Back to GetFilings.com
FORM 10-K
- ------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 27, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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 offices) (Zip Code)
Registrant's Telephone Number, including area code: (303) 673-5151
Securities Registered Pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class on which Registered
- ---------------------------------------- -----------------------
Common Stock ($.10 par value), including
related preferred stock purchase rights New York Stock Exchange
8% Convertible Subordinated Debentures
due 2015 New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:
NONE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] YES [ ] NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 3, 1997, there were 61,821,180 shares of common stock of the
registrant outstanding. The aggregate market value of voting stock held by
nonaffiliates of the registrant was $1,948,866,520 based on the last reported
sale price of the common stock of the registrant on the New York Stock
Exchange's consolidated transactions reporting system on March 3, 1997. For
purposes of this disclosure, shares of common stock held by persons who hold
more than 5% of the outstanding common stock and common stock held by
executive officers and directors of the registrant have been excluded in that
such persons may be deemed to be "affiliates" as that term is defined under
the rules and regulations promulgated under the Securities Act of 1933. This
determination is not necessarily conclusive for other purposes.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to
Regulation 14A under the Securities Exchange Act of 1934 within 120 days of
the end of its fiscal year ended December 27, 1996. Portions of the
registrant's definitive proxy statement for its annual meeting of
stockholders to be held on May 22, 1997 are incorporated by reference into
Part III of this Form 10-K.
Page 2
PART I
ITEM 1. BUSINESS
GENERAL
- -------
Storage Technology Corporation and its subsidiaries ("StorageTek(R)" or the
"Company") design, manufacture, market and maintain information storage
systems and network products. The Company's three principal product lines
are serial access storage subsystems (Nearline(R)), random access storage
subsystems (online) and network products. Nearline products include magnetic
tape storage devices and automated library systems. Online products consist
of rotating magnetic disk devices which utilize fault-tolerant array
technology (RAID). Network products include connectivity and security
products. The Company also offers professional consulting services with a
focus on information storage management. (See "MARKETING AND DISTRIBUTION;
SERVICES" below). StorageTek also maintains a customer service organization
to install, maintain and service its own and third-party equipment.
StorageTek operates in one principal industry segment. The Company sells its
products and services worldwide through its direct sales force located in
offices in major metropolitan areas of the United States, Europe, Canada,
Australia, Japan, Mexico, New Zealand, Singapore, and Brazil, and through
distributors located in other international markets in Africa, Asia, Europe
and other countries in South America. The Company also sells its products
through other indirect distribution channels, including original equipment
manufacturers (OEMs) and value-added resellers (VARs). In particular, in
1996, the Company changed its mainframe online technology business model to
focus on the OEM channel.
StorageTek's business model is focused on delivering information storage
solutions for the mainframe, open-systems and network-attached storage
marketplaces. The Company's strategy includes: identifying significant new
storage solution technologies; investing in identified opportunities through
research and development activities and the development of strategic
relationships; and delivering these solutions through the most effective
distribution channels. To this end, the Company continues to establish
strategic alliances with other manufacturers, developers, distributors and
suppliers. As a result of these alliances, it is possible for other
companies to be at various times collaborators, competitors and customers in
different markets.
Significant changes were made to the Company's business model during 1996 and
early 1997. The Company sold substantially all of its lease assets in March
1996. In connection with the sale, the Company formed a worldwide lease
financing alliance with Leasetec Corp. to provide lease financing for
products manufactured or sold by the Company. (For a discussion of the sale,
see Note 2, Sale of Midrange Business and Lease Assets, of NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K.) In June 1996, the
Company entered into a three-year, non-exclusive, worldwide OEM agreement
under which the Company develops and manufactures mainframe online storage
products for International Business Machines Corporation (IBM). IBM serves
as the Company's primary worldwide distribution channel for these
PAGE
Page 3
products, and the Company does not anticipate that it will sell these
products directly to end-user customers during the term of the agreement.
(For a discussion of this arrangement, see Note 3, IBM OEM Agreement, of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K.) In September
1996, the Company repurchased 4.5 million shares of common stock for a
purchase price of approximately $195.5 million.
On December 12, 1996, the Company announced that it had called for redemption
all of its outstanding 8% Convertible Subordinated Debentures on January 13,
1997. (For a discussion about this redemption, see "8% Convertible
Debentures", below, and Note 8, Debt, Banking Arrangements and Lease
Obligations, of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K.)
On February 20, 1997, the Company announced a stock repurchase program. Under
the program, the Company may repurchase up to 1.5 million shares of its common
stock on an annual basis. (For a discussion of this program, see "Recent
Developments" below, and Note 18, Subsequent Events, of NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS, of this Form 10-K.)
Storage Technology Corporation was incorporated in Delaware in 1969. Its
principal executive offices are located at 2270 South 88th Street,
Louisville, Colorado 80028-0001, telephone (303) 673-5151.
THE STATEMENTS IN THE FOLLOWING DESCRIPTION THAT REGARD THE COMPANY'S FUTURE
PRODUCT AND BUSINESS PLANS, FINANCIAL RESULTS, PERFORMANCE AND EVENTS ARE
FORWARD-LOOKING STATEMENTS AND ARE BASED ON CURRENT EXPECTATIONS. ACTUAL
RESULTS MAY DIFFER MATERIALLY DUE TO A NUMBER OF RISKS AND UNCERTAINTIES,
INCLUDING THE RISKS DETAILED IN PART II, ITEM 7, "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--RISK FACTORS THAT
MAY AFFECT FUTURE RESULTS," OF THIS FORM 10-K.
PRINCIPAL PRODUCTS
- ------------------
Product sales, including software license revenue, accounted for
approximately 73% of total revenue in 1996, while maintenance revenue
accounted for the balance. The following table presents revenue by product
line, which includes both product sales and maintenance revenue:
PAGE
Page 4
REVENUE BY PRODUCT LINE
FISCAL YEAR ENDED DECEMBER
----------------------------------------------------
1996 1995 1994
---------------- ---------------- ----------------
$ million % $ million % $ million %
--------- ---- -------- ---- -------- ----
Nearline Products $1,328.2 65.1 $1,197.7 62.1 $1,033.0 55.2
Online Products 429.3 21.1 375.9 19.5 254.2 13.6
Network Products 183.7 9.0 208.9 10.8 249.8 13.3
Other Products 98.4 4.8 147.0 7.6 334.4 17.9
------- ----- ------- ----- ------- -----
Total $2,039.6 100.0 $1,929.5 100.0 $1,871.4 100.0
======= ===== ======= ===== ======= =====
Additional information concerning revenue from each of the Company's product
lines is found in Part II, Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and geographic information is
found in Part IV, Item 14, Note 16 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, of this Form 10-K.
In January 1997, the Company organized its business into four separate
business groups designed to augment activities focused on providing new
solutions to customers and expanding into non-traditional markets. These
business groups consist of the Enterprise Nearline Business Group, Enterprise
DASD Business Group, Network Systems Group and Multi-Platform Systems
Business Group.
NEARLINE PRODUCTS
- -----------------
StorageTek's Nearline products include its Automated Cartridge System (ACS)
library and associated tape cartridge storage products. The Company's
current library products include: the PowderHorn 9310 (PowderHorn(R)), an ACS
library, which became available in the second quarter of 1993; the TimberWolf
9710 library and the TimberWolf 9714 library (TimberWolfTM), smaller capacity
libraries designed for the open-systems market, which became available in the
second quarter of 1996 and the third quarter of 1996, respectively; the
WolfCreek 9360 (WolfCreek(R)), a smaller, high-performance library, which
became available in the fourth quarter of 1993; and the Company's first
generation 4410 ACS library, which has been available since 1988.
The Company's tape cartridge storage products include: the Timberline 9490
(Timberline(R)), a high-performance 36-track cartridge subsystem, which
became available in the fourth quarter of 1994; the Silverton 4490
(Silverton), a 36-track cartridge subsystem, which became available in the
third quarter of 1993; RedWood SD-3 (RedwoodTM), a high-capacity cartridge
subsystem, which became available in the first quarter of 1995; the Twin
Peaks 4890 36-track cartridge subsystem (Twin Peaks), a cartridge subsystem
designed for the open-systems market, which has been available since the
second quarter of 1996; and the 4480 18-track cartridge subsystem, which has
PAGE
Page 5
been available since 1987. The Company also develops and licenses software
designed to expand the range of applications for and enhance the performance
of its Nearline products.
In addition, the Company is developing other new Nearline products and
enhancements, all of which are in the design or preliminary engineering phase
and for which no firm availability dates have been set. See Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," of this Form 10-K, which is incorporated by reference into Item
1 of Part I, for a discussion of operating results and certain risks
associated with the development and introduction of new products that may
affect future results.
ONLINE PRODUCTS
- ---------------
StorageTek's online products consist of online direct access storage device
(DASD) products. The Company's current product line is targeted at the
mainframe and open-systems marketplace. The characteristics of these
products differ principally in information storage capacity, transfer rate,
access time, attachment protocol and cost. In 1996, the Company changed its
business model for distributing mainframe online storage products. Under the
Company's non-exclusive worldwide OEM agreement with IBM, the Company
develops and manufactures mainframe online storage products, including
software enhancements, for IBM. IBM serves as the primary distribution
channel for this technology, and StorageTek does not anticipate continuing to
sell this technology directly to end-users during the term of the agreement.
As part of changing its business model for online products, the Company is
redirecting resources to other product lines, as well as to emerging products
and services outside its traditional markets. The Company has formed a new
business unit, the Multi-Platform Systems Business Group, that is focusing on
products targeted for the open-systems marketplace and establishing new
distribution channels for these products. See Part II, Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," of
this Form 10-K for a discussion of operating results and certain risks that
may affect future results.
NETWORK PRODUCTS
- ----------------
The Company's principal computer network product offerings consist of:
network connectivity and security products. Network connectivity products
include the Data Exchange (DXETM) series host and device controller, which
became available in the first quarter of 1993. The DXE series controllers
support a variety of channel interface options and media connections. The
Company's network security products include the BorderGuardTM 1000 and
BorderGuardTM 2000 products, which became available in the first half of
1995, and are targeted at branch office and enterprise-wide security
applications, respectively. The Company also offers the Central Archive
Management (CAMTM), a software application designed to provide backup and
recovery to a variety of network client systems, which has been available
since 1995. Other new products designed to support network attached storage
for the client-server environment are currently in the design or preliminary
engineering phase, and no firm availability dates have been set. See Part
II, Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operations", of this Form 10-K for a discussion of
PAGE
Page 6
operating results and certain risks associated with the development and
introduction of new products that may affect future results.
MARKETING AND DISTRIBUTION; SERVICES
- ------------------------------------
StorageTek is committed to a worldwide marketing and product maintenance
strategy. StorageTek sells its hardware and software products and services
to customers worldwide through a combination of direct and indirect channels.
The direct sales and service force operates in offices located in major
metropolitan areas in the United States, Europe, Canada, Australia, Japan,
Mexico, New Zealand, Singapore, and Brazil. In 1996, direct sales revenue
accounted for approximately 74% of the Company's total product sales revenue.
The Company also sells its products in certain international markets through
distributors, sometimes in tandem with other direct sales operations, located
in Africa, Asia, Europe and South America.
Indirect channels include: OEMs, system vendors that integrate the Company's
products with other hardware and software and provide independent marketing,
service and support programs to their customers; VARs, companies that add
value in the form of proprietary products, training and installation for sale
to their customers; independent distributors, who primarily serve markets in
which StorageTek does not have a direct presence; and telesales. Indirect
channel distribution accounted for approximately 26% of the Company's total
product sales revenue in 1996. Significant OEMs include IBM, in the
mainframe online products market, and NCR with respect to the TimberWolf 9710
ACS library. The Company's marketing activities include advertising in
business and computer publications, direct mailings and participating in
trade shows. Further development of the Company's indirect sales channels is
critical to gaining additional market penetration in a cost-effective manner
for current and future products targeted for the open-systems marketplace.
Revenues from outside the U.S. accounted for approximately 41% of total
revenue in 1996, 41% in 1995, and 39% in 1994. International operations
account for significant revenue contribution, and the Company is subject to
various risks associated with conducting business outside the United States.
See Part II, Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations - International Sales and Operations and
Hedging Activities," of this Form 10-K for a discussion of risk factors
associated with the Company's international business.
As of December 27, 1996, the order backlog was approximately $43 million,
compared to approximately $57 million as of December 29, 1995. In 1996,
approximately 53% of the backlog amount was attributable to the Company's
library and tape products, as compared to 37% in 1995. In addition to these
backlog amounts, the Company also had approximately $90 million of equipment
shipped awaiting revenue recognition as of December 27, 1996, compared to
approximately $88 million as of December 29, 1995. Backlog amounts are
calculated on an "if sold" basis and include orders from end-users, OEMs,
VARs and distributors for products that StorageTek expects to deliver during
the following 12 months. Units being evaluated or covered by letters of
intent or awaiting customer acceptance are not included in backlog amounts.
Unfilled orders and orders with respect to equipment shipped awaiting revenue
recognition may be canceled by the customer. Accordingly, backlog levels are
not a reliable indicator of future results, and
PAGE
Page 7
there can be no assurance that orders in backlog or equipment shipped
awaiting revenue recognition will ultimately be recognized as revenue.
The Company believes that the installed base of products under maintenance
agreements and the expertise of the Company's customer service engineers are
valuable assets of the Company. These assets are expected to continue to be
important competitive elements of the Company's business. The Company's
worldwide customer support organization includes field service engineers, and
product support and administrative support personnel. The customer support
organization installs, maintains and services StorageTek-manufactured
equipment, as well as equipment manufactured by third parties. The Company
provides local customer support services from its offices located in major
metropolitan cities, with spare parts stored at regional locations. The
Company generally warrants the performance of products for a specified period
of time, after which it services those products under maintenance agreements.
In response to continuing competitive pressures, many of the Company's
products include extended warranty periods, which may reduce future
maintenance revenue opportunities. The Company also has transitioned its
mainframe online business model to primarily serve as an OEM supplier. This
change may affect future maintenance revenue, as OEM customers generally
maintain their own products. Extending warranty periods has in the past and
may in the future adversely affect profit margins. In 1996, maintenance
revenue accounted for 27% of total revenue, compared to 30% in 1995 and 31%
in 1994.
In 1996, the Company expanded its offerings of professional services through
its Teris Consulting Group. The Company provides consulting and technical
services and technology as part of providing single point-of-contact
solutions. The Company's consultants help clients plan, implement, and
manage computing and storage environments.
MANUFACTURING AND MATERIALS
- ---------------------------
The Company's primary manufacturing facilities are currently located in
Colorado, Minnesota, Puerto Rico and France. The Company is in the process
of consolidating some of its manufacturing facilities located in Colorado.
This consolidation will be completed during the second quarter of 1997. A
significant portion of the Company's European requirements for both
Timberline and Iceberg products are manufactured at the Company's facility
located in Toulouse, France. In connection with the restructuring activities
announced in the fourth quarter of 1995, the Company ceased manufacturing
operations at its facilities in Florida and the United Kingdom during 1996.
All of the Company's manufacturing facilities are currently in compliance
with the ISO 9001 or 9002 international quality standard.
The Company manufactures certain key components for its products. In
addition, a substantial portion of the Company's production costs are related
to the purchase of subassemblies, parts and components for its products from
outside vendors. The balance of the Company's production costs relate to
in-house assembly and testing. Certain of the parts and components included
in the Company's products are obtained from a single source or a limited
group of suppliers. In particular, a key component of the Company's tape
drive heads is supplied by Sumitomo Corporation on a sole source
PAGE
Page 8
basis. The Company has long-term supply contracts with certain vendors and
suppliers; the remaining parts and components are obtained by delivering
purchase orders to vendors specifying the required components. These vendors
that are not obligated to supply products for an extended period at specific
quantities and prices. See Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Risk Factors that
May Affect Future Results," of this Form 10-K for a discussion of factors
that may affect the Company's ability to obtain materials, which information
is incorporated by reference into Part I, Item 1 of this Form 10-K.
COMPETITION
- -----------
The markets for the Company's products and services are intensely competitive
and are subject to rapid technological change, frequent product performance
improvements and price reductions. In the mainframe information storage
system marketplace, competition comes from companies that have substantially
greater resources, including IBM, Fujitsu Ltd. and Hitachi Ltd., as well as
several similarly sized companies, including Amdahl Corp. and EMC Corp. In
the network connectivity and security products marketplace, the competition
includes a number of large companies with significant market presence and
resources, including IBM, Hewlett-Packard Company and Channel Network
Technologies Corp., as well as a number of other companies.
The Company believes that its ability to compete successfully in its
traditional markets depends on a number of factors, both within and outside
of its control, including the quality, performance, and price of the
Company's and its competitors' products, the timing and success of new
product introductions by the Company and its competitors, and general
economic conditions within and outside the U.S. The strong competition faced
by the Company's product lines has in the past, and may in the future, result
in price discounting.
The Company is focusing significant resources on product offerings for the
open-systems market, emerging technologies and other non-traditional markets,
including professional services. The open-systems marketplace includes a
broad spectrum of customers, many that are outside the Company's traditional
customer base. The Company has established a new business group to focus on
multi-platform systems. Competition in this segment is robust, and the
Company will face competition from its traditional rivals, as well as new
sources. Competition is based primarily on system performance, product
quality, system scalability and price. The Company's ability to successfully
compete is dependent upon a number of factors, including the timely and
successful introduction of products designed for the open-systems marketplace
and the development of new distribution channels. In the professional
services marketplace, the Company competes against a number of large
companies with an established presence in the professional services industry,
including a number of equipment manufacturers. The Company's competitors in
this market include: IBM, Electronic Data Systems Corp. and Computer
Sciences Corporation. The Company anticipates that its ability to compete in
the professional services market will depend upon a number of factors within
and outside its control, including the effective management of the Company's
consulting arrangements, the strength of the Company's storage solution
offerings, and the competitiveness of its pricing for these solutions.
PAGE
Page 9
The Company expects that both the markets for its products and services, and
its competitors within such markets, will continue to change as customer
buying patterns continue to migrate to the open-systems and networking
environments. The Company expects that competition will likely intensify as
the Company and its competitors aggressively position themselves. The
ability to continue to develop and successfully market leading products will
continue to have a significant impact upon the Company's competitiveness and
its operating results.
NEW PRODUCT DEVELOPMENT
- -----------------------
The Company invests substantial resources in its product development efforts
in order to maintain and enhance the competitiveness of its products. In
1996, 1995 and 1994, the Company devoted approximately $176 million, $187
million and $206 million, or 9%, 10%, and 11%, respectively, of its total
revenue to develop new products and enhance the performance of existing
products. In an attempt to expand the Company's access to new technologies
and reduce the amount of time necessary to bring new products to the market,
the Company in the past has acquired other companies and has entered into
joint development and other similar relationships. For example, in 1995 the
Company acquired Network Systems. In 1996, the Company entered into a three-
year OEM agreement with IBM under which IBM will finance certain research and
development activities associated with future development and enhancements to
mainframe online products. The Company anticipates that its research and
development expenditures for new products outside its traditional businesses
will increase in the future.
