of 1998, respectively, was derived from OEM sales of mainframe
online products to IBM. The Company currently anticipates that it will derive a
significant portion of its sales revenue during the fourth quarter of 1998 and
during 1999 from product sales to IBM. However, there can be no assurance that
sales to IBM will continue at current volumes in future periods as IBM is not
subject to any long-term volume purchase commitments under a worldwide,
non-exclusive OEM agreement entered into during December 1997. IBM may terminate
the agreement for convenience or for cause, or upon certain instances of change
in control or the occurrence of certain other conditions. The Company
anticipates that it will continue to experience pricing pressure in future
periods due to scheduled price decreases provided for under the terms of the OEM
agreement. The Company's success under the OEM agreement is significantly
dependent upon achieving certain product development, delivery and performance
milestones. The Company's success is also dependent upon IBM's ability to
successfully market the mainframe online products, and developing and delivering
to the Company disk drives for inclusion in the products. Because of the
scheduled price decreases provided for under the OEM agreement, the Company must
continue to reduce costs and expenses associated with manufacturing the products
in order to achieve the expected benefits during the remaining term of the OEM
agreement. The OEM relationship may also cause the Company to incur additional
costs associated with unanticipated increases or decreases in manufacturing and
inventory volumes. There can be no assurance that the Company will achieve the
milestones contained in the OEM agreement or that IBM will successfully market
these products in the future.
In December 1997, the Company and IBM agreed to a settlement with the United
States Department of Justice (DOJ) concerning the Company's OEM relationship
with IBM. The terms of the settlement are contained in a consent decree which
was approved by the U.S. District Court for the District of Columbia on March
20, 1998. Under the terms of the consent decree, which expires in December 2002,
the Company must develop complementary domestic distribution channels for
delivery of its online products in 1999 or the Company could be subject to
limitations on its domestic sales to IBM in the future. The Company's current
OEM agreement with IBM expires in December 2000. IBM has indicated that it is
currently developing a competitive online product. As a result, the Company
anticipates that IBM will alter or reduce its purchasing patterns and may not
extend the relationship with respect to future products. Failure to develop new
distribution channels for the Company's mainframe online products could
adversely affect the Company's ability to sell its mainframe online products in
future periods.
COMPETITION
The markets for the Company's products and services are intensely competitive.
In the mainframe market, the Company's traditional competitors include IBM, EMC
Corp. and Hitachi LTD. Competition in the client-server market comes from the
Company's traditional rivals in the mainframe market, in addition to companies
focused on the client-server industry, such as Sun Microsystems Inc., Compaq and
Hewlett-Packard Co. A number of the Company's competitors have significantly
greater market presence and financial resources than the Company. In addition,
many of the Company's potential customers in the client-server market purchase
their storage requirements as part of a packaged server and storage product,
which may provide a competitive advantage to the Company's rivals. The Company
expects to address this issue by providing superior storage area network and
network-attached storage solutions that operate
<PAGE>
Form 10-Q, Page 21
across multiple computer platforms and by establishing distribution
relationships with these competitors. The Company has established
relationships with some of its competitors, including Compaq, IBM,
Hewlett-Packard Co., NCR Corp., Groupe Bull, and Siemens Nixdorf
Informationssysteme. There can be no assurances that the Company will be able to
successfully compete against other companies in the mainframe and
client-server markets.
VOLATILITY OF STOCK PRICE; EARNINGS FLUCTUATIONS
The trading price of the Company's common stock has fluctuated significantly
from period-to-period in the past, and may fluctuate significantly in the
future. Industry conditions, new product or product development
announcements by the Company or its competitors, announced acquisitions and
joint ventures by the Company or its competitors, broad market trends unrelated
to the Company's performance, changes in revenue or earnings estimates by the
investment community, global economic conditions and foreign currency exchange
rate fluctuations are among the factors that can affect the Company's stock
price. In addition, if the Company's reported operating results are below the
expectations of stock market analysts and investors, there could be an immediate
and significant adverse effect on the trading price of the Company's common
stock.
The Company's financial and operating results may fluctuate in the future for a
number of reasons. Factors such as customers' historical tendencies to make
purchase decisions near the end of the calendar year, the timing of the
announcement and availability of new products by the Company and its
competitors, fluctuating foreign currency exchange rates, changes in the mix and
configuration of products sold, rapid price erosion, and the purchasing patterns
of the Company's OEM partners and global economic conditions make the
forecasting of revenue inherently difficult and could cause period-to-period
fluctuations in operating results.