Current research and development projects include: the development of
enhancements for online products; development activities related to new
Nearline tape products and enhancements; network security software; and the
development of network-attached storage products. As of December 27, 1996,
approximately 1,250 employees were engaged on a full-time basis in
engineering and product development activities, primarily at facilities in
Colorado and France. Simultaneously, the Company is seeking to reduce
manufacturing costs and improve product development lead times. For further
discussion of risk factors concerning product development, see Part II, Item
7, "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Risk Factors that May Affect Future Results," of this Form
10-K.
INTELLECTUAL PROPERTY
- ---------------------
StorageTek's ability to compete is affected by its ability to protect its
proprietary information. StorageTek protects its intellectual property
rights through a combination of patents, trademarks, copyrights,
confidentiality procedures, trade secret laws and licensing arrangements.
The Company's policy is to apply for patents, or other appropriate
proprietary or statutory protection, when it develops new or improved
technology that is important to its business. StorageTek currently holds
over 280 U.S. patents, as well as foreign counterparts to many of these
patents in relevant markets, covering various aspects of its products. One
of these patents will expire in 1997 and the remainder will expire from 1998
through 2015. The Company also has pending approximately 100 U.S. patent
applications, including approximately 30 that have been allowed and are
expected to be formally issued soon, as well as pending foreign counterparts
to many of these applications. StorageTek also has licenses to use
PAGE
Page 10
patents held by others. StorageTek owns, has license rights to, and/or has
applied to register, over 45 trademarks, as well as copyrights. Taken as a
whole, these intellectual property assets are material to StorageTek's
business. However, no individual patent, trademark, license or other item of
proprietary information is singularly material to StorageTek's business.
Under the OEM agreement with IBM, certain research and development activities
will be funded by IBM; any technology that is developed will be owned by IBM,
subject to licensing rights by the Company. For a discussion of certain
legal proceedings relating to the Company's intellectual property, see Part
I, Item 3, "Legal Proceedings" of this Form 10-K. For a discussion of
certain risk factors concerning intellectual property see Part II, Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors that May Affect Future Results," of this Form 10-K.
ENVIRONMENT
- -----------
Compliance by StorageTek with the provisions of federal, state and local laws
regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment, has not had a material adverse
affect on StorageTek. For 1996, StorageTek did not have any material
expenditures for environmental control facilities. To date in 1997,
StorageTek does not have pending and has not budgeted any material estimated
expenditures for environmental control facilities. However, potential
liability under environmental legislation is ongoing, regardless of whether
or not StorageTek has complied with existing governmental guidelines.
Government regulation of the environment and related compliance costs have
increased in recent years. StorageTek cannot predict the nature or scope of
future environmental laws or regulations, how they will be administered, or
whether compliance will require substantial expenditures. Based upon
currently available information, StorageTek does not expect that future
compliance with environmental regulations will have a material effect on the
financial results and operations of StorageTek.
RESTRUCTURING PLAN
- ------------------
In the fourth quarter of 1995, the Company incurred restructuring charges of
$167.2 million, to cover the cost of work force reductions of approximately
1,700 employees, facility closings and consolidations affecting its
facilities located in Colorado and other facilities located both within and
outside the U.S., and asset writedowns. This restructuring was adopted in an
effort to establish a more competitive cost structure in response to slower
revenue growth and increasing price competition. In connection with the
restructuring, the Company is focusing on core businesses and is outsourcing
non-strategic activities and re-architecting its distribution processes both
within and outside the U.S. Additional information concerning the 1995
restructuring plan is found in Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and Part IV, Item
14, Note 15 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, of this Form 10-K.
PAGE
Page 11
8% CONVERTIBLE DEBENTURES
- -------------------------
In December 1996, the Company called for redemption, on January 13, 1997, of
all outstanding 8% Convertible Subordinated Debentures due 2015 (8%
Convertible Debentures). Debentures in the principal amount of $145.2
million were converted at a price of $35.25 per share into 4,118,906 shares
of the Company's common stock on or before January 13, 1997. The remaining
8% Convertible Debentures were redeemed for cash on January 13, 1997.
RECENT DEVELOPMENTS
- -------------------
On February 20, 1997, the Company announced a program to repurchase up to
1.5 million shares of the Company's common stock on an annual basis. The
repurchase program is expected to offset dilution associated with the
Company's stock purchase and stock option plans.
EMPLOYEES
- ---------
The Company employed approximately 8,300 persons on a full-time basis
worldwide as of December 27, 1996. The Company's future success will depend,
in part, on its ability to continue to attract, retain and motivate skilled
personnel.
OTHER MATTERS
- -------------
The Company historically has experienced increased sales revenue in the
fourth quarter compared to other quarters due to customers' tendencies to
make purchase decisions near the end of the calendar year. There can be no
assurance that this historical trend will continue in 1997 and that revenue
during the fourth quarter will be higher than any other quarter.
For the year ended December 27, 1996, no single customer accounted for 10% or
more of the Company's consolidated total revenue. The Company anticipates
that in 1997, sales of mainframe online products to IBM under the OEM
agreement may account for over 10% of the Company's consolidated total
revenue.
No material portion of the Company's business is subject to contract
termination at the election of the U.S. government.
Reference is made to the following NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS set forth in Part IV, Item 14, of this Form 10-K for certain
additional information, which information is incorporated by reference
herein:
Note 2 Description of the Company's sale of its lease assets.
Note 3 Description of the Company's OEM Agreement with IBM.
Note 8 Description of the Company's debt and banking arrangements.
PAGE
Page 12
Note 16 Information on the geographic operations of the Company's
single business segment. See also Part II, Item 7,
"Management's Discussion and Analysis of Financial
Condition and Results of Operations -- International
Operations and Hedging Activities," for further discussion
of the risks associated with the Company's foreign
operations.
Reference is also made to Part II, Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," of this Form
10-K, for information regarding liquidity, including working capital
practices, restructuring plans and risk factors that may affect future
results.
ITEM 2. PROPERTIES
StorageTek occupies facilities in 16 separate buildings in Boulder County,
Colorado, comprising approximately 2.4 million square feet. The company owns
facilities with approximately 2.2 million square feet; the remaining space is
leased. These facilities include StorageTek's executive offices, as well as
manufacturing, research and development, and spare parts storage facilities.
Substantially all of the Boulder County space is fully utilized with the
exception of the research and manufacturing facility located in Longmont,
Colorado, comprising approximately 500,000 square feet. The Longmont
operations are being consolidated into the Company's Louisville, Colorado
facilities and the Company is pursuing efforts to sell the Longmont
facilities. The Company plans to move substantially all of its operations
out of the Longmont facility by the end of the second quarter of 1997.
StorageTek owns approximately 199,000 square feet of manufacturing facilities
in the Palm Bay/Melbourne, Florida, area. A majority of this space is leased
to a third party. The Company owns 200,000 square feet of manufacturing,
research and development, and administrative facilities in the Minneapolis,
Minnesota area, which are approximately 85% utilized. StorageTek leases
approximately 200,000 square feet of engineering, manufacturing and marketing
facilities in Toulouse, France, which are approximately 60% utilized. The
Company occupies manufacturing facilities in Puerto Rico, of which
approximately 78,000 square feet are owned and 50,000 square feet are leased.
The facilities in Puerto Rico are approximately 95% utilized.
In addition, StorageTek leases facilities at approximately 286 locations
throughout the world, primarily for sales and customer support activities,
spare parts storage, and limited research and product development activities.
Of these leased offices, approximately 197 offices are located in North
America, with combined office and warehouse space totaling approximately
1,348,000 square feet. The Company maintains approximately 77 offices in
Europe comprising approximately 515,000 square feet, and 12 offices in the
Asia/Pacific region comprising approximately 68,000 square feet.
PAGE
Page 13
Many of the Company's leases throughout the world contain renewal rights,
cancellation rights and rights of first refusal on contiguous expansion
space. At the present time, such facilities are adequate for the Company's
purposes.
ITEM 3. LEGAL PROCEEDINGS
In January 1994, Stuff Technology Partners II, a Colorado Limited Partnership
(Stuff), filed suit in Boulder County, Colorado, District Court against the
Company and certain subsidiaries. The suit alleged that the Company breached
a 1990 settlement agreement that had resolved earlier litigation between the
parties. The suit sought injunctive relief and damages in the amount of
$2,400,000,000. 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. Oral
argument on the appeal is scheduled for March 1997.
On February 15, 1994, the Company filed suit in Boulder County, Colorado,
District Court against Array Technology Corporation (Array) and Tandem
Computers Incorporated (Tandem). The suit asked that the court order Array
and Tandem to either support certain disk drives purchased from them or
provide the Company with technical data necessary for StorageTek to provide
such customer support. In March 1994, Array and Tandem filed their answer
and also filed counterclaims against the Company alleging breach of contract
and claiming damages. On June 10, 1994, the court ordered Array and Tandem
to continue to provide support for these products and to maintain, in an
independent escrow account, the materials necessary to enable the Company to
support the products in the event Array and Tandem failed to provide such
services. On May 30, 1995, the Company filed an amended complaint seeking
damages. The case is in the discovery phase. A trial date has been set for
October 1997.
On June 29, 1995, Odetics, Inc. filed a patent infringement suit in the U.S.
District Court for the Eastern District of Virginia against the Company and
two of its customers 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 fees and costs. A
trial commenced on January 22, 1996, and on February 1, 1996, a jury found
that the Company's products did not infringe the 151 Patent. A notice of
appeal to the U.S. Court of Appeals for the Federal Circuit was filed by
Odetics, Inc. on March 8, 1996. Oral arguments were held in January 1997. A
decision is expected in the second or third quarter of 1997.
On December 8, 1995, Odetics, Inc. 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 infringe the 151 Patent. The
complaint seeks injunctive relief, treble damages in an unspecified amount,
and an award of attorney fees and costs. This case has been stayed pending
the outcome of the appeal to the U.S. Court of Appeals for the Federal
Circuit with respect to the case filed by Odetics, Inc. in June 1995.
PAGE
Page 14
On July 30, 1996, the Company received Civil Investigative Demands (CID) from
the U.S. Department of Justice Antitrust Division concerning the OEM
agreement with IBM for mainframe online storage subsystems. The Company
received two additional CIDs in October 1996 and one additional CID in
February 1997. The CIDs requested production of documents and testimony in
connection with a review of the agreement for compliance with the Sherman
Act.
In addition, the Company is involved in various other less significant legal
proceedings. 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 cases
could result in outcomes unfavorable to the Company. 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 effect on the Company's
financial position or reported results of operations in a particular quarter.
An adverse 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 certain of these legal proceedings is also contained
in Note 13 of NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS included in Part
IV, Item 14, of this Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of StorageTek security holders during the
fourth quarter of the fiscal year ended December 27, 1996.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following persons were serving as executive officers of the Company
as of March 7, 1997.
NAME POSITION WITH COMPANY AGE
- ------------------------------------------------------------------------
David E. Weiss..... Chairman of the Board, President and
Chief Executive Officer 52
Lowell Thomas Gooch Executive Vice President and General
Manager of Network Systems 52
David E. Lacey..... Executive Vice President and Chief
Financial Officer 50
John V. Williams... Executive Vice President of Worldwide
Field Operations 53
W. Russell Wayman.. Corporate Vice President, General
Counsel and Secretary 52
PAGE
Page 15
Mr. Weiss has served as Chairman of the Board, President and Chief Executive
Officer since May 23, 1996. Prior to that, he served as Chief Operating
Officer of the Company from March 1995 to May 1996, Executive Vice President
of Systems Development from January 1993 to March 1995, Senior Vice President
of Marketing and Program Management Process from June 1992 to January 1993,
and Corporate Vice President of Market Planning from August 1991 to
June 1992. Mr. Weiss joined the Company in March 1991 as Staff Vice
President.
Mr. Gooch was appointed as Executive Vice President and General Manager of
the Company's Network Systems Group in November 1995. From January 1989 to
November 1995, Mr. Gooch was Executive Vice President of Operations of the
Company. Mr. Gooch has been employed by the Company in various capacities
since 1972.
Mr. Williams was appointed Executive Vice President of Worldwide Field
Operations on January 1, 1995. From August 1993 through December 1994, he
served as Senior Vice President, Americas. Mr. Williams was Corporate Vice
President from February 1992 through August 1993 and Vice President of North
America from September 1990 through February 1992.
Mr. Lacey was appointed Executive Vice President and Chief Financial Officer
on May 23, 1996. From February 1995 to May 1996, Mr. Lacey served as Interim
Chief Financial Officer and Corporate Vice President. Mr. Lacey was
appointed a Corporate Vice President in December 1990 and served as Corporate
Controller of the Company from October 1989 to February 1995.
Mr. Wayman has served as Corporate Vice President since March 1991, General
Counsel since January 1990 and Corporate Secretary of the Company since
February 1990.
PAGE
Page 16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The common stock of Storage Technology Corporation is traded on the New York
Stock Exchange under the symbol STK. The table below reflects the high and
low closing sales prices of the common stock on the New York Stock Exchange
composite tape as reported by The Wall Street Journal during each fiscal
quarter of 1996 and 1995. On December 27, 1996, there were 14,832 record
holders of common stock of StorageTek.
1996 High Low
--------------------------------------------------
First Quarter $31.250 $22.375
Second Quarter 42.875 24.375
Third Quarter 40.000 31.875
Fourth Quarter 51.000 38.000
1995 High Low
--------------------------------------------------
First Quarter $32.625 $18.625
Second Quarter 26.750 17.875
Third Quarter 29.500 23.750
Fourth Quarter 27.625 22.250
Dividends
- ---------
StorageTek has never paid cash dividends on its common stock. The Company
currently plans to continue to retain future earnings for use in its
business. The Company's existing $150 million credit agreement contains
provisions restricting the payment of cash dividends.
PAGE
Page 17
ITEM 6. SELECTED FINANCIAL DATA
The following data, insofar as it relates to the three fiscal years 1994
through 1996 (except for the 1994 Balance Sheet Data), has been derived from
the consolidated financial statements appearing elsewhere herein, including
the Consolidated Balance Sheet as of December 27, 1996, and December 29,
1995, and the related Consolidated Statement of Operations for each of the
three years in the period ended December 27, 1996, and notes thereto. The
data, insofar as it relates to the Balance Sheet Data as of December 30,
1994, December 31, 1993, and December 25, 1992, and the Statement of
Operations Data for the fiscal years 1993 and 1992, has been derived from the
historical financial statements of the Company for such periods, restated as
appropriate to reflect mergers accounted for as poolings of interests.
The following table data (in thousands of dollars, except per share amounts)
should be read in conjunction with the consolidated financial statements and
notes thereto.
YEAR ENDED DECEMBER
------------------------------------------------------------------------
1996 1995 1994 1993 1992
------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA
Revenue $2,039,550 $1,929,485 $1,871,350 $1,617,691 $1,774,325
Cost of revenue 1,192,777 1,217,622 1,186,942 1,072,784 1,179,756
--------- --------- --------- --------- ---------
Gross profit 846,773 711,863 684,408 544,907 594,569
Research and product development costs 176,422 187,275 206,083 191,048 177,699
Marketing, general, administrative and
other income and expense, net 444,870 445,889 425,490 393,991 388,496
Restructuring and other charges (Note 15) 212,207 8,000 90,414(a) 60,310(b)
--------- --------- --------- --------- ---------
Operating profit (loss) 225,481 (133,508) 44,835 (130,546) (31,936)
Interest income (expense), net 1,211 8,978 6,103 18,585 25,894
--------- --------- --------- --------- ---------
Income (loss) before income taxes,
accounting change and extra-
ordinary item 226,692 (124,530) 50,938 (111,961) (6,042)
Provision for income taxes (55,900) (17,800) (18,900) (9,500) (27,200)
--------- --------- --------- --------- ---------
Income (loss) before accounting
change and extraordinary item 170,792 (142,330) 32,038 (121,461) (33,242)
Cumulative effect of accounting change 40,000
Extraordinary item, net of taxes (Note 2) 9,535
--------- --------- --------- --------- ---------
Net income (loss) $ 180,327 $ (142,330) $ 32,038 $ (81,461) $ (33,242)
========= ========= ========= ========= =========
Primary earnings (loss) per common share:
Income (loss) before accounting
change and extraordinary item $ 3.00 $ (2.91) $ 0.38 $ (2.59) $ (0.66)
Net income (loss) 3.17 (2.91) 0.38 (1.80) (0.66)
Fully diluted earnings per common share:
Income before extraordinary item 2.84
Net income 2.98
BALANCE SHEET DATA
Working capital $ 724,171 $ 425,351 $ 501,065 $ 492,576 $ 402,876
Total assets 1,884,276 1,888,629 2,144,458 2,064,851 2,011,007
Total debt 155,257 449,222 464,690 469,490 447,747
Stockholders' equity 1,180,983 962,833 1,265,285 1,215,877 1,138,927
(a) In 1993, the Company recognized restructuring charges of $77,832,000; acquired research
and development expenses of $7,060,000; and merger expenses of $5,522,000.
(b) In 1992, the Company recognized restructuring charges of $60,310,000.
PAGE
Page 18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Certain statements in the following discussions regarding the Company's
future product and business plans, financial results, performance and events
are forward-looking statements and are based on current expectations. Actual
results may differ materially due to a number of risks and uncertainties,
including the risks detailed below in "RISK FACTORS THAT MAY AFFECT FUTURE
RESULTS."
GENERAL
- -------
The Company reported net income for the year ended December 27, 1996, of
$180.3 million on revenue of $2.04 billion, compared to a net loss for the
year ended December 29, 1995, of $142.3 million on revenue of $1.93 billion
and net income for the year ended December 30, 1994, of $32.0 million on
revenue of $1.87 billion. The Company's results include an extraordinary
gain on sale of lease assets of $9.5 million in 1996, and restructuring and
other charges of $212.2 million in 1995, and $8.0 million in 1994.
Revenue increased 6% in 1996 compared to 1995. The Company received
increased sales revenue from the TimberLine 9490 (TimberLine(R)) 36-track
cartridge subsystem in 1996. RedWood SD-3 (RedWood(TM)), a high-capacity
cartridge subsystem; PowderHorn 9310 (PowderHorn(R)), an Automated Cartridge
System (ACS) Library; and TimberWolf 9710 (TimberWolf), an open-systems ACS
Library, also contributed to increased revenue during the year. As
anticipated, revenue from older generation Nearline(R) products decreased
during 1996 as compared to 1995. Revenue from mainframe online products
increased during 1996 as compared to 1995, as a result of increased sales
volumes under the OEM agreement with International Business Machines
Corporation (IBM) in the second half of 1996, coupled with end-user sales of
the Company's 9200 Virtual Storage Facility (Iceberg(R)) in the first half of
1996. Revenue contribution from network products decreased during 1996
primarily due to the continued decline in revenue from a number of older
network products and the sale of a non-strategic network business during the
third quarter of 1996. Revenue contribution from other products declined in
1996 as compared to 1995, due primarily to the sale of substantially all of
the Company's midrange lease assets and midrange service business in the
second and third quarter of 1995, respectively.
Revenue increased 3% in 1995 compared to 1994, primarily due to incremental
sales revenue from TimberLine and increased sales revenue from Iceberg.
These increases were partially offset by a decline in sales revenue from
other products as well as anticipated declines in revenue from older
generation Nearline products. The decline in other product revenue was
primarily due to the sale of substantially all of the Company's midrange
lease assets and midrange service business in 1995.
The Company's future revenue and operating results are significantly
dependent upon sustained demand for TimberLine and PowderHorn; successfully
identifying and capitalizing on product and service markets outside the
Company's traditional marketplace, including solutions targeted for the open-
systems market; achieving the milestones and reducing the costs associated
with the Company's manufacture of mainframe online products under the OEM
PAGE
Page 19
agreement with IBM; and expanding its distribution channels. For discussion
of these and other risk factors, see "Risk Factors That May Affect Future
Results," below.
The Company's cash balances increased $123.9 million during 1996. Net cash
flows generated from operations of $464.7 million includes cash generated
from the sale of substantially all of the Company's lease assets. These
operating cash flows were partially offset by the repurchase of 4.5 million
shares of the Company's common stock for $195.5 million, net repayments of
debt of $100.0 million, and investments in property, plant and equipment of
$68.9 million. The Company's cash balances increased $36.4 million during
1995 as cash generated from operations of $306.0 million was partially offset
by net repayments of debt of $201.9 million, and investments in property,
plant, and equipment of $58.0 million.
The following table, stated as a percentage of total revenue, presents
consolidated statement of operations information and revenue by product line,
which includes product sales, maintenance, and software revenue.
Year Ended December
---------------------------------
1996 1995 1994
---------------------------------
Revenue:
Nearline Products 65.1% 62.1% 55.2%
Online Products 21.1 19.5 13.6
Network Products 9.0 10.8 13.3
Other Products 4.8 7.6 17.9
----- ----- -----
Total revenue 100.0 100.0 100.0
Cost of revenue 58.5 63.1 63.4
----- ----- -----
Gross profit 41.5 36.9 36.6
Research and product development costs 8.6 9.7 11.0
Marketing, general, administrative
and other income and expense, net 21.8 23.1 22.8
Restructuring and other charges 11.0 0.4
----- ----- -----
Operating profit (loss) 11.1 (6.9) 2.4
Interest income (expense), net 0.4 0.3
----- ----- -----
Income (loss) before income
taxes and extraordinary item 11.1 (6.5) 2.7
Provision for income taxes (2.7) (0.9) (1.0)
----- ----- -----
Income (loss) before extraordinary
item 8.4 (7.4) 1.7
Extraordinary gain, net of income taxes 0.4
----- ----- -----
Net income (loss) 8.8% (7.4)% 1.7%
===== ===== =====
REVENUE
- -------
NEARLINE PRODUCTS
Revenue from Nearline products increased 11% in 1996 compared to 1995,
primarily due to increased sales revenue from TimberLine. RedWood,
PowderHorn, and TimberWolf also contributed to increased revenue during 1996.
As anticipated, revenue from earlier generation Nearline products, such as
4480 18-Track Tape Cartridge Subsystem (4480 18-Track), and Silverton 4490
36-Track Tape Cartridge Subsystem (Silverton), declined during 1996 as
PAGE
Page 20
compared to 1995. Revenue from the first generation 4410 ACS library also
declined slightly in 1996.
Revenue from Nearline products increased 16% in 1995 compared to 1994,
primarily due to incremental sales of TimberLine, which became available in
the fourth quarter of 1994. Revenue from PowderHorn also increased in 1995
compared to 1994. As anticipated, revenue from the 4480 18-Track and
Silverton declined in 1995. Revenue from the 4410 ACS library also declined
slightly in 1995.
Future results of the Nearline product line are significantly dependent upon
the continued demand for TimberLine and PowderHorn; gaining market acceptance
for other new Nearline products, including products targeted for the open-
systems market; expanding the Company's distribution channels; and
effectively managing pricing pressures. During the third quarter of 1996,
the Company announced an OEM agreement with NCR Corporation for its open-
systems TimberWolf products. Sales of TimberLine, PowderHorn and other new
Nearline products are expected to offset anticipated further declines in
revenue from earlier generation Nearline products. There can be no assurance
that TimberLine and PowderHorn will continue to sustain their historical
market growth or that other new Nearline products and enhancements will be
developed in a timely manner or gain market acceptance in the future.
ONLINE PRODUCTS
Revenue from online products increased 14% in 1996 as compared to 1995. This
online revenue increase is primarily due to increased sales volume of
mainframe online storage products under the OEM agreement with IBM in the
second half of 1996, coupled with end-user sales of Iceberg in the first half
of 1996. These increases were partially offset by a decrease in revenue
contribution from earlier generation online products.
Revenue from online products increased 48% in 1995 compared to 1994,
primarily due to incremental sales of Iceberg, which became available during
the second quarter of 1994. While Iceberg sales revenue increased during
1995, the rate of revenue growth fell short of the Company's expectations,
primarily due to rapid price erosion in the online marketplace, and slower
than expected customer acceptance of Iceberg.
On June 7, 1996, StorageTek entered into a worldwide non-exclusive OEM
agreement with IBM under which the Company develops and manufactures
mainframe online storage products for IBM. IBM serves as StorageTek's
primary distribution channel for this technology and StorageTek does not
anticipate that it will continue to sell this technology directly to end-user
customers during the term of the agreement. The agreement, which expires in
1999, contains certain minimum purchase commitments on behalf of IBM. The
agreement also contains product quality, availability, supply, delivery, and
development milestones. The Company's failure to achieve these milestones
may result in reduced purchase commitments, the imposition of penalties and,
under certain circumstances, IBM may terminate the agreement.
The Company anticipates the OEM agreement with IBM will benefit the Company
in 1997 through increased sales revenue contribution from the mainframe
online product line, due to increased market penetration. Additionally, the
OEM arrangement is expected to allow the Company to redirect resources to
other products and services outside the Company's traditional marketplace,
including products targeted for the open-systems market. There can be
PAGE
Page 21
no assurance that the Company will achieve the milestones provided for in the
OEM agreement, that the Company will realize the anticipated benefits
associated with the agreement, or that the Company will succeed in its
efforts outside its traditional marketplace.
NETWORK PRODUCTS
Revenue from network products decreased 12% in 1996 as compared to 1995.
This decrease is due primarily to the continued decline in revenue from a
number of older network products and the sale of a non-strategic network
business in the third quarter of 1996 as the Company continued the
implementation of restructuring actions aimed at increasing the focus on core
network products for the information storage systems marketplace. The
Company's 1995 restructuring activities resulted in the realization of cost
savings associated with the manufacture of network products during 1996.
Revenue from network products decreased 16% in 1995 compared to 1994. This
decrease reflects declines in older network products, coupled with slower
than expected market acceptance of internetworking products which support
communication between networks. Revenue and operating results associated
with network products during 1995 were adversely affected by difficulties
encountered with the integration of Network Systems Corporation (Network
Systems), which was acquired in March 1995.
Future revenue and operating results from the Company's network products are
significantly dependent upon increasing the market penetration for network
connectivity and security products; successfully expanding the network
product line; and establishing new distribution channels. There can be no
assurance that new network products will be successfully and timely developed
or gain market acceptance, or that the network product line will generate any
significant profits in the future.
OTHER PRODUCTS
Revenue from other products decreased 33% in 1996 compared to 1995;
representing less than 5% of total revenue. Revenue from other products
decreased 56% in 1995 compared to 1994. These declines are primarily the
result of the sale of the midrange lease assets during the second quarter of
1995 and the sale of substantially all of the midrange service business
during the third quarter of 1995. No material gain or loss resulted from the
sale of the midrange lease assets as the gain on the lease asset sale was
largely offset by transaction and integration costs. A one-time gain of
approximately $8.8 million was recognized in 1995 in connection with the sale
of the midrange service business.
GROSS PROFIT
- ------------
Gross profit on sales increased to 39% in 1996, compared to 37% in 1995,
principally as a result of cost savings achieved in connection with the
Company's 1995 restructuring, increased manufacturing volumes, and lower
purchase costs associated with components for online and Nearline products.
Product sales margins in 1996 also benefited from reduced sales revenue
contribution from lower margin midrange products as a result of the sale of
this business.
Gross profit on product sales of 37% in 1995 was unchanged, compared to 1994.
Gross profit improvements were obtained in 1995 from product cost
improvements, principally from Iceberg,
PAGE
Page 22
and cost savings associated with the increased manufacturing volumes during
1995 for online and Nearline products. Product sales margins also benefited
from reduced sales revenue contribution from lower margin midrange products
as a result of the sale of this business. The improvements in 1995 were
offset by the continuation of price declines in the online marketplace, and a
significant decrease in margin contribution from higher margin network
products.
Gross profit on maintenance revenue increased to 47% in 1996, compared to 36%
in 1995. This increase is primarily due to cost savings associated with the
1995 restructuring and reduced maintenance revenue contribution from lower-
margin midrange services as a result of the sale of the midrange service
business in 1995. Gross profit on maintenance revenue was unchanged at 36%
in 1995, as compared to 1994.
The Company's ability to sustain or improve product sales margins during 1997
is significantly dependent upon the Company's continued success in reducing
manufacturing costs in all of its product lines. The Company anticipates
that sales margins for its mainframe online products will be pressured due to
lower OEM pricing and scheduled price reductions over the term of the OEM
agreement with IBM. While pricing pressures are expected to be partially
offset by lower manufacturing costs resulting from increased volumes and
operating expense savings, the Company must further reduce costs and expenses
associated with manufacturing these products in order to achieve expected
benefits. Product sales margins also may be adversely affected by inventory
writedowns resulting from rapid technological changes and delays in gaining
market acceptance for new products. Maintenance margins may be adversely
affected in the future by increased price competition.
RESEARCH AND PRODUCT DEVELOPMENT
- --------------------------------
Research and product development expenditures decreased 6% in 1996 as
compared to 1995. The decrease in expenditures during 1996 reflects IBM's
agreement to finance the development of enhancements to mainframe online
products, effective July 1, 1996, pursuant to the OEM agreement. Research
and product development expenditures decreased 9% in 1995 compared to 1994 as
a result of the completion of several major product development programs in
1994 and the implementation of cost-control measures directed at achieving
targeted expense ratios. The Company anticipates that its research and
development investments in new products outside its traditional markets will
increase in future periods.
PAGE
Page 23
MARKETING, GENERAL, ADMINISTRATIVE AND OTHER
- --------------------------------------------
Marketing, general, administrative and other income and expense (MG&A and
Other) remained relatively unchanged and decreased 1% as a percent of revenue
in 1996 compared to 1995, as cost savings associated with the 1995
restructuring were partially offset by increased marketing expense resulting
from higher sales volumes. MG&A and Other increased 5% in 1995 compared to
1994 due primarily to increased marketing expenses resulting from higher
sales volumes. MG&A and Other expense for 1995 includes a charge of $13.7
million associated with the 1995 restructuring activities and a gain of $8.8
million realized on the sale of the Company's midrange service business.
Gains and losses associated with foreign currency transactions and
translation adjustments, net of associated hedging results, are included in
MG&A and Other and aggregated a net loss of $0.5 million for 1996, compared
to net losses of $4.3 million in 1995 and $1.2 million in 1994. See
"INTERNATIONAL OPERATIONS AND HEDGING ACTIVITIES," below, for further
discussion of the foreign exchange risks associated with the Company's
international operations and the related foreign currency hedging activities.
INTEREST INCOME AND EXPENSE
- ---------------------------
Interest income decreased 37% in 1996, compared to 1995, primarily due to a
reduction in the Company's net investment in sales-type lease balances.
Interest expense decreased 24% in 1996, as compared to 1995, due primarily to
a reduction in nonrecourse borrowings and other long-term debt. The decrease
in interest expense was partially offset during the first six months of 1996
by incremental interest expense associated with the exchange of the Company's
7% Convertible Subordinated Debentures for its $3.50 Convertible Exchangeable
Preferred Stock in the fourth quarter of 1995. As further discussed in Note
8 to the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, the 7% Convertible
Subordinated Debentures were called for redemption in June 1996, and were
either converted into shares of the Company's common stock or redeemed for
cash on or before July 12, 1996.
Interest income decreased 8% in 1995, compared to 1994, principally due to a
reduction in the Company's net investment in sales-type lease balance.
Interest expense decreased 16% in 1995 compared to 1994, primarily due to a
reduction of nonrecourse borrowings and other long-term debt in the second
half of 1995.
INCOME TAXES
- ------------
Statement of Financial Accounting Standards (SFAS) No. 109 requires that
deferred income tax assets be recognized to the extent realization of such
assets is more likely than not. Based on the currently available
information, management has determined that the Company will more likely than
not realize $122.2 million of deferred income tax assets as of December 27,
1996. The Company's valuation allowance of approximately $100.5 million as
of December 27, 1996, was established based upon the consideration of a
variety of factors, including the Company's earnings history, the number of
years the Company's operating loss and tax credits can be carried forward,
the existence of taxable temporary differences, near-term expectations, and
the highly competitive nature of the marketplace in which the Company
competes.
PAGE
Page 24
The Company's provision for income taxes relates primarily to U.S. state
taxes and taxable earnings associated with its international operations in
certain foreign countries. The Company's effective tax rate can be subject
to significant fluctuations due to dynamics associated with the mix of its
U.S. and international taxable earnings. See Note 9 of NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS for information with respect to the current status of
the Internal Revenue Service examinations.
EXTRAORDINARY GAIN
- ------------------
As more fully discussed in Note 2 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, in March 1996, StorageTek sold to Leasetec Corporation (Leasetec)
substantially all of the Company's net investment in sales-type leases,
installment receivables, and equipment held subject to operating leases. The
sale was part of the Company's efforts to focus on core businesses and
outsource non-core activities, including its capital intensive lease
financing business. Leasetec assumed approximately $6.0 million of
associated nonrecourse borrowings and the Company used a portion of the cash
proceeds to retire its remaining nonrecourse borrowings and 9.53% Senior
Secured Notes. The transactions resulted in an extraordinary gain of $9.5
million, net of applicable taxes of $8.2 million, in 1996.
RESTRUCTURING AND OTHER CHARGES
- -------------------------------
Restructuring and other charges consist of the following (in thousands of
dollars):
Year Ended
----------------------------
December 29, December 30,
1995 1994
----------------------------
Restructuring charges $167,175 $8,000
Litigation settlement 30,680
Merger and consolidation charges 14,352
------- -----
$212,207 $8,000
======= =====
See Note 15 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for a discussion of
the $30.7 million charge associated with the settlement of litigation in
1995. See Note 4 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for a
discussion of the $14.4 million charge associated with the merger with
Network Systems in 1995. During the fourth quarter of 1994, Network Systems
recorded a restructuring charge of $8.0 million in connection with an expense
reduction plan.
PAGE
Page 25
The following table summarizes the activity in the Company's restructuring
reserves (in thousands of dollars):
Employee Asset Lease Other
Severance Writedowns Abandonments Exit Costs Total
--------------------------------------------------------------------------
Balances, December 31, 1993 $ 6,239 $ 0 $ 5,257 $ 3,796 $ 15,292
Restructuring charges 3,000 2,200 2,300 500 8,000
Cash payments (6,203) (1,775) (684) (8,662)
Asset writedowns (2,200) (2,200)
------- ------- ------ ------ -------
Balances, December 30, 1994 3,036 0 5,782 3,612 12,430
Restructuring charges 49,265 91,609 16,660 9,641 167,175
Cash payments (9,613) (3,904) (3,081) (16,598)
Asset writedowns (91,609) (91,609)
------- ------- ------ ------ -------
Balances, December 29, 1995 42,688 0 18,538 10,172 71,398
Cash payments (26,837) (2,907) (9,414) (39,158)
Reclassifications 301 (154) 1,222 1,369
------- ------- ------ ------ -------
Balances, December 27, 1996 $ 16,152 $ 0 $15,477 $ 1,980 $ 33,609
======= ======= ====== ====== =======
RESTRUCTURINGS
As more fully discussed in Note 15 of NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS, during the fourth quarter of 1995, the Company recorded a
restructuring charge of $167.2 million related to the adoption by the Company
of a formal action plan for restructuring its enterprise and network
businesses. The restructuring was adopted in an effort to establish a more
cost efficient business structure in response to competition. Elements of
the Company's restructuring plan include focusing on core businesses,
outsourcing non-strategic activities, rearchitecting its distribution
processes and accelerating the integration of Network Systems.
Cash payments during 1996 are primarily the result of termination payments
associated with the reduction in the number of employees by approximately
1,700 people. Reclassifications during consist principally of reclassifying
a restructuring accrual as other exit costs of approximately $1.4 million,
which was previously recorded as a direct write-off of a fixed asset. The
reclassifications had no effect on the Company's reported results within the
Consolidated Statement of Operations. While the majority of these remaining
accruals are expected to result in future cash outflows, these outflows are
not expected to have a material effect on the Company's liquidity.
The elimination of recurring costs associated with the restructuring was
expected to yield expense reductions on an annual basis of approximately $125
million at the time of the restructuring. During 1996, the Company exceeded
these expected expense reductions. The Company anticipates that
substantially all restructuring activities will be completed in 1997. While
the Company is evaluating various outsourcing and automation projects in
order to gain
PAGE
Page 26
further improvements in operating efficiencies, the Company does not
anticipate that any material incremental costs have been or will be incurred
as part of the restructuring which would offset the anticipated expense
reductions.
The Company believes that its restructuring programs have eliminated certain
non-essential functions and excess costs. Based on current short- and long-
term forecasts, the Company believes that such cost reductions will benefit
future operations. While the Company does not currently foresee any
significant additional restructuring charges, the continuing success of the
Company's ongoing restructuring activities is critical to achieving improved
operating results in future periods. There can be no assurance that the
anticipated expense reductions will be achieved, or that the Company's
restructuring activities will otherwise be successful or sufficient to allow
the Company to generate improved operating results in future periods. It is
possible that changes in the Company's business or in its industry may
necessitate future restructuring charges, which may be significant.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
WORKING CAPITAL
The Company's cash balances increased $123.9 million from December 29, 1995,
to December 27, 1996. The increase in cash balances in 1996 primarily
resulted from cash generated from operations of $464.7 million which was
offset by net repayments of nonrecourse borrowings and other debt of $100.0
million, the repurchase of 4.5 million shares of common stock for a purchase
price of approximately $195.5 million, investments in property plant and
equipment of $68.9 million, and an increase of short-term investments of
$29.2 million. Net cash from operating activities during 1996 includes cash
received from the sale of lease assets and cash payments associated with the
1995 restructuring. In connection with the sale of lease assets, the Company
used a portion of the cash proceeds to retire its remaining nonrecourse
borrowings and its 9.53% Senior Secured Notes.