SOLE SOURCE SUPPLIERS
The Company generally uses standard parts and components for its products and
believes that, in most cases, there are a number of alternative, competent
vendors for most of those parts and components. Certain of the Company's key
components and products are purchased from single suppliers that the Company
believes are currently the only manufacturers of the particular components that
meet the Company's qualification requirements and other specifications or for
which alternative sources of supply are not readily available. In particular, a
key component of the Company's tape drive heads is supplied by Sumitomo
Corporation on a sole source basis. Certain of the Company's suppliers have
experienced occasional technical, financial or other problems in the past that
have delayed deliveries, but without significant effect on the Company. An
unanticipated failure of any sole source supplier to meet the Company's
requirements for an extended period, or an interruption in the Company's ability
to secure comparable components, could have a material adverse effect on the
Company's revenue and operating results. In the event a sole source supplier was
unable or unwilling to continue to supply components, the Company would have to
identify and qualify other acceptable suppliers. This process could take an
extended period, and no assurance can be given that any additional source would
become available or would be able to satisfy the Company's production
requirements on a timely basis.
INFORMATION SYSTEMS TRANSITION
The Company is in the process of replacing many of its internal information
systems with new, integrated information systems that are complex and that will
affect numerous operational,
<PAGE>
Form 10-Q, Page 22
transactional, financial and reporting processes. The transition to these new
systems and processes is expected to be completed in the first half of 1999,
and involves a number of risks and uncertainties. The Company must
successfully manage the transfer of critical information to the new systems,
the integration of these systems, and the implementation of associated
process changes and employee training programs. The Company intends to conduct
extensive tests on these new processes prior to implementing the systems;
however, these tests may not be able to fully simulate the transition phase and
day-to-day operating environment. There can be no assurance that the transition
to the new information systems will not cause interruptions in the Company's
critical business processes. Failure to successfully manage the transition could
adversely affect the Company's operating and financial results.
RISKS ASSOCIATED WITH THE YEAR 2000
The Company's product lines include information storage systems and network
products which collect, move, and store data. In order to properly process data,
the Company's products must manage and manipulate data that includes both 20th
and 21st century dates (Year 2000 Compliant). The Company has evaluated all of
its currently offered products and believes that they are Year 2000 Compliant,
provided they have been upgraded to include all recommended engineering changes.
However, there can be no assurance that the Company's current products will be
Year 2000 Compliant in all environments. In addition, the Company does not
currently intend to develop modifications to certain of its older products to
make them Year 2000 Compliant and is in the process of notifying the affected
maintenance customers of potential year 2000 problems with older products in
order to raise their awareness.
The Company generally believes that it is not legally responsible for costs
incurred by its customers to achieve their year 2000 compliance. Should the
Company's products fail to be Year 2000 Compliant, however, the Company may
experience increased warranty and other customer satisfaction costs. Since the
year 2000 complications are not fully known and potential liability issues are
uncertain, the effect of the year 2000 on the Company's product warranty costs
and financial results are not known at this time, but could be material in any
given quarter.
The Company is currently in the process of replacing many of its internal
information systems with new integrated information systems. See "Information
Systems Transition" above. These new systems are believed to be Year 2000
Compliant. The Company has also completed its assessment on its other critical
internal information systems which are not being replaced and has implemented
remediation programs on non-Year 2000 Compliant systems. The Company is
currently assessing critical non-information systems to determine if they are
Year 2000 Compliant and anticipates this assessment will be completed by
December 1998. The remediation programs for its information and
non-information systems that are not Year 2000 Compliant are expected to be
substantially completed and tested by June 1999. The Company is evaluating
contingency plans in the event of a system failure or delay.
The costs incurred to date directly related to the Company's remediation
activities total approximately $2 million. Future costs related to the
remediation activities are not expected to exceed approximately $3 million;
however the amount may change as the year 2000 activities progress during
1999. These remediation costs do not include the costs associated with the
Company's new information systems, which are expected to be Year 2000
Compliant. The Company has invested approximately $30 million in these new
information systems as of the end of the third quarter, and the future
investment in these systems is estimated to be
<PAGE>
Form 10-Q, Page 23
approximately $15 million. While the Company has not yet completed its year
2000 remediation and testing activities on its information and
non-information systems, the Company does not currently believe that these
activities will have a material adverse effect on the Company's operations and
financial results. Delays in implementing new external information systems or a
failure to fully identify all year 2000 dependencies in the Company's systems
could have material adverse consequences, including delays in the delivery or
sale of the Company's products, or cause the Company to incur unexpected
additional costs.
The Company also has implemented a program to assess the possible effects on its
operations of the year 2000 readiness of key suppliers and vendors and is in the
process of receiving information concerning the suppliers' and vendors' status.
The Company's dependence on suppliers and vendors, and therefore, on the proper
functioning of their information systems and software, means that their failure
to address year 2000 issues could have a material effect on the Company's
operations and financial results. The Company anticipates completing its
assessment by the end of 1998. Based on the results of the assessment, the
Company may identify alternative suppliers and vendors.