The Company's cash balances increased $36.4 million from December 30, 1994,
to December 29, 1995. The increase in cash during 1995 primarily resulted
from cash generated from operations of $306.0 million; offset by net
repayments of debt of $201.9 million and investments in property, plant and
equipment of $58.0 million. Net cash from operating activities during 1995
includes cash generated from the sale of midrange lease assets and the
midrange service business, offset by a one-time payment associated with the
settlement of shareholder litigation. The net repayment of debt for 1995 of
$201.9 million was primarily due to the repayment of borrowings associated
with the sale of midrange lease assets.
The current ratio increased to 2.4 as of December 27, 1996, from 1.8 as of
December 29, 1995, principally due to an increase in cash of $123.9 million
and accounts receivable of $157.7 million. Accounts receivable increased
from $396.5 million as of December 29, 1995, to $554.2 million as of December
27, 1996, primarily due to the Company's OEM agreement with IBM and its exit
from the leasing business during 1996. As a result of the arrangement with
IBM, the Company has experienced an increase in concentration of credit risk
associated with the Company's accounts receivable. The Company monitors this
concentration and does not believe any significant credit risk exists as of
December 27, 1996. Inventories increased from $214.6 million as of December
29, 1995, to $288.6 million as of December 27, 1996, due to the
PAGE
Page 27
reclassification of inventory consigned for sale to customers (see Note 2 of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS).
AVAILABLE FINANCING LINES
The Company has a $150 million secured credit agreement (the Revolver) which
expires in May 1998. The interest rates available under the Revolver depend
on the type of advance selected. The current primary advance rate is the
agent bank's prime lending rate plus 0.125% (8.375% as of December 27, 1996).
Under the Revolver, the Company is required to comply with certain financial
and other covenants, including restrictions on the payment of cash dividends
on its common stock. As of December 27, 1996, the Company had issued letters
of credit for approximately $25.4 million and had approximately $124.6
million of available credit under the Revolver.
In December 1996, the Company entered into a financing agreement with a bank
which provides for the issuance of promissory notes in the principal amount
of up to $25 million at any one time. The agreement, which expires on
January 15, 1998, provides for commitments by the bank to purchase promissory
notes denominated in a variety of foreign currencies with the foreign
currency exchange rate applicable to each note set at the time the Company
commits to a future borrowing. The promissory notes, together with accrued
interest, are payable in U.S. dollars within 90 to 110 days from the date of
issuance and will bear interest at rates equal to the Eurodollar rate plus at
least 0.50% (6.12% as of December 27, 1996). Under the terms of the
agreement, the Company is required to comply with certain covenants which
can, under certain circumstances, include the maintenance of compensating
cash balances. As of December 27,1996, the Company had not committed to any
future borrowings under this agreement.
In January 1996, the Company entered into a financing agreement with a bank
which provides for the sale of certain U.S. and foreign based accounts
receivable on a recourse basis. This agreement, which expires on January 31,
1998, allows for receivable sales of up to $40 million at any one time and
the Company's obligations under the agreement are secured by a letter of
credit for the amount of the receivables sold. The selling price of the
receivables is partially determined based upon foreign currency exchange
rates and any gains or losses on the sales are recognized within marketing,
general, administrative and other income and expense, net, in the
Consolidated Statement of Operations at the time the receivables are sold.
During 1996, the Company sold approximately $202.3 million of receivables in
connection with this agreement. As of December 27, 1996, the outstanding
balance associated with receivables sold on a recourse basis, but not
collected, was approximately $25.0 million and the Company had committed to
future cumulative sales of approximately $378.7 million. Gains and losses
associated with the receivable sales are not expected to have a material
effect on the Company's reported financial results after taking into
consideration other transactions associated with the Company's international
operations. Based upon the Company's past credit and collection experience
with respect to the receivables that it expects to sell, the Company believes
that no material credit risk exists under the recourse provisions of the
agreement.
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 intends to continue to
commit substantial resources to research and development
PAGE
Page 28
projects and may, from time to time, as market and business conditions
warrant, invest in or acquire complementary businesses, products or
technologies. The Company may seek to fund these activities or possible
transactions through the issuance of additional equity or debt. The issuance
of equity or convertible debt securities could result in dilution to the
Company's stockholders. There can be no assurance that such additional
financing, if required, can be completed on terms acceptable to the Company.
TOTAL DEBT-TO-TOTAL CAPITALIZATION
The Company's total debt-to-total capitalization ratio decreased from 32% as
of December 29, 1995, to 12% as of December 27, 1996. This decrease resulted
from the conversion of 7% Convertible Subordinated Debentures in the
principal amount of $171.1 million into 7.3 million shares of common stock,
the increase in stockholders' equity resulting from net income earned by the
Company during 1996 of $180.3, and the repayment of its nonrecourse
borrowings and 9.53% Senior Secured Notes. This decrease was partially
offset by a reduction in stockholders' equity resulting from the repurchase
of 4.5 million shares of the Company's common stock. In December 1996, the
Company called for redemption on January 13, 1997, all outstanding 8%
Convertible Subordinated Debentures (8% Convertible Debentures). With the
conversion of the 8% Convertible Debentures into 4.1 million shares of common
stock on or before January 13, 1997, the Company is effectively free of debt.
INTERNATIONAL OPERATIONS AND HEDGING ACTIVITIES
- -----------------------------------------------
During 1996, approximately 41% of the Company's revenue was generated by its
international operations, and 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 operations and financial results can
be materially affected by changes in foreign currency exchange rates.
In an attempt to mitigate the impact of foreign currency fluctuations, the
Company employs a hedging program which takes into account operating and
financing activities to reduce exposures and utilizes foreign currency
options and forward exchange contracts to further reduce exposures. The
Company 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 on the options are deferred and recognized as
an adjustment to the associated revenue. 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 net
monetary assets held in foreign currencies. The forward contracts are
marked-to-market each month with any gains or losses recognized within MG&A
and Other as an adjustment to the foreign exchange gains and losses on the
translation of net monetary assets.
The Company's international business may be affected by changes in demand
resulting from localized economic and market conditions. For example, in the
past, the Company's business has been adversely affected by recessions in
Europe. In addition, the Company is subject to
PAGE
Page 29
the risks of conducting business outside the United States, including changes
in, or impositions of, legislative or regulatory requirements, tariffs,
quotas, difficulty in obtaining export licenses, potentially adverse taxes,
the burdens of complying with a variety of foreign laws and other factors
outside the Company's control. There can be no assurances 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.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
- -------------------------------------------
NEW PRODUCTS AND TECHNOLOGICAL CHANGE
The Company's results of operations and competitive strength depend upon the
successful and rapid development of new products and enhancements to existing
products. The market for the Company's products is characterized by rapid
technological advances and changes in customer demand, which necessitate
frequent product introductions and enhancements. These factors can result in
unpredictable product transitions and shortened product life cycles, and can
render existing products obsolete or unmarketable. The Company must make
significant investments in research and product development and successfully
introduce competitive new products and enhancements on a timely basis. The
success of new product introductions is dependent on a number of factors,
including the rate at which a new product gains acceptance and the Company's
ability to effectively manage product transitions. The development of new
technology, products, and enhancements is complex and involves uncertainties,
which increases the risk of delays in the introduction of new products and
enhancements. From time to time the Company has encountered delays that have
adversely affected the Company's financial results and competitive position
in the market. There can be no assurances that the Company will not
encounter development or production delays, or that despite intensive testing
by the Company, flaws in design or production will not occur in the future.
Design flaws could result in the Company experiencing a rate of failure in
its products that delays the shipment or sale of its products, triggers
substantial repair or replacement costs, damages the Company's reputation and
causes material adverse effect upon the Company's financial results.
The Company has historically generated a significant portion of its revenue
and operating profits from the sale and maintenance of products for the
mainframe marketplace. The Company is focusing resources on expanding into
new marketplaces including: investing in research and development of new
products for the open-systems marketplace; developing network-attached
storage solutions; establishing a professional services consulting group to
capitalize on the Company's expertise in information storage management; and
expanding the Company's distribution channels. There can be no assurances
that the Company will be successful in expanding into new markets.
DEPENDENCE ON IBM
Many of the Company's products are designed to be compatible with certain IBM
operating systems, and many of its products function like IBM equipment due
to the significance of the IBM computer operating environments. Future
revenue from products and maintenance is therefore dependent on the
marketplace's continued widespread acceptance of, and IBM's continued support
of, these products.
PAGE
Page 30
In June 1996, the Company entered into a worldwide non-exclusive OEM
agreement with IBM under which StorageTek develops and manufactures mainframe
online storage products for IBM. IBM serves as StorageTek's primary
worldwide distribution channel for this technology. This OEM arrangement
represents a significant change from the Company's past business model. The
Company's success in its mainframe online storage business is now
significantly dependent upon achieving certain milestones contained in the
OEM agreement and IBM's continuous support for and success in marketing these
products to end-user customers. Because of lower OEM pricing and scheduled
price reductions over the term of the agreement, the Company must reduce
costs and expenses associated with manufacturing these products in order to
achieve the expected benefits under the agreement. In addition, subject to
required lead times and minimum purchase commitment terms, the OEM business
model arrangement may cause the Company to incur additional costs associated
with unanticipated increases or decreases in manufacturing volumes. The
agreement includes termination provisions. The Company may elect to
terminate the agreement if IBM fails to meets its minimum volume commitments
and would be entitled to receive certain amounts from IBM. IBM may elect to
terminate the agreement for convenience, or on the occurrence of certain
other conditions, in each case making payment to the Company. IBM may also
elect to terminate the agreement on the occurrence of certain instances of
change in control of the Company or for cause.
On July 30, 1996, the Company received Civil Investigative Demands (CID) from
the U.S. Department of Justice Antitrust Division concerning the OEM
agreement with IBM for mainframe online storage subsystems. The Company
received two additional CIDs in October 1996 and one additional CID in
February 1997. The CIDs requested production of documents and testimony in
connection with a review of the agreement for compliance with the Sherman
Act. While the Company believes that the agreement is in compliance with
antitrust laws, it is unable to predict the outcome of the investigation. In
the event of an unfavorable outcome, the Company could be required to pay
penalties, modify the agreement or terminate the agreement.
COMPETITION
The market for the Company's products is intensely competitive and subject to
continuous, rapid technological change, frequent product performance
improvements and price reductions. In the mainframe marketplace, competition
comes from companies that have substantially greater resources, including
IBM, Fujitsu Ltd., and Hitachi, Ltd., as well as several similarly sized
companies, including Amdahl Corp. and EMC Corp. As it moves into the open-
systems marketplace, the Company will face competition both from its
traditional rivals and new sources. In the network connectivity and security
product marketplace, the competition includes a number of large companies
with significant market presence and resources, including IBM, Hewlett-
Packard Company, Computer Network Technologies Corp. as well as a number of
other companies. The Company expects that the markets for its products will
continue to change as customer buying patterns migrate to the open-systems
and network environments, and as a result of focusing on emerging products
and technologies. The Company's ability to compete will depend to a
considerable extent on its ability to continuously develop and introduce new
products and enhancements to existing products and expand its distribution
channels. The Company's competitiveness could also be affected by
cooperative alliances between the Company's competitors or other
relationships between its competitors, who may emerge and rapidly acquire
market share. These alliances and acquisitions may result in companies with
increased market presence or proprietary technology in the Company's markets,
as well as other companies being
PAGE
Page 31
at various times, collaborators, competitors and customers in different
markets. Increased competition may result in price reductions, reduced
margins and declining market share, which may have a material adverse effect
on the Company's business and financial results.
INTELLECTUAL PROPERTY
The Company's intellectual property rights are material assets and key to its
business and competitive strength. StorageTek protects its intellectual
property rights through a combination of patents, trademarks, copyrights,
confidentiality procedures, trade secret laws and licensing arrangements.
The Company's policy is to apply for patents, or other appropriate
proprietary or statutory protection, when it develops new or improved
technology that is important to its business. Such protection, however, may
not preclude competitors from developing products similar to the Company's
products. In addition, competitors may attempt to restrict the Company's
ability to compete by advancing various intellectual property legal theories
which could, if enforced by the courts, restrict the Company's ability to
develop and manufacture interoperable products. Also, the laws of certain
foreign countries do not protect the Company's intellectual property rights
to the same extent as the laws of the United States. The Company also relies
on certain technology that is licensed from others. The Company is unable to
predict whether its license arrangements can be renewed on terms acceptable
to the Company. The failure to successfully protect its intellectual
property rights or obtain licenses from others as needed could have a
material adverse effect on the Company's business and financial results. In
1996, the Company entered into an OEM agreement with IBM under which certain
research and development activities will be funded by IBM; any technology
that is developed will be owned by IBM, and subject to licensing rights by
the Company.
The high technology industry is characterized by vigorous pursuit and
protection of intellectual property rights or positions, which in some
instances has resulted in significant litigation that is often protracted and
expensive. From time to time, StorageTek has commenced actions against other
companies to protect or enforce its intellectual property rights. Similarly,
from time to time, StorageTek has been notified that it may be infringing
certain patent or other intellectual property rights of others. Licenses or
royalty agreements are generally offered in such situations. Litigation by
or against the Company may result in significant expense and divert the
efforts of the Company's technical and management personnel, whether or not
such litigation results in any determination unfavorable to the Company. In
the event of an adverse result, the Company could be required to pay
substantial damages; cease the manufacture, use and sale of infringing
products; expend significant resources to develop non-infringing technology;
or discontinue the use of certain processes if it is unable to enter into
royalty arrangements. There can be no assurances that litigation will not be
commenced in the future regarding patents, copyrights, trademarks or trade
secrets or that any license, royalty or other rights can be obtained on
acceptable terms, or at all. StorageTek is currently engaged in certain
proceedings relating to its intellectual property and alleged patent
infringements. See Note 13 of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS for
additional information with respect to the Company's legal proceedings.
INFORMATION SYSTEMS
The Company is currently in the process of replacing certain transaction
systems, including the order management, distribution, and finance systems.
While the Company expects that the new integrated system will increase
operational efficiencies and support future growth, future operating
PAGE
Page 32
results and financial condition could be adversely affected by functional or
performance difficulties with the new system during the transition period.
MANUFACTURING RISKS; DEPENDENCE ON 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. The Company manufactures key
components for its products and purchases certain important components and
products. Some of these 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 of the Company's ability to secure comparable
components, could have a material adverse effect on its revenue and results
of operations. 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.
EARNINGS FLUCTUATIONS
The Company's reported earnings have fluctuated significantly in the past and
may continue to fluctuate significantly in the future from quarter to quarter
due to a variety of factors, including, among others, the effects of (i)
customers' historical tendencies to make purchase decisions near the end of
the calendar year, (ii) the timing of the announcement and availability of
products and product enhancements by the Company and its competitors, (iii)
fluctuating foreign currency exchange rates, (iv) changes in the mix of
products sold, (v) variations in customer acceptance periods for the
Company's products, and (vi) global economic conditions.
VOLATILITY OF STOCK PRICE
The trading price of the Company's common stock has fluctuated and in the
future may fluctuate substantially in response to anticipated or reported
operating results, 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, general market and economic
conditions, international currency fluctuations and other events or factors.
Further, the volatility of the stock markets in recent years has caused wide
fluctuations in trading prices of stocks of high technology companies
independent of their individual operating results. In the future, the
Company's reported operating results may be below the expectations of stock
market analysts and investors, and in such events, there could be an
immediate and significant adverse effect on the trading price of the
Company's common stock.
PAGE
Page 33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data listed in the Index to
Consolidated Financial Statements at Item 14 of this Form 10-K are
incorporated by reference into this Item 8 of Part II of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
There have been no disagreements with the Company's independent accountants
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure or any reportable events.
As described in the Company's current report on Form 8-K dated as of April 3,
1995, and amended by Forms 8-K/A dated April 7, 1995, and April 12, 1995, at
a meeting of the Company's Audit Committee held on March 16, 1995, the
Committee determined to engage the accounting firm of Price Waterhouse LLP
(Price Waterhouse) as independent accountants for all subsidiaries of the
Company for 1995, subject to approval of shareholders. The shareholders
ratified the appointment on May 24, 1995, at the Annual Meeting of
Shareholders. As a result, the Company's subsidiary, Network Systems,
disengaged the accounting firm of Ernst & Young LLP (Ernst & Young) and
retained the accounting firm of Price Waterhouse, who had been auditing the
Company and all subsidiaries except Network Systems. Price Waterhouse has
expressed reliance upon Ernst & Young's report in their report on the
consolidated financial statements of the Company for the year ended December
30, 1994. Ernst & Young's report on the financial statements for 1994
contained no adverse opinion or disclaimer of opinion and was not qualified
or modified as to uncertainty or audit scope. Additionally, there were no
report modifications for accounting principles in the year ended December 30,
1994.
PAGE
Page 34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information concerning the Company's directors required by this Item is
incorporated by reference from the information set forth under the caption
"Election of Directors" in the Company's definitive Proxy Statement
concerning the Annual Meeting of Stockholders to be held May 22, 1997 (the
"Proxy Statement"). Also, the information concerning executive officers
required by this Item is set forth under the caption "Executive Officers of
the Registrant," in Part I of this Form 10-K and is incorporated herein by
reference.
The information required by this Item concerning compliance with Section
16(a) of the Securities Exchange Act of 1934, as amended, is incorporated by
reference to the information under the caption "Compensation of Executive
Officers -- Section 16(a) Beneficial Ownership Reporting Compliance" in
the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
information under the captions "Compensation of Executive Officers" and
"Standard Arrangements for Compensation of Directors" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The information required by this Item is incorporated by reference to the
information under the caption "Voting Securities of the Company -- Security
Ownership" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
information under the captions "Standard Arrangements for Compensation of
Directors" and "Compensation of Executive Officers" in the Proxy Statement.
PAGE
Page 35
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. Financial Statements: PAGE
--------------------
Consolidated Balance Sheet at December 27, 1996,
and December 29, 1995 F-1
Consolidated Statement of Operations for the
Years Ended December 27, 1996, December 29, 1995
and December 30, 1994 F-2
Consolidated Statement of Cash Flows for the
Years Ended December 27, 1996, December 29, 1995
and December 30, 1994 F-3
Consolidated Statement of Changes in Stockholders'
Equity for the Years Ended December 27, 1996,
December 29, 1995, and December 30, 1994 F-4
Notes to Consolidated Financial Statements F-5
Report of Independent Accountants for Storage
Technology Corporation F-27
Report of Independent Accountants for
Network Systems Corporation F-28
2. Financial Statement Schedules:
-----------------------------
Schedule II - Valuation and Qualifying Accounts and Reserves F-29
All other schedules are omitted because they are not applicable, or the
required information is included in the consolidated financial statements or
notes thereto.
PAGE
Page 36
3. Exhibits:
--------
The exhibits listed below are filed as part of this Annual Report on Form
10-K or are incorporated by reference into this Annual Report on Form 10-K:
2.1 Restated Agreement and Plan of Merger by and among the
Registrant, StorageTek Eagle Corporation and Network Systems
Corporation dated as of August 8, 1994, as amended as of
August 25, 1994 and September 9, 1994, and Restated on
November 15, 1994 (filed November 16, 1994, as Exhibit 2.1 to
the Company's Registration Statement on Form S-4, File No. 33-
55343, and incorporated herein by reference).
2.2 Amendment to Restated Agreement and Plan of Merger among
Storage Technology Corporation, StorageTek Eagle Corporation
and Network Systems Corporation dated as of February 8, 1995
(filed as an Exhibit to the Company's Current Report on Form
8-K dated February 8, 1995, and incorporated herein by
reference).
3.1 Restated Certificate of Incorporation and Restated Bylaws of
Storage Technology Corporation dated July 28, 1987 (filed as
Exhibit 3 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 25, 1987, and as Exhibit 3.1(ii) to
the Company's Quarterly Report on Form 10-Q, for the quarter
ended September 29, 1995, filed on November 13, 1995, and
incorporated herein by reference).
3.2 Certificate of Amendment dated May 22, 1989 to the Restated
Certificate of Incorporation dated July 28, 1987 (filed as
Exhibit (c)(1) to the Company's Current Report on Form 8-K
dated June 2, 1989, and incorporated herein by reference).
3.3 Certificate of Second Amendment dated June 2, 1992, to the
Restated Certificate of Incorporation dated July 28, 1987
(filed as Exhibit 3 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 26, 1992, and incorporated
herein by reference).
3.4 First Amendment dated February 2, 1988, to the Restated Bylaws
of Storage Technology Corporation, amending Section IV (filed
as Exhibit 3(c) to the Company's Annual Report on Form 10-K for
the fiscal year ended December 25, 1987, and incorporated
herein by reference).
3.5 Second Amendment dated May 25, 1995, to the Restated Bylaws of
Storage Technology Corporation, amending Article II (filed as
Exhibit 3.3(ii) to the Company's Quarterly Report on Form 10-Q,
for the quarter ended September 29, 1995, filed on November 13,
1995, and incorporated herein by reference).
PAGE
Page 37
4.1 Specimen Certificate of Common Stock, $0.10 par value of
Registrant (filed as Exhibit (c)(2) as to the Company's Current
Report on Form 8-K dated June 2, 1989, and incorporated herein
by reference).
4.2 Indenture dated as of May 31, 1990, between Storage Technology
Corporation and Manufacturers Hanover Trust Company of
California, Trustee, relating to the Company's 8% Convertible
Subordinated Debentures due May 31, 2015 (filed as Exhibit 4.6
to the Company's Registration Statement on Form S-3 filed
May 11, 1990, File No. 33-34876, and incorporated herein by
reference).
4.3 Registration Statement of the Registrant on Form 8-A dated
August 13, 1981 (filed as Exhibit 4.7 to the Company's
Registration Statement on Form S-3 filed January 29, 1993, File
No. 33-57678, and incorporated herein by reference).
4.4 Rights Agreement dated as of August 20, 1990, between Storage
Technology Corporation and First Fidelity Bank, N.A., New
Jersey, Rights Agent, (filed as Exhibit 4.1 to the Company's
Current Report on Form 8-K dated August 20, 1990, and
incorporated herein by reference).
4.5 Certificate of Designations of Series B Junior Participating
Preferred Stock (filed as Exhibit A to Exhibit 4.1 to the
Company's Current Report on Form 8-K dated August 8, 1990, and
incorporated herein by reference).
10.1 (1) 1987 Employee Stock Purchase Plan, as amended (filed as part of
the Company's Registration Statement on Form S-8 filed
September 8, 1994, File No. 33-42818, and incorporated herein
by reference).
10.2 (1) 1987 Equity Participation Plan (filed as part of the Company's
Registration Statement on Form S-8, filed December 28, 1987,
File No. 33-19426, and incorporated herein by reference).
10.3 (1) Amendment to the 1987 Equity Participation Plan (filed as
Exhibit 10(h) to the Company's Annual Report on Form 10-K for
the fiscal year ended December 28, 1990, File No. 1-7534, and
incorporated herein by reference).
10.4 (1) 1995 Equity Participation Plan (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q, for the quarter ended
June 30, 1995, filed on August 11, 1995, and incorporated
herein by reference).
- -------------------
(1) Contract or compensatory plan or arrangement in which directors and/or
officers participate.
PAGE
Page 38
10.5 (1) Storage Technology Corporation MBO Plan (filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarter
ended July 1, 1994, filed on August 12, 1994, and incorporated
herein by reference).
10.6 (1) Storage Technology Corporation Amended and Restated Stock
Option Plan for Non-Employee Directors (filed as an Exhibit to
the Company's Registration Statement on Form S-8, filed
September 18, 1991, File No. 33-42817, and incorporated herein
by reference).
10.7 (1) Employment Agreement between the Company and Ryal Poppa dated
December 13, 1989, as amended on March 8, 1995 and July 27,
1995, (filed as Exhibit 10.4 to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 1995, and as
Exhibit 10.1 to the Quarterly Report on Form 10-Q for the
quarter ended June 30, 1995, respectively, and incorporated
herein by reference).
10.8 (1) Employment Agreement between the Company and L. Thomas Gooch,
dated February 17, 1995 (filed as Exhibit 10.9 to the Company's
Annual Report on Form 10-K, for the fiscal year ended
December 30, 1994, and incorporated herein by reference).
10.9 (1) Amendment to Employment Agreement between the Company and L.
Thomas Gooch, dated December 1, 1995 (filed as Exhibit 10.11 to
the Company's Annual Report on Form 10-K for the fiscal year
ended December 29, 1995, and incorporated herein by reference).
10.10 (1) Employment Agreement between the Company and W. Russell Wayman,
dated February 17, 1995 (filed as Exhibit 10.11 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 30, 1994, and incorporated herein by reference).
10.11 (1) Employment Agreement between the Company and John V. Williams,
dated February 17, 1995 (filed as Exhibit 10.13 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 30, 1994, and incorporated herein by reference).
10.12 Multicurrency Credit Agreement dated as of March 31, 1993,
among the Registrant, Storage Technology De Puerto Rico, Inc.,
XL/Datacomp, Inc. and StorageTek Financial Services Corporation
as Borrowers and Bank of America National Trust and Savings
Association as Agent, Swing Line Bank and Issuing Bank, and the
other banks and financial institutions parties thereto (filed
as Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q
for the
- -------------------
(1) Contract or compensatory plan or arrangement in which directors and/or
officers participate.
PAGE
Page 39
quarter ended March 26, 1993, and incorporated herein by
reference).
10.13 Amended and Restated Multicurrency Credit Agreement dated as of
September 28, 1994 (filed as Exhibit 10.0 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1994, filed on November 14, 1994, and
incorporated herein by reference).
10.14 First Amendment and Waiver dated as of April 20, 1995, to
Amended and Restated Multicurrency Credit Agreement dated as of
September 28, 1994 (filed as Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30,
1995, filed on August 11, 1995, and incorporated herein by
reference).
10.15 Second Amendment and Waiver dated as of June 27, 1995, to
Amended and Restated Multicurrency Credit Agreement (filed as
Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995, filed on August 11, 1995, and
incorporated herein by reference).
10.16 Third Amendment and Waiver dated September 28, 1995, to Amended
and Restated Multicurrency Credit Agreement dated as of
September 28, 1994 (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 29, 1995, filed on November 13, 1995, and
incorporated herein by reference).
10.17 Fourth Amendment dated as of December 22, 1995, to Amended and
Restated Multicurrency Credit Agreement dated as of
September 28, 1994 (filed as Exhibit 10.20 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
29, 1995, and incorporated herein by reference).
10.18 Multicurrency Receivables Transfer Agreement dated as of
January 29, 1996 (filed as Exhibit 10.21 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
29, 1995, and incorporated herein by reference).
10.19 Second Amended and Restated Credit Agreement dated as of March
28, 1996, among the registrant, Storage Technology de Puerto
Rico, Inc., Bank of America National Trust and Savings
Association and the other financial institutional parties there
(filed as Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended March 29, 1996, filed on May
10, 1996, and incorporated herein by reference).
PAGE
Page 40
10.20 (1) Tenth Amendment and Restatement of Storage Technology
Corporation 1987 Employee Stock Purchase Plan (filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 28, 1996, filed on August 12, 1996, and
incorporated herein by reference).
10.21 (1) Storage Technology Corporation Amended and Restated Stock
Option Plan for Non-Employee Directors (filed as Exhibit 10.2
to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 28, 1996, filed on August 12, 1996, and incorporated
herein by reference).
10.22 (1) Employment Agreement between the Company and David E. Weiss,
dated June 24, 1996 (filed as Exhibit 10.3 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 28,
1996, filed on August 12, 1996, and incorporated herein by
reference).
10.23 (1) Employment Agreement between the Company and David E. Lacey,
dated June 24, 1996 (filed as Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 28,
1996, filed on August 12, 1996, and incorporated herein by
reference).
10.24 OEM Agreement between the Company and International Business
Machines Corporation ("IBM"), dated June 7, 1996 (filed as
Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q/A
for the quarter ended June 28, 1996, filed on October 30, 1996,
and incorporated herein by reference). The OEM Agreement
contains certain confidential information which has been
omitted pursuant to an order of the Securities and Exchange
Commission granted to the Company under Rule 24b-2 of the
Securities Exchange Act of 1934.
10.25 Amendment dated July 26, 1996, to Multicurrency Receivables
Transfer Agreement dated January 29, 1996 (filed as Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 27, 1996, filed on November 8, 1996,
and incorporated herein by reference).
10.26 Amendment dated August 26, 1996, to Multicurrency Receivables
Transfer Agreement dated January 29, 1996 (filed as Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 27, 1996, filed on November 8, 1996,
and incorporated herein by reference).
- -------------------
(1) Contract or compensatory plan or arrangement in which directors and/or
officers participate.
PAGE
Page 41
10.27 (1) Storage Technology Corporation 1995 Equity Participation Plan,
as amended September 1996 (filed as Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 27, 1996, filed on November 8, 1996, and incorporated
herein by reference).
10.28 (2) Amendment dated December 12, 1996 to Multicurrency Receivables
Transfer Agreement dated January 29, 1996.
10.29 (2) Contingent Multicurrency Note Purchase Commitment Agreement
dated as of December 12, 1996, between the Company and Bank of
America National Trust and Savings Association.
11.0 (2) Computation of Earnings (Loss) per Common Share.
21.0 (2) Subsidiaries of Registrant.
23.1 (2) Consent of Price Waterhouse LLP.
23.2 (2) Consent of Ernst & Young LLP.
24.0 (2) Power of Attorney (See Page 42).
27.0 (2) Financial Data Schedule.
(b) Reports on Form 8-K.
--------------------
On December 13, 1996, the Company filed a Current Report on Form 8-K
dated December 11, 1996, concerning the redemption, on January 13, 1997,
of all of the Company's outstanding 8% Convertible Subordinated
Debentures due May 31, 2015.
(c) Exhibits.
--------
The Exhibits listed in Item 14(a)(3) hereof are filed as part of this
Annual Report on Form 10-K.
(d) Financial Statement Schedules.
-----------------------------
See Item 14(a)(3) above.
- -------------------
(1) Contract or compensatory plan or arrangement in which directors and/or
officers participate.
(2) Indicates exhibits filed within this Annual Report on Form 10-K.
PAGE
Page 42
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.
Dated: March 7, 1997 STORAGE TECHNOLOGY CORPORATION
By: /s/ David E. Weiss
--------------------------------
David E. Weiss
Chairman of the Board,
President and Chief Executive Officer
(Principal Executive Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints David E. Weiss, David E. Lacey and W. Russell
Wayman, jointly and severally, his or her attorneys-in-fact, each with the
power of substitution, for him or her in any and all capacities, to sign any
amendments to this Report on Form 10-K, and file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his substitute or substitutes, may do or cause to be
done by virtue hereof.
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.
SIGNATURE TITLE DATE
--------- ------- ------
/s/ David E. Weiss Chairman of the Board March 7, 1997
- ------------------- (Director), President and Chief
David E. Weiss Executive Officer (Principal
Executive Officer)
/s/ David E. Lacey Executive Vice President and March 7, 1997
- ------------------- Chief Financial Officer
David E. Lacey (Principal Financial Officer
and Principal Accounting
Officer)
PAGE
Page 43
SIGNATURE TITLE DATE
--------- ------- ------
/s/ Judith E.N. Albino Director March 7, 1997
- ------------------------
Judith E.N. Albino
/s/ William L. Armstrong Director March 7, 1997
- ------------------------
William L. Armstrong
/s/ Robert A. Burgin Director March 7, 1997
- ------------------------
Robert A. Burgin
/s/ Paul Friedman Director March 7, 1997
- ------------------------
Paul Friedman
/s/ William R. Hoover Director March 7, 1997
- ------------------------
William R. Hoover
/s/ Stephen J. Keane Director March 7, 1997
- ------------------------
Stephen J. Keane
/s/ Robert E. LaBlanc Director March 7, 1997
- ------------------------
Robert E. LaBlanc
/s/ Robert E. Lee Director March 7, 1997
- ------------------------
Robert E. Lee
/s/ Harrison Shull Director March 7, 1997
- ------------------------
Harrison Shull
/s/ Richard C. Steadman Director March 7, 1997
- ------------------------
Richard C. Steadman
PAGE
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In Thousands of Dollars)
December 27, December 29,
1996 1995
--------------------------------
ASSETS
Current assets:
Cash, including cash equivalents of $315,795 in 1996 and
$190,451 in 1995 $ 388,401 $ 264,502
Short-term investments 29,176
Accounts receivable, net of allowance for doubtful accounts
of $12,907 in 1996 and $14,665 in 1995 554,159 396,499
Notes and installment receivables 10,766
Net investment in sales-type leases (Note 2) 88,668
Inventories (Note 5) 288,615 214,553
--------- ----------
Total current assets 1,260,351 974,988
Notes and installment receivables 10,113
Net investment in sales-type leases (Note 2) 150,751
Equipment held for sale or lease, at cost net of accumulated
depreciation of $117,377 in 1995 (Note 2) 139,629
Spare parts for maintenance, at cost net of accumulated
amortization of $53,872 in 1996 and $87,980 in 1995 29,625 29,468
Property, plant and equipment, at cost net of accumulated
depreciation (Note 6) 327,534 333,021
Deferred income tax assets, net of valuation allowance (Note 9) 122,190 74,902
Other assets 144,576 175,757
--------- ----------
$1,884,276 $1,888,629
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Current liabilities:
Nonrecourse borrowings secured by lease commitments (Note 8) $ 19,415
Current portion of other long-term debt (Note 8) $ 4,451 65,844
Accounts payable 82,949 93,129
Accrued liabilities (Note 7) 369,309 361,286
Income taxes payable (Note 9) 79,471 9,963
--------- ---------
Total current liabilities 536,180 549,637
Nonrecourse borrowings secured by lease commitments (Note 8) 20,980
Other long-term debt (Note 8) 150,806 342,983
Deferred income tax liabilities (Note 9) 16,307 12,196
--------- ---------
Total liabilities 703,293 925,796
--------- ---------
Commitments and contingencies (Notes 8 and 13)
STOCKHOLDERS' EQUITY
Common stock, $.10 par value, 150,000,000 shares authorized;
58,175,120 shares issued in 1996, and 53,352,087 shares
issued in 1995 5,818 5,335
Capital in excess of par value 1,444,939 1,414,551
Accumulated deficit (265,434) (445,761)
Treasury stock of 62,514 shares in 1996 and 43,773
shares in 1995 (790) (777)
Unearned compensation (3,550) (6,427)
Notes receivable from stockholders (4,088)
--------- ---------
Total stockholders' equity 1,180,983 962,833
--------- ---------
$1,884,276 $1,888,629
========= =========
The accompanying notes are an integral part of the consolidated financial statements.
F-1
PAGE
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(In Thousands, Except Per Share Amounts)
Year Ended
-------------------------------------------------------
December 27, December 29, December 30,
1996 1995 1994
-----------------------------------------------------
Sales revenue $1,478,685 $1,345,260 $1,289,271
Maintenance revenue 560,865 584,225 582,079
--------- --------- ---------
Total revenue 2,039,550 1,929,485 1,871,350
--------- --------- ---------
Cost of sales revenue 897,548 841,583 812,228
Cost of maintenance revenue 295,229 376,039 374,714
--------- --------- ---------
Total cost of revenue 1,192,777 1,217,622 1,186,942
--------- --------- ---------
Gross profit 846,773 711,863 684,408
Research and product development costs 176,422 187,275 206,083
Marketing, general, administrative and other income
and expense, net 444,870 445,889 425,490
Restructuring and other charges (Note 15) 212,207 8,000
--------- --------- ---------
Operating profit (loss) 225,481 (133,508) 44,835
Interest income 27,333 43,325 46,935
Interest expense (26,122) (34,347) (40,832)
--------- --------- ---------
Income (loss) before income taxes and
extraordinary item 226,692 (124,530) 50,938
Provision for income taxes (Note 9) (55,900) (17,800) (18,900)
--------- --------- ---------
Income (loss) before extraordinary item 170,792 (142,330) 32,038
Extraordinary gain on sale of lease assets net of
income taxes of $8,200 (Note 2) 9,535
--------- --------- ---------
Net income (loss) 180,327 (142,330) 32,038
Preferred dividend requirement (Note 10) (11,544) (12,075)
--------- --------- ---------
Income (loss) applicable to common shares $ 180,327 $ (153,874) $ 19,963
========= ========= =========
EARNINGS (LOSS) PER COMMON SHARE
Primary:
Income (loss) before extraordinary item $ 3.00 $ (2.91) $ 0.38
Extraordinary gain, net .17
--------- --------- ---------
$ 3.17 $ (2.91) $ 0.38
========= ========= =========
Weighted average common shares and equivalents 56,943 52,798 52,410
========= ========= =========
Fully Diluted:
Income before extraordinary item $ 2.84
Extraordinary gain, net .14
---------
$ 2.98
=========
The accompanying notes are an integral part of the consolidated financial statements.