The effect that the year 2000 will have on customers' information technology
spending patterns is uncertain at this time. The potential adverse consequences
resulting from customers' year 2000 concerns could include, among others,
decreased spending on new information storage systems in future periods as
customers complete their year 2000 testing activities and delays in customer
purchase decisions once customers have verified the year 2000 readiness of their
information systems. The demand for the Company's products worldwide could be
adversely affected in the event these patterns were to materialize, which could
have an adverse effect on the Company's financial results.
EURO CONVERSION
Effective January 1, 1999, eleven of the 15 member countries of the European
Union are scheduled to adopt a single European currency, the euro, as their
common legal currency. Like many companies that operate in Europe, various
aspects of the Company's business and financial accounting will be affected by
the conversion to the euro. The Company is currently evaluating the European
pricing strategies for its products and services, the legal implications of the
conversion on its contractual agreements, and its accounting system
capabilities. While the Company has not yet completed its evaluation of the
impact of the conversion, it does not believe that the conversion will impact
the competitiveness of its products in Europe as significant price transparency
already exists. In addition, the Company does not believe that the conversion to
the euro will result in the cancellation of any significant contracts, or cause
it to incur significant adverse tax consequences, or significantly affect its
foreign currency risk management operations. The Company will continue to
evaluate the impact of the euro conversion going forward. The Company believes
that its internal accounting, order management, and finance and banking systems
will accommodate the conversion with minimal modification. There can be no
assurances that the conversion will not adversely impact the Company's pricing,
tax, currency hedging strategies, or other systems and processes in the future.
<PAGE>
Form 10-Q, Page 24
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
- --------------------------
See Part I, Item 3 - Legal Proceedings, of the Company's Form 10-K for the
fiscal year ended December 26, 1997, filed with the Commission on March 6, 1998.
On June 29, 1995, Odetics, Inc. (Odetics) filed a patent infringement suit in
the U.S. District Court for the Eastern District of Virginia against the Company
alleging that the "pass-through" port in certain of the Company's tape library
products infringed U.S. Patent No. 4,779,151 (the "151 Patent"). The complaint
asked the court to impose injunctive relief, treble damages in an unspecified
amount, and an award of attorney's fees and costs. In February 1996, a jury
found that the Company's products did not infringe the 151 Patent. Odetics
appealed and in June 1997, the U.S. Court of Appeals for the Federal Circuit
reversed the District Court's ruling and remanded the case back to the District
Court for further proceedings. On March 27, 1998, a second trial was held and a
jury found that a pass-through port in certain of the Company's tape library
products willfully infringed the 151 Patent and awarded actual damages to
Odetics of $70.6 million. On July 31, 1998, the Court granted the Company's
motion for judgment as a matter of law, overturning the jury's verdict, and
entered judgment in favor of the Company. On August 10, 1998, Odetics appealed
the judgment to the U.S. Court of Appeals for the Federal Circuit, and on August
26, 1998, the Company filed a cross-appeal. These appeals are pending before the
U.S. Court of Appeals.
On December 8, 1995, Odetics filed a second patent infringement suit in the U.S.
District Court for the Eastern District of Virginia against the Company. The
complaint alleges that the "cartridge access port" in certain of the Company's
tape library products also infringes the 151 Patent. The complaint seeks
injunctive relief, treble damages in an unspecified amount, and an award of
attorney's fees and costs. This case has been stayed pending the outcome of the
case filed by Odetics on June 29, 1995, which is described above.
On October 3, 1995, certain former employees of the Company filed suit in the
U.S. District Court for the District of Colorado against the Company. The
amended suit alleges violations of the Age Discrimination in Employment Act
(ADEA) and the Employee Retirement Income Security Act (ERISA) between the
period of April 13, 1993, and December 31, 1996. On November 26, 1997, the Court
granted the plaintiffs' request to proceed as a collective action on the ADEA
claims. On November 6, 1998, the Court issued a ruling from the bench
granting the plaintiffs' request to proceed as a class on the ERISA claims.
Approximately 1,266 persons are eligible members of the ERISA class, which
includes approximately 400 persons of the ADEA class. The plaintiffs seek,
among other things, compensatory damages in an unspecified amount, including
the value of back pay and benefits; reinstatement as employees or alternatively
the value of future earnings and benefits; and exemplary or liquidated
damages. The Company has filed an answer denying both the ADEA and ERISA
claims. A trial has been set for October 1999.
The Company believes it has adequate legal defenses with respect to each of the
actions cited above and intends to vigorously defend against these actions.