F-2
PAGE
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(In Thousands of Dollars)
Year Ended
-------------------------------------------------
December 27, December 29, December 30,
1996 1995 1994
-------------------------------------------------
OPERATING ACTIVITIES
Cash received from customers $ 2,158,927 $ 2,036,789 $ 1,820,260
Cash paid to suppliers and employees (1,662,990) (1,715,669) (1,760,344)
Interest received 26,448 53,362 55,484
Interest paid (21,866) (30,401) (38,480)
Income taxes paid, net (35,819) (38,056) (1,675)
---------- ---------- ----------
Net cash from operating activities 464,700 306,025 75,245
---------- ---------- ----------
INVESTING ACTIVITIES
Purchase of property, plant and equipment (68,946) (58,003) (120,057)
Short-term investments, net (29,176) 5,508 18,804
Business acquisitions, net of cash acquired (11,165) (11,161)
Other assets, net 10,059 (8,842) (37,246)
---------- ---------- ----------
Net cash used in investing activities (88,063) (72,502) (149,660)
---------- ---------- ----------
FINANCING ACTIVITIES
Proceeds from nonrecourse borrowings 2,593 167,237
Repayments of nonrecourse borrowings (33,533) (150,818) (147,632)
Proceeds from other debt 1,104 847 17,839
Repayments of other debt (67,607) (54,536) (46,977)
Repurchases of common stock (195,498) (442)
Proceeds from employee stock plans and warrants 39,154 12,443 24,394
Preferred stock dividend payments (12,075) (12,075)
---------- ---------- ----------
Net cash from (used in) financing activities (256,380) (201,546) 2,344
---------- ---------- ----------
Effect of exchange rate changes on cash 3,642 4,444 19,179
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents 123,899 36,421 (52,892)
Cash and cash equivalents - beginning of the year 264,502 228,081 280,973
---------- ---------- ----------
Cash and cash equivalents - end of the year $ 388,401 $ 264,502 $ 228,081
========== ========== ==========
RECONCILIATION OF NET INCOME (LOSS) TO NET CASH
FROM OPERATING ACTIVITIES
Net income (loss) $ 180,327 $ (142,330) $ 32,038
Depreciation and amortization expense 174,763 208,991 203,372
Translation (gain) loss 4,193 (2,910) (10,424)
Restructuring and other charges (Note 15) 91,609 2,200
Other non-cash adjustments to income 16,208 40,975 10,191
Increase in accounts receivable (143,103) (41,351) (92,165)
Decrease in notes receivable and sales-type leases 246,297 149,158 49,232
(Increase) decrease in inventories 11,886 36,615 (44,210)
Increase in equipment held for sale or lease, net (24,080) (59,773) (93,263)
Increase in spare parts, net (9,316) (7,243) (32,143)
(Increase) decrease in net deferred income tax asset (42,689) (22,750) 7,914
Increase (decrease) in accounts payable (9,360) (31,699) 22,872
Increase (decrease) in accrued liabilities (11,396) 85,102 10,320
Increase in income taxes payable 70,970 1,631 9,311
---------- ---------- ----------
Net cash from operating activities $ 464,700 $ 306,025 $ 75,245
========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements.
F-3
PAGE
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(In Thousands of Dollars)
Notes
Capital in Receivable
Preferred Common Excess of Par Accumulated Treasury Unearned From
Stock Stock Value Deficit Stock Compensation Stockholders
- --------------------------------------------------------------------------------------------------------------------------------
Balances, December 31, 1993 $ 35 $5,088 $1,529,352 $(311,319) $(735) $(6,544)
Shares issued under stock purchase
plan, and for exercises of options
(1,684,570 shares) 168 32,037 (33)
Shares purchased and retired (11,574
shares) (1) (441)
Cash dividends paid on preferred
stock ($3.50 per share) (12,075)
Notes receivable from stockholders
for the purchase of shares (Note 11) $(4,291)
Net income 32,038
Other (3) 1,620 (5) 394
--- ----- --------- -------- ---- ------ ------
Balances, December 30, 1994 35 5,252 1,562,568 (291,356) (773) (6,150) (4,291)
Preferred stock exchanged and
retired (3,450,000 shares) (Note 10) (35) (165,194)
Shares issued under stock purchase
plan, and for exercises of options
(743,432 shares) 74 14,620
Cash dividends paid on preferred
stock ($3.50 per share) (12,075)
Net loss (142,330)
Other 9 2,557 (4) (277) 203
--- ----- --------- -------- ---- ------ ------
Balances, December 29, 1995 0 5,335 1,414,551 (445,761) (777) (6,427) (4,088)
7% Convertible Subordinated
Debentures exchanged for stock
(7,282,536 shares) (Note 8) 728 168,273
8% Convertible Subordinated
Debentures exchanged for stock
(566,410 shares) (Note 8) 57 19,628
Shares issued under stock purchase
plan, and for exercises of options
(1,472,312 shares) 147 37,555
Repurchase of common stock
(4,500,000 shares) (450) (195,048)
Net income 180,327
Other 1 (20) (13) 2,877 4,088
--- ----- --------- -------- ---- ------ ------
Balances, December 27, 1996 $ 0 $5,818 $1,444,939 $(265,434) $(790) $(3,550) $ 0
=== ===== ========= ======== ==== ====== ======
The accompanying notes are an integral part of the consolidated financial statements.
F-4
PAGE
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Storage Technology Corporation and its wholly owned subsidiaries
(collectively hereinafter referred to as StorageTek or the Company). All
intercompany accounts and transactions have been eliminated in consolidation.
NATURE OF OPERATIONS
StorageTek designs, manufactures, markets and maintains information storage
systems and network products. StorageTek sells its products to end-user
customers, original equipment manufacturers (OEMs), and value-added resellers
of computer systems. The principal markets for the Company's products and
services are located in the United States and Europe.
SIGNIFICANT ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements
and the reported amounts of revenue and expenses during the periods.
Significant estimates have been made by management in several areas including
the realizability of the Company's deferred tax assets, the possible outcome
of outstanding litigation, and future obligations associated with the
Company's 1995 restructuring. Actual results could differ from these
estimates making it reasonably possible that a change in these estimates
could occur in the near term. See Notes 9, 13 and 15, respectively, for
additional information with respect to these estimates.
REVENUE RECOGNITION
Revenue from end-user equipment sales, and associated software licenses, is
recognized at the time of acceptance by the customer, generally after
installation at a customer site. Revenue from certain customer-installable
products, as well as revenue from OEMs and value-added resellers, is
generally recognized at the time of shipment. Costs associated with post-
installation warranty obligations are estimated and accrued at the time of
revenue recognition.
StorageTek customers generally contract with the Company for equipment
maintenance and software support, which includes normal maintenance and
repair or replacement of product components. Maintenance revenue is
recognized as earned and the costs associated with these activities are
expensed as incurred.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents are short-term, highly liquid investments that are both
readily convertible to cash and have remaining maturities of three months or
less at the time of acquisition. The carrying value of the Company's cash
equivalents approximates fair value. Investments that do not qualify as cash
equivalents are classified as short-term investments. Short-term
F-5
PAGE
investments are principally comprised of commercial paper and are recorded at
cost plus accrued interest, which approximates fair value.
CAPITALIZED SOFTWARE COSTS
The Company capitalized costs of $510,000 in 1996, $25,463,000 in 1995, and
$30,607,000 in 1994 associated with acquiring and developing software
products to be marketed to customers. Other assets as shown on the
Consolidated Balance Sheet include unamortized software costs of $33,988,000
as of December 27, 1996, and $54,034,000 as of December 29, 1995.
Amortization expense is calculated based on the greater of straight-line
amortization over estimated useful lives, generally three to four years, or
the percentage of actual revenue versus total anticipated revenue.
Amortization expense and write-offs associated with capitalized software
costs were $20,556,000 in 1996, $26,627,000 in 1995, and $15,671,000 in 1994.
The Company evaluates the realizability of the carrying value of the
capitalized software based upon estimates of the associated future revenue.
DEPRECIATION AND AMORTIZATION
Depreciation of property, plant and equipment is computed using the straight-
line method over the estimated useful lives of the related assets. Other
assets as shown on the Consolidated Balance Sheet include unamortized
goodwill of $32,226,000 as of December 27, 1996, and $52,298,000 as of
December 29, 1995. Amortization of goodwill is calculated on a straight-line
basis over a period not exceeding 10 years. The Company evaluates the
realizability of the carrying value of goodwill based upon estimated future
cash flows calculated on an undiscounted basis.
TRANSLATION OF FOREIGN CURRENCIES
The functional currency for StorageTek's foreign subsidiaries is the U.S.
dollar, reflecting the significant volume of intercompany transactions and
associated cash flows which result from the fact that the majority of the
Company's products sold worldwide are manufactured in the United States.
Accordingly, monetary assets and liabilities are translated at year-end
exchange rates while non-monetary items are translated at historical exchange
rates. Revenue and expenses are translated at the average exchange rates in
effect during the year, except for cost of sales and depreciation, which are
translated at historical exchange rates. See Note 14 for information with
respect to the Company's accounting policies for financial instruments
utilized in its foreign currency hedging program.
STOCK-BASED COMPENSATION PLANS
Stock-based compensation plans are accounted for using the intrinsic value
method prescribed in Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees", rather than applying the fair
value method prescribed in Statement of Financial Accounting Standards (SFAS)
No. 123, "Accounting for Stock-Based Compensation."
EARNINGS (LOSS) PER COMMON SHARE
Earnings (loss) per common share is computed using the treasury stock method
based upon the weighted average number of common shares and dilutive common
stock equivalent shares outstanding during the year. The Company's
convertible debentures (see Note 8) are not common stock equivalents and,
therefore, have been excluded from the computation of primary
F-6
PAGE
earnings (loss) per common share. Fully diluted earnings per common share
for the year ended December 27, 1996, reflects the assumed conversion of the
convertible debentures outstanding during the period. These convertible
debentures were not outstanding or not dilutive for all other periods
presented.
RECENTLY ISSUED ACCOUNTING STANDARD
In June 1996, the Financial Accounting Standards Board issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." SFAS No. 125, which is effective for
transactions occurring after December 31, 1996, provides accounting and
reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities based on a consistent application of a
financial-components approach that focuses on control. The adoption of SFAS
No. 125 is not expected to have a material effect on the Company's
consolidated financial position or results of operations.
NOTE 2 - SALE OF MIDRANGE BUSINESS AND LEASE ASSETS
In June 1995, the Company completed the sale of substantially all of its net
investment in sales-type leases associated with its midrange business.
During the second quarter of 1995, the Company also announced plans to fully
integrate StorageTek Distributed Systems Division, Inc., the Company's wholly
owned midrange subsidiary, into StorageTek. The gain associated with the
lease asset sale was largely offset by transaction and integration costs. In
September 1995, the Company completed the sale of substantially all of its
midrange service business. A gain of approximately $8,800,000 was recognized
in connection with this transaction and has been included within marketing,
general, administrative and other income and expense on the Consolidated
Statement of Operations.
In March 1996, StorageTek sold all of the issued and outstanding stock of its
wholly owned lease financing subsidiary, StorageTek Financial Services
Corporation (SFSC), as well as the lease assets of certain of the Company's
foreign subsidiaries to Leasetec Corp. (Leasetec). These transactions
resulted in the sale of substantially all of the Company's net investment in
sales-type leases, installment receivables, and equipment held subject to
operating leases. Leasetec assumed approximately $6,000,000 of associated
nonrecourse borrowings, and the Company used a portion of the cash proceeds
to retire its remaining nonrecourse borrowings and 9.53% Senior Secured
Notes. The transactions resulted in an extraordinary gain of $9,535,000, net
of applicable taxes of $8,200,000, in the first quarter of 1996.
Prior to the sale of the lease assets, the Company offered lease financing to
its customers to support the acquisition of StorageTek products. Lease
financings were made under both sales-type leases and, to a lesser extent,
operating leases. These leases typically provided for a lease term of up to
five years and the retention of title to the equipment by StorageTek. The
majority of StorageTek's lease financings were made within the United States.
Because of the sale of lease assets to Leasetec during 1996, all remaining
equipment held for sale to customers is classified as inventory on the
Consolidated Balance Sheet as of December 27, 1996.
F-7
PAGE
The components of net investment in sales-type leases as of December 29,
1995, were as follows (in thousands of dollars):
Total minimum lease and maintenance payments $324,678
Less: Executory costs (maintenance payments) (61,860)
-------
Net minimum lease payments 262,818
Estimated unguaranteed residual values 5,070
Less: Unearned interest income (28,469)
-------
239,419
Less: Current portion (88,668)
-------
$150,751
=======
Equipment held for sale or lease to customers as of December 29, 1995,
consisted of the following (in thousands of dollars):
Equipment shipped awaiting revenue
recognition $ 88,337
Equipment off-rent 40,143
Equipment on-rent 11,149
-------
$139,629
=======
NOTE 3 - IBM OEM AGREEMENT
On June 7, 1996, StorageTek entered into a worldwide non-exclusive OEM
agreement with International Business Machines Corporation (IBM) under which
the Company develops and manufactures mainframe online storage products for
IBM. IBM serves as StorageTek's primary worldwide distribution channel for
this technology, and StorageTek does not anticipate that it will continue to
sell this technology directly to end-user customers during the term of the
agreement. The agreement, which expires in 1999, contains certain minimum
purchase commitments on behalf of IBM. The agreement also contains product
quality, availability, supply, delivery, and development milestones. The
Company's failure to achieve these milestones may result in reduced purchase
commitments, the imposition of penalties and, under certain circumstances,
IBM may terminate the agreement. StorageTek is required to perform, and IBM
will fund, certain research and development activities associated with the
development of enhancements to these products. The technology which is
developed will be owned by IBM, and subject to licensing rights by
StorageTek.
NOTE 4 - NETWORK SYSTEMS MERGER
In March 1995, the Company issued approximately 8,000,000 shares of
StorageTek common stock in exchange for all of the outstanding common stock
of Network Systems Corporation (Network Systems). The Company also reserved
approximately 500,000 shares for issuance in connection with Network Systems'
outstanding employee stock purchase and option plans. The transaction was
accounted for as a pooling of interests and, accordingly, the consolidated
financial statements for 1995 and 1994 include the operations of Network
Systems, adjusted to conform with StorageTek's accounting policies and
presentation. Merger and consolidation expenses in the amount of
$14,352,000, included within restructuring and other charges on the
Consolidated Statements of Operations (see Note 15), were recognized in 1995
and consist
F-8
PAGE
principally of change in control payments, financial advisor fees, legal
fees, and accounting fees.
NOTE 5 - INVENTORIES
Inventories include material, labor and factory overhead and are accounted
for at the lower of cost (first-in, first-out method) or market. The Company
evaluates the need for reserves associated with obsolete, slow-moving, and
nonsalable inventory by reviewing net realizable values on a quarterly basis.
Equipment shipped awaiting revenue recognition as of December 29, 1995 was
included within equipment held for sale or lease to customers on the
Consolidated Balance Sheet (see Note 2). The components of inventories are
as follows (in thousands of dollars):
December 27, December 29,
1996 1995
-------------------------------
Raw materials $ 76,152 $ 75,673
Work-in-process 78,834 92,487
Finished goods 43,279 46,393
Equipment shipped awaiting
revenue recognition 90,350
------- -------
$288,615 $214,553
======= =======
NOTE 6 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands of
dollars):
December 27, December 29,
1996 1995
-------------------------------
Machinery and equipment $ 640,932 $ 667,425
Buildings and building improvements 169,327 174,742
Land and land improvements 18,863 18,701
-------- --------
829,122 860,868
Less: Accumulated depreciation (501,588) (527,847)
-------- --------
$ 327,534 $ 333,021
======== ========
Machinery and equipment includes capitalized leases of $34,940,000 as of
December 27, 1996, and $51,039,000 as of December 29, 1995. Accumulated
depreciation includes accumulated amortization on such capitalized leases of
$12,228,000 as of December 27, 1996, and $24,653,000 as of December 29, 1995.
F-9
PAGE
NOTE 7 - ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands of dollars):
December 27, December 29,
1996 1995
-------------------------------
Restructuring costs (see Note 15) $ 33,609 $ 71,398
Deferred revenue 66,813 44,549
Other 268,887 245,339
------- -------
$369,309 $361,286
======= =======
Other accrued liabilities consists of items which are individually
immaterial.
NOTE 8 - DEBT, BANKING ARRANGEMENTS AND LEASE OBLIGATIONS
Long-term debt, including capitalized lease obligations consists of the
following (in thousands of dollars):
December 27, December 29,
1996 1995
-------------------------------
8% Convertible Subordinated
Debentures due 2015 $125,677 $145,645
7% Convertible Subordinated
Debentures due 2008 171,205
9.53% Senior Secured Notes due 1996 55,000
Capitalized lease obligations 27,420 32,659
Other 2,160 4,318
------- -------
155,257 408,827
Less: Current portion (4,451) (65,844)
------- -------
$150,806 $342,983
======= =======
8% CONVERTIBLE DEBENTURES
In December 1996, the Company called for redemption on January 13, 1997, all
outstanding 8% Convertible Subordinated Debentures due 2015 (8% Convertible
Debentures). As of December 27, 1996, 8% Convertible Debentures in the
principal amount of $19,968,000 had been converted at a price of $35.25 per
share into 566,410 shares of common stock. Debentures in the principal
amount of $145,201,000 were converted into 4,118,906 shares of the Company's
common stock on or before January 13, 1997. The remaining 8% Convertible
Debentures were redeemed for cash on January 13, 1997.
7% CONVERTIBLE DEBENTURES
In June 1996, the Company called for redemption on July 12, 1996, all
outstanding 7% Convertible Subordinated Debentures due 2008 (7% Convertible
Debentures). Debentures in the principal amount of $171,140,000 were
converted at a price of $23.50 per share into 7,282,536 shares of the
Company's common stock on or before July 12, 1996. The remaining 7%
Convertible Debentures were redeemed for cash on July 12, 1996.
F-10
PAGE
9.53% SENIOR SECURED NOTES
As further discussed in Note 2, in March 1996 the Company used a portion of
the cash proceeds from the sale of lease assets to retire its 9.53% Senior
Secured Notes due August 31, 1996, in the principal amount of $55,000,000.
FINANCING ARRANGEMENTS
The Company has a $150,000,000 secured credit agreement (the Revolver) which
expires in May 1998. The interest rates available under the Revolver depend
on the type of advance selected. The current primary advance rate is the
agent bank's prime lending rate plus 0.125% (8.375% as of December 27, 1996).
Under the Revolver, the Company is required to comply with certain financial
and other covenants, including restrictions on the payment of cash dividends
on its common stock. As of December 27, 1996, the Company had issued letters
of credit for approximately $25,413,000 and had approximately $124,587,000 of
available credit under the Revolver.
In December 1996, the Company entered into a financing agreement with a bank
which provides for the issuance of promissory notes in the principal amount
of up to $25,000,000 at any one time. The agreement, which expires on
January 15, 1998, provides for commitments by the bank to purchase promissory
notes denominated in a number of foreign currencies with the foreign currency
exchange rate applicable to each note set at the time the Company commits to
a future borrowing. The promissory notes, together with accrued interest,
are payable in U.S. dollars within 90 to 110 days from the date of issuance
and will bear interest at rates equal to the Eurodollar rate plus at least
0.50% (6.12% as of December 27, 1996). Under the terms of the agreement, the
Company is required to comply with certain covenants which can, under certain
circumstances, include the maintenance of compensating cash balances. As of
December 27, 1996, the Company had not committed to any future borrowings.
In January 1996, the Company entered into a financing agreement with a bank
which provides for the sale of certain U.S. and foreign based accounts
receivable on a recourse basis. This agreement, which expires on January 31,
1998, allows for receivable sales of up to $40,000,000 at any one time, and
the Company's obligations under the agreement are secured by a letter of
credit for the amount of the receivables sold. The selling price of the
receivables is partially determined based upon foreign currency exchange
rates, and any gains or losses on the sales are recognized within marketing,
general, administrative and other income and expense, net, in the
Consolidated Statement of Operations at the time the receivables are sold.
During 1996, the Company sold approximately $202,300,000 of receivables in
connection with this agreement. As of December 27, 1996, the outstanding
balance associated with receivables sold on a recourse basis, but not
collected, was approximately $25,000,000, and the Company had committed to
future cumulative sales of approximately $378,700,000. Gains and losses
associated with the receivable sales are not expected to have a material
effect on the Company's reported financial results after taking into
consideration other transactions associated with the Company's international
operations.
F-11
PAGE
SCHEDULED DEBT MATURITIES
Scheduled maturities of debt as of December 27, 1996, are as follows (in
thousands of dollars):
Capitalized Other Total Debt
Leases Debt Commitments
---------------------------------------------
1997 $ 6,215 $ 1,007 $ 7,222
1998 5,540 766 6,306
1999 3,650 116 3,766
2000 2,702 124 2,826
2001 2,380 147 2,527
Thereafter 21,282 125,677 146,959
------- ------- -------
41,769 $127,837 $169,606
======= ======= =======
Less: Amount representing interest (14,349)
-------
Present value of capitalized lease
obligations (including $3,444
classified as current) $ 27,420
=======
OPERATING LEASE OBLIGATIONS
StorageTek has various operating leases in effect for certain buildings,
sales offices, and machinery and equipment. Rent expense was $41,144,000 in
1996; $50,643,000 in 1995; and $50,095,000 in 1994. Future minimum rental
commitments required under all noncancellable operating leases with terms of
one year or more as of December 27, 1996, were as follows: $37,437,000 in
1997; $29,647,000 in 1998; $21,509,000 in 1999; $15,562,000 in 2000;
$9,804,000 in 2001; and $21,879,000 thereafter.
NOTE 9 - INCOME TAXES
Income (loss) before income taxes and extraordinary item consists of the
following (in thousands of dollars):
Year Ended
--------------------------------------------
December 27, December 29, December 30,
1996 1995 1994
--------------------------------------------
United States $220,495 $ (98,450) $ 69,949
International 6,197 (26,080) (19,011)
------- -------- -------
$226,692 $(124,530) $ 50,938
======= ======== =======
F-12
PAGE
The provision for income taxes attributable to the amounts shown above
consists of the following (in thousands of dollars):
Year Ended
--------------------------------------------
December 27, December 29, December 30,
1996 1995 1994
--------------------------------------------
Current tax provision:
U.S. federal $ 44,400 $ 11,900 $ 3,300
International 38,800 14,200 11,600
State 15,100 11,900 3,100
------- ------- -------
98,300 38,000 18,000
------- ------- -------
Deferred tax provision
(benefit):
U.S. federal (31,300) (12,100) 2,300
International (11,200) (7,300) (100)
State 100 (800) (1,300)
------- ------- -------
(42,400) (20,200) 900
------- ------- -------
$ 55,900 $ 17,800 $ 18,900
======= ======= =======
The provision for income taxes attributable to income (loss) before income
taxes and extraordinary item includes benefits of $53,900,000 in 1996;
$4,098,000 in 1995; and $34,325,000 in 1994 from the utilization of net
operating loss carryforwards. The provision for income taxes also includes a
net expense of $1,815,000 in 1996; and net benefits of $8,558,000 in 1995,
and $7,236,000 in 1994, as a result of the Company's Grant of Industrial Tax
Exemption issued by the Commonwealth of Puerto Rico (the Tax Grant). On a
per common share basis, the Tax Grant resulted in a net expense of $0.03 in
1996; and net benefits of $0.16 in 1995, and $0.14 in 1994. The benefits
from the Tax Grant include reduced tax rates and, through 1995, included the
ability to utilize U.S. net operating losses to further reduce Puerto Rico
tax liabilities. To the extent U.S. net operating losses used to reduce
Puerto Rico taxable income are subsequently used to also reduce U.S. taxable
income, the Puerto Rico benefit from the utilization of these operating
losses must be repaid to Puerto Rico. As of December 27, 1996, no cumulative
benefit has been realized with respect to this provision of the Tax Grant due
to repayments made to Puerto Rico as a result of the utilization of U.S. net
operating losses to reduce U.S. taxable income. The Tax Grant provision
allowing reduced tax rates expires in 2007.
The deferred income tax balances on the Consolidated Balance Sheet consist of
the following (in thousands of dollars):
December 27, December 29,
1996 1995
-------------------------------
Deferred income tax assets, net
of valuation allowance $122,190 $ 74,902
Deferred income tax liabilities (16,307) (12,196)
------- -------
Net deferred income tax asset $105,883 $ 62,706
======= =======
F-13
PAGE
The Company's net deferred income tax asset consists of the following (in
thousands of dollars):
December 27, December 29,
1996 1995
-------------------------------
Gross deferred income tax assets:
Net operating loss carryforwards $ 15,482 $ 57,617
Capitalized rental equipment 86,886
Tax credit carryforwards 37,205 86,231
Restructuring accruals 9,939 36,226
Other accrued liabilities
and reserves 56,265 63,410
Capitalized inventory costs 47,103 9,383
Deferred intercompany profit 12,172 18,099
Other 45,424 32,895
-------- --------
223,590 390,747
Less: Valuation allowance (100,523) (189,483)
-------- --------
123,067 201,264
-------- --------
Gross deferred income tax liabilities:
Deferred income from sales-type
leases (80,518)
Depreciation (11,148) (34,609)
Other (6,036) (23,431)
-------- --------
(17,184) (138,558)
-------- --------
Net deferred income tax asset $ 105,883 $ 62,706
======== ========
The net change in the valuation allowance for deferred income tax assets was
a decrease of $88,960,000 in 1996 and an increase of $32,705,000 in 1995.
The valuation allowance relates primarily to net deductible temporary
differences, tax credit carryforwards, and net operating loss carryforwards.
The Company evaluates a variety of factors in determining the amount of the
deferred income tax assets to be recognized pursuant to SFAS No. 109,
"Accounting for Income Taxes," including the Company's earnings history, the
number of years the Company's operating loss and tax credits can be carried
forward, the existence of taxable temporary differences, near-term earnings
expectations, and the highly competitive nature of the marketplace in which
the Company competes. Approximately $62,000,000 of the Company's deferred
deductions relate to tax deductions associated with stock option plans and,
accordingly, the related benefit will be credited to stockholders' equity
when realized. StorageTek is also subject to alternative minimum tax and had
approximately $28,000,000 of alternative minimum tax credit carryforwards
available as of December 27, 1996. Although realization is not assured,
management believes it is more likely than not that all of the net deferred
income tax asset will be realized.
StorageTek has not provided for income taxes on the cumulative undistributed
earnings of its foreign subsidiaries to the extent they are considered to be
reinvested indefinitely (approximately $31,900,000 as of December 27, 1996).
The amount of the unrecognized deferred tax liability for these unremitted
earnings was $10,600,000 as of December 27, 1996.
F-14
PAGE
The provision for income taxes differs from the amount computed by applying
the U.S. federal income tax rate of 35% to income (loss) before income taxes
and extraordinary item for the following reasons (in thousands of dollars):
Year Ended
----------------------------------------------------
December 27, December 29, December 30,
1996 1995 1994
----------------------------------------------------
U.S. federal income tax at statutory rate $ 79,342 $(43,586) $ 17,828
Increase (decrease) in income taxes
resulting from:
Unrecognized net operating losses,
future deductions and credits (72,755) 39,209 (22,254)
Foreign tax rate and exchange rate
differentials 29,325 9,989 14,605
Nondeductible items 4,644 13,362 7,567
State income taxes, net of federal benefits 13,545 2,467 6,158
Effect of Puerto Rico operations 5,190 (4,075) (3,634)
Other, net (3,391) 434 (1,370)
------- ------- -------
Income tax expense attributable to
income (loss) before extraordinary item $ 55,900 $ 17,800 $ 18,900
======= ======= =======
The Internal Revenue Service is currently auditing the Company's federal
income tax returns for 1991 through 1994. In addition, the Internal Revenue
Service is currently auditing Network Systems' federal income tax returns for
1992 and 1993.
NOTE 10 - EXCHANGE OF PREFERRED STOCK
In December 1995, the Company exercised its right to exchange 7% Convertible
Subordinated Debentures due 2008 for all of its 3,450,000 outstanding shares
of $3.50 Convertible Exchangeable Preferred Stock, $.01 par value. In
conjunction with the exchange, the Company issued 7% Convertible Debentures
in the aggregate principal amount of $171,205,000. As further discussed in
Note 8, the Company redeemed all outstanding 7% Convertible Debentures on
July 12, 1996.
NOTE 11 - EMPLOYEE BENEFIT PLANS, OPTIONS AND WARRANTS
EMPLOYEE STOCK PURCHASE PLAN
Under the Company's 1987 Employee Stock Purchase Plan (Purchase Plan), as
amended, employees may be offered the option to collectively purchase a
maximum of 300,000 shares of StorageTek's common stock, plus any remaining
shares from earlier offering periods, in consecutive six-month offering
periods. As of December 27, 1996, the Company had an aggregate of 960,709
common shares reserved for issuance under the Purchase Plan. Eligible
employees may contribute up to 10% of their pay toward purchase of StorageTek
common stock at a price equal to 85% of the lower of the market price on the
first or the last day of each offering period. Proceeds received from the
issuance of shares are credited to stockholders' equity in the fiscal year
the shares are issued. Under the purchase plan, the Company issued 558,750,
622,810 and 503,179 shares of StorageTek common stock in 1996, 1995 and 1994,
F-15
PAGE
respectively. The weighted average fair value of options granted under the
Purchase Plan are estimated as $9.35 per share during 1996 and $5.55 per
share during 1995, using the Black-Scholes option pricing model with the
following weighted average assumptions: dividend yield of 0%; volatility of
37.60% in 1996 and 37.84% in 1995; risk-free interest rate of 5.68% in 1996
and 5.84% in 1995; and an expected life of 0.5 years.
STOCK OPTION AND RESTRICTED STOCK PLANS
As of December 27, 1996, the Company had an aggregate of 3,393,872 common
shares reserved for issuance under its equity plans (Equity Plans). These
plans provide for the issuance of common shares pursuant to stock option
exercises, restricted stock awards and other equity based awards. There were
985,496 shares available for grant under the Equity Plans as of December 27,
1996.
Stock options have been granted under the Equity Plans at the fair market
value of the common stock on the date of grant and generally vest over a
period of between three and six years. Options granted under the Equity
Plans must be exercised no later than 10 years from the date of grant.
Restricted stock awards of the Company's common stock are made pursuant to
its Equity Plans at a purchase price per share equal to par value. Unearned
compensation, which is determined as the difference between par value and
market value of the Company's common stock on the date of the award, is
charged to stockholders' equity and amortized to expense over the vesting
period of the stock. No restricted stock shares were awarded during 1996. A
total of 70,237 shares of restricted stock with a weighted average grant-date
fair value of $25.92 per share using the Black-Scholes option pricing model
were awarded during 1995. Total compensation expense recognized in the
Consolidated Statement of Operations for restricted stock awards was
$2,057,378 and $538,570 during 1996 and 1995, respectively. A total of
225,810 shares of restricted stock were outstanding as of December 27, 1996.
The Company also has a Nonemployee Director Stock Option Plan (Director Plan)
under which the Company grants stock options to nonemployee directors for the
purchase of an aggregate maximum of 530,000 shares of common stock. Stock
options are granted at the fair market value of the common stock on the date
of grant. There were 75,000 shares available for grant under the Director
Plan as of December 27, 1996.
F-16
PAGE
The following summarizes information with respect to options granted under
the Company's Equity and Director Plans:
Weighted Average
Exercise Price of
Number of Shares Shares Under Plan
-----------------------------------------
Outstanding, December 30, 1994 2,912,019 $29.36
Granted 1,665,591 25.84
Exercised (162,363) 20.53
Forfeited or expired (1,004,204) 33.73
----------
Outstanding, December 29, 1995 3,411,043 26.77
Granted 618,725 41.62
Exercised (913,562) 26.00
Forfeited or expired (325,378) 31.16
---------- -----
Outstanding, December 27, 1996 2,790,828 $29.81
========== =====
The following table summarizes information concerning outstanding and
exercisable options as of December 27, 1996:
Options Outstanding Options Exercisable
--------------------------------------- ----------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life in Years Price Exercisable Price
- ------------------------------------------------------------------------------
$ 0 - $20 216,475 3.94 $16.16 216,475 $16.16
20 - 30 1,835,011 7.85 26.80 869,496 26.22
30 - 45 409,764 8.22 35.31 113,564 37.62
45 - 76 329,578 9.82 48.69 9,103 55.66
--------- ---------
2,790,828 1,208,638
========= =========
NOTES RECEIVABLE FROM STOCKHOLDERS
In connection with the Network Systems merger (see Note 4), the Company
assumed Network Systems' notes receivable from stockholders. These notes
related to loans made by Network Systems to certain of its officers prior to
the merger to fund the exercise price of employee stock options pursuant to a
restricted stock purchase program and were secured by the shares purchased
and any other collateral required to maintain 100% collateralization at the
time of each loan. All notes receivables from stockholders had been
collected as of December 27, 1996.
WARRANTS
In connection with a merger in 1993, the Company assumed obligations with
respect to warrants for the purchase of 324,000 shares of common stock at a
price of $30.86 per share. All of these warrants expired unexercised on
December 16, 1996.
F-17
PAGE
EMPLOYEE PROFIT SHARING AND THRIFT PLAN
StorageTek has a Profit Sharing and Thrift Plan whereby participants may
contribute a percentage of compensation, but not in excess of the maximum
allowed under the Internal Revenue Code. Effective January 1, 1996, the plan
provides for a matching contribution by the Company equal to 50% of the
participant's contribution for each pay period, up to a maximum of 3% of the
participant's compensation for the pay period. The Company's matching
contribution for 1996 was $7,463,000. Company contributions in excess of the
matching contribution are contingent upon realization of profits by the
Company which, at the sole discretion of the Board of Directors, are adequate
to justify a corporate contribution. The Board authorized additional
contributions of $5,550,000 and $3,000,000 in 1996 and 1995, respectively.
No contributions from StorageTek were authorized for 1994.
SFAS NO. 123
The Company applies the intrinsic value method set forth in APB No. 25 in
accounting for its stock-based compensation plans. Net income and earnings
per share as reported and as calculated pursuant to SFAS No. 123 to reflect
the fair value method of accounting for stock-based compensation plans (SFAS
123) were as follows (in thousands, except per share amounts):
Year Ended
-------------------------
December 27, December 29,
1996 1995
-------------------------
Net Income: As Reported $180,327 $(142,330)
SFAS 123 169,703 (147,036)
Primary Earnings
Per Share: As Reported $ 3.17 $ (2.91)
SFAS 123 3.01 (3.00)
Fully Diluted Earnings
Per Share: As Reported $ 2.98
SFAS 123 2.85
The weighted average fair value of options are estimated as $21.91 per option
granted during 1996 and $13.29 per option granted during 1995, using the
Black-Scholes option pricing model with the following weighted average
assumptions: dividend yield of 0%; volatility of 52.00% in 1996 and 60.60% in
1995; risk-free interest rate of 6.28% in 1996 and 5.91% in 1995; and an
expected life of 5.4 years in 1996 and 4.2 years in 1995. Compensation cost
for the options granted is computed reflecting the actual forfeitures of
options with the respective years.
NOTE 12 - STOCKHOLDER RIGHTS PLAN
In 1990, the Board of Directors adopted a new Stockholder Rights Plan (Rights
Plan). The Rights Plan is designed to deter coercive or unfair takeover
tactics and to prevent an acquiring entity from gaining control of the
Company without offering a fair price to all of the Company's shareholders.
Each right would entitle the holder of the Company's common stock to purchase
one one-hundredth of a share of Series B Junior Participating Preferred Stock
at an exercise price of
F-18
PAGE
$150, subject to adjustment to prevent dilution. The rights are evidenced by
the common stock certificates and will not separate from the common stock
until the earlier of (i) 20 days following the date on which any person or
entity acquires beneficial ownership of 15% or more of the common stock (an
Acquiring Person) and the right of redemption has not been reinstated; or
(ii) 10 days after a public announcement of a tender or exchange offer by any
person or entity if upon consummation such person would be an Acquiring
Person. Further, upon the occurrence of certain events described below, the
rights generally entitle each right holder (except the Acquiring Person) to
purchase that number of shares of the Company's common stock which equals the
$150 exercise price of the right divided by one-half of the current market
price of the common stock. Those events generally include (i) 20 days after
any person or entity becomes an Acquiring Person; and (ii) if any person or
entity becomes an Acquiring Person and thereafter, (a) the Company is merged
with or into an Acquiring Person and the Company's common stock is changed,
converted or exchanged; or (b) 50% or more of the Company's assets or earning
power is sold; or (c) an Acquiring Person engages in one or more "self-
dealing" transactions as described in the Rights Agreement.
The Company is generally entitled to redeem the rights for $.01 per right at
any time prior to the earlier of the date on which any person or entity
becomes an Acquiring Person or August 31, 2000. The rights will expire on
August 31, 2000, unless redeemed or exchanged earlier by the Company pursuant
to the Rights Plan.
NOTE 13 - 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. Oral
argument on the appeal is scheduled for March 1997.
On February 15, 1994, the Company filed suit in Boulder County, Colorado,
District Court against Array Technology Corporation (Array) and Tandem
Computers Incorporated (Tandem). The suit asked that the court order Array
and Tandem to either support certain disk drives purchased from them or
provide the Company with technical data necessary for StorageTek to provide
such customer support. In March 1994, Array and Tandem filed their answer
and also filed counterclaims against the Company alleging breach of contract
and claiming damages. On June 10, 1994, the court ordered Array and Tandem
to continue to provide support for these products and to maintain, in an
independent escrow account, the materials necessary to enable the Company to
support the products in the event Array and Tandem failed to provide such
services. On May 30, 1995, the Company filed an amended complaint seeking
damages. The case is in the discovery phase. A trial date has been set for
October 1997.