However, it is reasonably possible that these actions could result in outcomes
unfavorable to the Company. The Company is also involved in various other less
significant legal actions. While the Company currently believes that the amount
of the ultimate potential loss would not be material to the Company's financial
position, the outcome of these actions is inherently difficult to predict. In
<PAGE>
Form 10-Q, Page 25
the event of an adverse outcome, the ultimate potential loss could have a
material adverse effect on the Company's financial position or reported results
of operations in a particular quarter. An unfavorable decision, particularly in
patent litigation, could require material changes in production processes and
products or result in the Company's inability to ship products or components
found to have violated third-party patent rights.
Information concerning these legal proceedings is also contained in Note 4 of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS included in Part I of this Form 10-Q.
<PAGE>
Form 10-Q, Page 26
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
- -----------------------------------------
(a) Exhibits
11.0 Computation of Earnings Per Common Share.
27.0 Financial Data Schedule for nine months ended September 25,
1998.
(b) Reports on Form 8-K
No current reports on Form 8-K were filed during the quarter ended
September 25, 1998.
<PAGE>
Form 10-Q, Page 27
Pursuant to the requirements 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.
STORAGE TECHNOLOGY CORPORATION
(Registrant)
November 6, 1998 /s/ DAVID E. LACEY
- ------------------------------- ------------------------------------------
(Date) David E. Lacey
Executive Vice President
and Chief Financial Officer
(Principal Financial Officer)
November 6, 1998 /s/ THOMAS G. ARNOLD
- ------------------------------- ------------------------------------------
(Date) Thomas G. Arnold
Vice President and Corporate Controller
(Principal Accounting Officer)
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER COMMON SHARE
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
---------------------------- ---------------------------
SEPTEMBER 25, SEPTEMBER 26, SEPTEMBER 25, SEPTEMBER 26,
1998 1997 1998 1997
---------------------------- ---------------------------
<S> ......................................... <C> <C> <C> <C>
BASIC (A)
Earnings:
Net income ............................... $ 50,623 $ 54,530 $145,623 $148,103
======== ======== ======== ========
Shares:
Weighted average shares outstanding ...... 102,178 123,189 105,242 122,890
======== ======== ======== ========
Earnings per share:
Basic earnings per share ................. $ 0.50 $ 0.44 $ 1.38 $ 1.21
======== ======== ======== ========
DILUTED (A)
Earnings:
Net income ............................... $ 50,623 $ 54,530 $145,623 $148,103
Adjustment for interest and amortization
of debt issue costs on 8% Convertible
Debentures, net of estimated tax effects 255
-------- -------- -------- --------
Net income, as adjusted .................. $ 50,623 $ 54,530 $145,623 $148,358
======== ======== ======== ========
Shares:
Weighted average shares outstanding ...... 102,178 123,189 105,242 122,890
Dilutive effect of outstanding options
(as determined under the treasury
stock method) .......................... 2,545 2,007 2,788 1,829
Adjustment for shares issuable upon
assumed conversion of 8% Convertible
Debentures ............................. 385
-------- -------- -------- --------
Weighted-average and dilutive
potential shares ....................... 104,723 125,196 108,030 125,104
======== ======== ======== ========
Earnings per share:
Diluted earnings per share ............... $ 0.48 $ 0.44 $ 1.35 $ 1.19
======== ======== ======== ========
(A) Earnings per share has been restated to reflect the effect of the 2-for-1 stock split in the form
of a stock dividend on June 26, 1998.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION
EXTRACTED FROM THE COMPANY'S FORM 10-Q DATED
SEPTEMBER 25, 1998 AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000094673
<NAME> STORAGE TECHNOLOGY CORPORATION
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-25-1998
<PERIOD-END> SEP-25-1998
<CASH> 217,792
<SECURITIES> 0
<RECEIVABLES> 657,541 <F1>
<ALLOWANCES> 0
<INVENTORY> 265,511
<CURRENT-ASSETS> 1,242,780
<PP&E> 304,276 <F1>
<DEPRECIATION> 0
<TOTAL-ASSETS> 1,715,259
<CURRENT-LIABILITIES> 866,134
<BONDS> 0
0
0
<COMMON> 9,986
<OTHER-SE> 821,191
<TOTAL-LIABILITY-AND-EQUITY> 1,715,259
<SALES> 1,127,350
<TOTAL-REVENUES> 1,598,257
<CGS> 570,651
<TOTAL-COSTS> 842,923
<OTHER-EXPENSES> 171,800
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,138
<INCOME-PRETAX> 234,923
<INCOME-TAX> 89,300
<INCOME-CONTINUING> 145,623
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 145,623
<EPS-PRIMARY> 1.38
<EPS-DILUTED> 1.35
<FN>
<F1> Asset values for the interim period represent
net amounts.
</FN>
</TABLE>