On June 29, 1995, Odetics, Inc. filed a patent infringement suit in the U.S.
District Court for the Eastern District of Virginia against the Company and
two of its customers 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
F-19
PAGE
damages in an unspecified amount, and an award of attorneys fees and costs.
A trial commenced on January 22, 1996, and on February 1, 1996, a jury found
that the Company's products did not infringe the 151 Patent. A notice of
appeal to the U.S. Court of Appeals for the Federal Circuit was filed by
Odetics, Inc. on March 8, 1996. Oral arguments were held in January 1997. A
decision is expected in the second or third quarter of 1997.
On December 8, 1995, Odetics, Inc. 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 infringe the 151 Patent. The
complaint seeks injunctive relief, treble damages in an unspecified amount,
and an award of attorneys fees and costs. This case has been stayed pending
the outcome of the appeal to the U.S. Court of Appeals for the Federal
Circuit with respect to the case filed by Odetics, Inc. in June 1995.
On July 30, 1996, the Company received Civil Investigative Demands (CID) from
the U.S. Department of Justice Antitrust Division concerning the OEM
agreement with IBM for mainframe online storage subsystems. The Company
received two additional CIDs in October 1996 and one additional CID in
February 1997. The CIDs requested production of documents and testimony in
connection with a review of the agreement for compliance with the Sherman
Act.
In addition, the Company is involved in various other less significant legal
proceedings. 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. 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 effect on the Company's
financial position or reported results of operations in a particular quarter.
An adverse 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 14 - FINANCIAL INSTRUMENTS AND OFF-BALANCE-SHEET RISKS
FOREIGN CURRENCY OPTIONS AND FORWARD EXCHANGE CONTRACTS
A significant portion of the Company's revenue is generated by its
international operations. As a result, the Company's operations and
financial results can be materially affected by changes 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. The Company does not hold
or issue foreign currency options or forward exchange contracts for trading
purposes.
The Company periodically utilizes purchased foreign currency options,
generally with maturities of less than one year, to hedge its exposure to
exchange-rate fluctuations in connection with anticipated revenue from its
international operations. The Company utilizes hedge accounting for its
foreign currency options with gains and losses associated with the options
recognized at the same time as the underlying anticipated transactions. The
Company held no foreign
F-20
PAGE
currency options as of December 27, 1996. Purchased foreign currency options
with a face value of approximately $168,997,000 were held as of December 29,
1995. Deferred realized and unrealized losses associated with the foreign
currency options held as of December 29, 1995, which aggregated approximately
$2,498,000, were recognized as an adjustment to the associated revenue in
1996 in the Consolidated Statement of Operations.
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 monetary assets and liabilities held in
foreign currencies. 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. Realized and unrealized
gains and losses on the forward contracts are recognized currently within
marketing, general, administrative and other income and expense, net, on the
Consolidated Statement of Operations as adjustments to the foreign exchange
gains and losses on the translation of net monetary assets. The Company held
forward foreign exchange contracts with a face value of approximately
$87,513,000 as of December 27, 1996, and $114,644,000 as of December 29,
1995.
The forward exchange contracts and foreign currency options do not subject
the Company to risk due to exchange rate movements, as gains and losses on
the contracts offset gains and losses on the transactions being hedged. The
foreign currency hedging instruments utilized by StorageTek are generally
traded over the counter. The Company does not believe there is significant
credit risk associated with these contracts, as the counterparties consist of
major international financial institutions, and the Company monitors the
amount of the contracts it enters into with any one party. There was no
credit exposure with respect to the Company's foreign currency forward
contracts as of December 27, 1996, as the fair value of these contracts was
approximately zero.
Losses associated with foreign currency translation adjustments and foreign
currency transactions, net of associated hedging results, aggregated $447,000
in 1996, $4,303,000 in 1995, and $1,178,000 in 1994.
CONCENTRATIONS OF CREDIT RISK
Other financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash
investments, trade receivables, and outstanding letters of credit under the
Company's Revolver. The Company has a cash investment policy which restricts
investments to ensure preservation of principal and maintenance of liquidity.
The majority of the Company's trade receivable balances are not required to
be collateralized and are therefore unsecured. As of December 27, 1996,
approximately 19% of the Company's outstanding accounts receivable balance
was due from IBM. The Company monitors this concentration and does not
believe any significant credit risk exists at December 27, 1996. The
concentration of credit risk with respect to the remaining trade receivables
is limited due to the large number of customers comprising the Company's
customer base, and their dispersion across many different industries and
geographic areas. As further discussed in Note 8, the Company's outstanding
letters of credit of approximately $25,413,000 relate principally to the sale
of certain U.S. and foreign based accounts receivable on a recourse basis.
Based upon the Company's past credit and collection experience with respect
to the receivables that it expects to sell, the Company believes that no
material credit risk exists under the recourse provisions of the agreement.
F-21
PAGE
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying and estimated fair values of the Company's 8% Convertible
Subordinated Debentures were $125,677,000 and $165,894,000, respectively.
The fair value of the 8% Convertible Subordinated Debentures was based upon
the closing sales prices on the New York Stock Exchange as of December 27,
1996. The carrying amounts of the Company's accounts receivable, accounts
payable and accrued liabilities are either equal to or approximate their fair
values. The Company's foreign currency forward contracts, which are an off-
balance-sheet financial instrument, were entered into on December 27, 1996,
and accordingly, had a carrying value and fair value approximating zero.
NOTE 15 - RESTRUCTURING AND OTHER CHARGES
Restructuring and other charges consist of the following (in thousands of
dollars):
Year Ended
----------------------------
December 29, December 30,
1995 1994
----------------------------
Restructuring charges $167,175 $8,000
Litigation settlement 30,680
Merger and consolidation charges 14,352
------- -----
$212,207 $8,000
======= =====
In 1995, the Company and the plaintiffs in a shareholder class action and
derivative litigation reached an agreement to settle the litigation. The
settlement provided that, without admitting any wrongdoing, the Company would
pay $30,680,000 for its portion of the settlement. The Company's insurance
policies paid $24,320,000 as part of the total settlement of $55,000,000.
See Note 4 for a discussion of the $14,352,000 charge associated with the
merger with Network Systems in 1995.
F-22
PAGE
The following table summarizes the activity in the Company's restructuring
reserves (in thousands of dollars):
Employee Asset Lease Other
Severance Writedowns Abandonments Exit Costs Total
----------------------------------------------------------------------------
Balances, December 31, 1993 $ 6,239 $ 5,257 $ 3,796 $ 15,292
Restructuring charges 3,000 $ 2,200 2,300 500 8,000
Cash payments (6,203) (1,775) (684) (8,662)
Asset writedowns (2,200) (2,200)
------- ------- ------ ------ -------
Balances, December 30, 1994 3,036 0 5,782 3,612 12,430
Restructuring charges 49,265 91,609 16,660 9,641 167,175
Cash payments (9,613) (3,904) (3,081) (16,598)
Asset writedowns (91,609) (91,609)
------- ------- ------ ------ -------
Balances, December 29, 1995 42,688 0 18,538 10,172 71,398
Cash payments (26,837) (2,907) (9,414) (39,158)
Reclassifications 301 (154) 1,222 1,369
------- ------- ------ ------ -------
Balances, December 27, 1996 $ 16,152 $ 0 $15,477 $ 1,980 $ 33,609
======= ======= ====== ====== =======
RESTRUCTURINGS
During the fourth quarter of 1995, the Company recorded a restructuring
charge of $167,175,000 related to the adoption by the Company of a formal
action plan for restructuring its enterprise and network businesses. The
restructuring was adopted in an effort to establish a more cost efficient
business structure in response to competition. Elements of the Company's
restructuring plan include focusing on core businesses, outsourcing non-
strategic activities, rearchitecting its distribution processes and
accelerating the integration of Network Systems.
In connection with the plan, the Company incurred employee severance costs of
approximately $49,265,000.
Asset writedowns incurred in connection with the restructuring included a
charge of approximately $21,310,000 associated with the planned disposal of
excess spare parts in connection with the consolidation of maintenance
depots; a charge of approximately $19,600,000 primarily associated with the
writedown of manufacturing equipment which will be scrapped or sold; a charge
of approximately $18,484,000 associated with goodwill and other investment
writedowns on business activities which are being discontinued; a charge of
approximately $16,361,000 associated with the shutdown of manufacturing and
research facilities; a charge of approximately $10,758,000 associated with
excess and obsolete inventories resulting from the decision to discontinue
various product lines; and a charge of approximately $5,096,000 associated
with other asset writedowns resulting from discontinued business activities.
Charges of approximately $16,660,000 were incurred in connection with the
abandonment of real estate leases. Other exit costs of approximately
$9,641,000 were incurred principally
F-23
PAGE
related to equipment lease terminations and the discontinuation of
engineering support agreements.
During 1994, Network Systems recorded a restructuring charge of $8,000,000 in
connection with an expense reduction plan.
NOTE 16 - OPERATIONS OF BUSINESS SEGMENTS AND IN GEOGRAPHIC AREAS
BUSINESS SEGMENTS
StorageTek operates in one principal business segment - the design,
manufacturing, marketing, and maintenance of information storage systems and
network products.
GEOGRAPHIC AREAS
StorageTek operates principally in the United States and Europe. Operations
in geographic areas other than the United States and Europe individually
account for less than 10% of the consolidated revenue and identifiable
assets, and have been combined and shown in the table below as "Other."
Information regarding each geographic area on an unconsolidated basis is
shown below (in thousands of dollars):
Consolidated
1996 United States Europe Other Eliminations Total
- ------------------------------------------------------------------------------------------------------------------
Revenue from unaffiliated
customers $1,281,118 (1) $587,951 $170,481 $2,039,550
Transfers between areas 370,814 $(370,814)
--------- ------- ------- -------- ---------
Total revenue $1,651,932 $587,951 $170,481 $(370,814) $2,039,550
========= ======= ======= ======== =========
Operating profit (loss) $ 243,447 $ (886) $ (4,400) $ 17,424 $ 255,585
========= ======= ======= ========
Interest income (expense), net 1,211
General corporate expenses (30,104)
---------
Income before income taxes $ 226,692
=========
Identifiable assets $1,060,243 $560,993 $156,062 $(252,975) $1,524,323
========= ======= ======= ========
General corporate assets 359,953
---------
Total assets $1,884,276
=========
F-24
PAGE
Consolidated
1995 United States Europe Other Eliminations Total
- ------------------------------------------------------------------------------------------------------------------
Revenue from unaffiliated
customers $1,227,509 (1) $553,064 $148,912 $1,929,485
Transfers between areas 380,194 $(380,194)
--------- ------- ------- -------- ---------
Total revenue $1,607,703 $553,064 $148,912 $(380,194) $1,929,485
========= ======= ======= ======== =========
Operating loss $ (22,769) $(27,296) $ (7,047) $ (7,631) $ (64,743)
========= ======= ======= ========
Interest income (expense), net 8,978
General corporate expenses (68,765) (2)
---------
Loss before income taxes $ (124,530)
=========
Identifiable assets $1,304,606 $494,499 $122,149 $(233,300) $1,687,954
========= ======= ======= ========
General corporate assets 200,675
---------
Total assets $1,888,629
=========
Consolidated
1994 United States Europe Other Eliminations Total
- ------------------------------------------------------------------------------------------------------------------
Revenue from unaffiliated
customers $1,242,166 (1) $499,939 $129,245 $1,871,350
Transfers between areas 308,978 $(308,978)
--------- ------- ------- -------- ---------
Total revenue $1,551,144 $499,939 $129,245 $(308,978) $1,871,350
========= ======= ======= ======== =========
Operating profit (loss) $ 90,529 $(17,640) $ 4,321 $ (11,604) $ 65,606
========= ======= ======= ========
Interest income (expense), net 6,103
General corporate expenses (20,771)
---------
Income before income taxes $ 50,938
=========
Identifiable assets $1,764,903 $380,999 $ 79,917 $(216,858) $2,008,961
========= ======= ======= ========
General corporate assets 135,497
---------
Total assets $2,144,458
=========
(1) U.S. revenue from unaffiliated customers includes international export sales to customers of $67,636,000
in 1996; $79,714,000 in 1995; and $94,959,000 in 1994.
(2) General corporate expenses in 1995 include a charge of $30,680,000 associated with the settlement of
litigation, as well as merger and consolidation expenses of $14,352,000.
Sales between geographic areas are generally priced to reflect market value
and to provide an appropriate gross margin to the affiliate. Operating
profit, for the purpose of this footnote, consists of total revenue less
operating expenses, and excludes interest income, interest expense and
general corporate expenses for all years presented. U.S. operating profit
includes profit recognized in the United States on transfers to other
geographic areas. Identifiable assets are those assets that are associated
with the operations in each geographic area. General corporate assets are
primarily cash and short-term investments not used in the operations of the
individual geographic regions.
F-25
PAGE
NOTE 17 - QUARTERLY INFORMATION (UNAUDITED)
The consolidated results of operations on a quarterly (13-week) basis were as
follows (in thousands of dollars, except per share amounts):
Quarter Ended 1996
-------------------------------------------------------------
March 29 June 28 September 27 December 27
-------------------------------------------------------------
Revenue $453,481 $479,305 $486,085 $620,679
Cost of revenue 259,567 272,989 293,551 366,670
------- ------- ------- -------
Gross profit 193,914 206,316 192,534 254,009
Operating expenses 157,736 153,511 141,282 168,763
------- ------- ------- -------
Operating profit 36,178 52,805 51,252 85,246
Interest income (expense), net (1,189) (945) 2,248 1,097
------- ------- ------- -------
Income before income taxes 34,989 51,860 53,500 86,343
Provision for income taxes (9,400) (14,000) (14,000) (18,500)
------- ------- ------- -------
Income before extraordinary item 25,589 37,860 39,500 67,843
Extraordinary gain, net of income taxes 9,535
------- ------- ------- -------
Net income $ 35,124 $ 37,860 $ 39,500 $ 67,843
======= ======= ======= =======
Income per common share:
Primary $ 0.66 $ 0.70 $ 0.65 $ 1.16
======= ======= ======= =======
Fully diluted $ 0.62 $ 0.65 $ 1.12
======= ======= =======
Quarter Ended 1995
-------------------------------------------------------------
March 31 June 30 September 29 December 29
-------------------------------------------------------------
Revenue $450,186 $480,702 $439,596 $ 559,001
Cost of revenue 288,089 306,942 276,228 346,363
------- ------- ------- --------
Gross profit 162,097 173,760 163,368 212,638
Operating expenses 157,233 159,651 135,207 181,073
Restructuring and other charges 14,352 30,680 167,175
------- ------- ------- --------
Operating profit (loss) (9,488) 14,109 (2,519) (135,610)
Interest income (expense), net 1,574 2,246 3,038 2,120
------- ------- ------- --------
Income (loss) before income taxes (7,914) 16,355 519 (133,490)
Provision for income taxes (1,000) (4,500) (7,500) (4,800)
------- ------- ------- --------
Net income (loss) $ (8,914) $ 11,855 $ (6,981) $(138,290)
======= ======= ======= ========
Income (loss) per common share $ (0.23) $ 0.17 $ (0.19) $ (2.65)
======= ======= ======= ========
NOTE 18 - SUBSEQUENT EVENT
On February 20, 1997, the Company announced a program to repurchase up to 1.5
million shares of the Company's common stock on an annual basis. The
repurchase program is expected to offset dilution associated with the
Company's stock purchase and stock option plans.
F-26
PAGE
REPORT OF INDEPENDENT ACCOUNTANTS
----------------------------------
FOR STORAGE TECHNOLOGY CORPORATION
----------------------------------
To the Stockholders and
Board of Directors of
Storage Technology Corporation
In our opinion, based upon our audits and the report of other auditors, the
consolidated financial statements listed in the index appearing under Item
14.(a)1. and 2. on page 35 present fairly, in all material respects, the
financial position of Storage Technology Corporation and its subsidiaries at
December 27, 1996 and December 29, 1995, and the results of their operations
and their cash flows for each of the three years in the period ended December
27, 1996, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based
on our audits. We did not audit the consolidated financial statements of
Network Systems Corporation, a wholly owned subsidiary, which statements
reflect total revenue of $231,756,000 for the year ended December 31, 1994.
Those statements were audited by other auditors whose report thereon has been
furnished to us, and our opinion expressed herein, insofar as it relates to
the amounts included for Network Systems Corporation is based solely on the
report of the other auditors. We conducted our audits of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits and the report
of the other auditors provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Denver, Colorado
February 21, 1997
F-27
PAGE
REPORT OF INDEPENDENT ACCOUNTANTS
----------------------------------
FOR NETWORK SYSTEMS CORPORATION
--------------------------------
Board of Directors and Stockholders
Network Systems Corporation
We have audited the consolidated statement of operations, stockholders'
equity and cash flows for year in the period ended December 31, 1994 (not
presented separately herein). These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of its operations and its
cash flows for the year in the period ended December 31, 1994, in conformity
with generally accepted accounting principles.
ERNST & YOUNG LLP
Minneapolis, Minnesota
March 10, 1995
F-28
PAGE
STORAGE TECHNOLOGY CORPORATION AND SUBSIDIARIES
------------------------------------------------
SCHEDULE II
----------
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
----------------------------------------------
(In Thousands of Dollars)
Additions -
Balance Charged to Deductions -
Beginning of Cost of Spare Parts Balance End
Year Maintenance Written Off of Year
--------------------------------------------------------------------------
Amortization of spare parts for
maintenance:
For the year ended:
December 27, 1996 $87,980 $ 9,159 $43,267 $53,872
====== ====== ====== ======
December 29, 1995 $74,685 $43,378 $30,083 $87,980
====== ====== ====== ======
December 30, 1994 $65,350 $27,526 $18,191 $74,685
====== ====== ====== ======
Additions -
Balance Charged to Deductions -
Beginning of Cost of Spare Parts Balance End
Year Maintenance Written Off of Year
--------------------------------------------------------------------------
Inventory reserves:
For the year ended:
December 27, 1996 $45,290 $55,771 $49,723 $51,338
====== ====== ====== ======
December 29, 1995 $51,803 $37,353 $43,866 $45,290
====== ====== ====== ======
December 30, 1994 $40,208 $44,852 $33,257 $51,803
====== ====== ====== ======
Additions -
Balance Charged to Deductions -
Beginning of Cost of Spare Parts Balance End
Year Maintenance Written Off of Year
--------------------------------------------------------------------------
Allowance for doubtful accounts on
accounts receivable:
For the year ended:
December 27, 1996 $14,665 $ 3,838 $ 5,596 $12,907
====== ====== ====== ======
December 29, 1995 $13,387 $ 8,198 $ 6,920 $14,665
====== ====== ====== ======
December 30, 1994 $13,196 $ 6,678 $ 6,487 $13,387
====== ====== ====== ======
F-29
PAGE