1
EXHIBIT 13.1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
RESULTS OF OPERATIONS
The Company's net revenues increased 8% to $1,007 million in fiscal 1998, 42% to
$934 million in fiscal 1997 and 41% to $659 million in fiscal 1996. The increase
in net revenues has been primarily attributable to increased shipments of the
Company's host adapters. This has reflected growth in the high-performance
microcomputer markets, demand for SCSI in the client/server environment, the
ongoing deployment of sophisticated operating systems and an increase in the use
of diverse peripherals such as high capacity hard drives, scanners and optical
drives. While net revenues and shipments of the Company's host adapters and
ASICs increased year over year between the 1996 and 1998 fiscal years, net
revenues for the fourth quarter of fiscal 1998 decreased 23% compared with
revenues for the fourth quarter of 1997. This decrease was primarily due to
lower sales of the Company's SCSI host adapters and peripheral technology
solutions. The demand for SCSI has been adversely impacted by the trend to lower
priced PCs for mainstream corporate desktop applications as well as enhancements
to the EIDE standard which is used predominantly in the desktop market. The
Company believes that the resulting shift of corporate buying towards lower
cost, more limited function PCs has been fueled by the delay in the introduction
of Windows NT 5.0 and Windows 98 and by the redirection of corporate management
information systems budgets towards resolving the Year 2000 issue and investing
in backbone network infrastructure. Net revenues from sales of the Company's
peripheral technology solutions have been adversely impacted by the turbulent
disk drive market and the recent instability in the Asian markets. The Company
presently expects that its sales growth is unlikely to resume before the third
quarter of fiscal 1999 at the earliest.
Gross margin in fiscal 1998 was 61% compared to 58% in both the 1997 and 1996
fiscal years. Gross margin in fiscal 1998 increased from fiscal 1997 primarily
due to proportionally greater shipments of the Company's higher margin SCSI host
adapters. Gross margins also increased due to the Company's continued focus on
component cost reductions and on improving manufacturing efficiencies.
Research and development expenditures in fiscal 1998 increased as a percentage
of revenues to 17% compared with 14% and 13% for the 1997 and 1996 fiscal years,
respectively. The percentage increase between fiscal 1997 and 1998 was primarily
due to lower than expected revenues for fiscal 1998. In absolute dollars,
spending for the three fiscal years was $173 million, $129 million and $88
million, respectively. The increase in spending in fiscal 1998 was primarily a
result of increased staffing levels to support the Company's commitment to
invest in newer hardware and software solutions, including RAID and external
storage, Fibre Channel, File Array and CD recordable software solutions.
Sales, marketing and administrative expenses in fiscal 1998 increased as a
percentage of revenues to 22% compared with 17% and 18% for the 1997 and 1996
fiscal years, respectively. The percentage increase between fiscal 1997 and 1998
was primarily due to lower than expected revenues for fiscal 1998. Spending for
the three fiscal years was $219 million, $163 million and $117 million,
respectively. These increases in actual spending were primarily a result of
increased staffing levels to support the Company's worldwide growth. In
addition, the Company increased advertising and promotional programs aimed at
leveraging the Company's brand image and generating demand for its products.
During fiscal 1997, the Company acquired complementary businesses recorded under
the purchase method of accounting, resulting in an aggregate write-off of
acquired in-process technology of approximately $90 million. Additionally, the
Company acquired one business under the pooling-of-interests method of
accounting. Professional fees totaling approximately $2 million were incurred in
connection with the acquisition and have been included in "write-off of acquired
in-process technology and other charges. The Company did not complete any
acquisitions during fiscal 1998, but did enter into agreements to acquire
Symbios, Inc. ("Symbios") and read channel technology from Analog Devices, Inc.
("ADI"). At March 31, 1998, these acquisitions were subject to regulatory
approval. In addition, subsequent to March 31, 1998, the Company acquired Ridge
Technologies. The Company believes that the integration of these acquisitions
will result in higher research and development and sales, marketing and
administrative expenditures in fiscal 1999. In addition, the Company anticipates
that it will incur significant one time charges in connection with these
acquisitions.
Interest income, net of interest expense for fiscal 1998 increased 94% from the
prior fiscal year due to higher cash and balances during the year primarily as a
result of cash generated by operations and proceeds received in connection with
$230 million of Convertible Subordinated Notes that the Company issued in
February 1997. The coupon interest rate associated with these notes is 4-3/4%.
2
The Company's effective tax rate for fiscal years 1998, 1997 and 1996 was 26%,
37% and 25%, respectively. Excluding the effect of write-offs in fiscal 1998 and
write-offs of acquired in-process technology in fiscal 1997, the Company's
effective tax rate was 25% in each of these fiscal years. The accounting for
write-offs of acquired in-process technology changed in fiscal 1997 due to an
interpretation of SFAS 109 that the Company adopted upon its issuance. In fiscal
1996, the Company was allowed to gross-up the acquired in-process technology and
record a dollar-for-dollar credit against its tax provision, allowing the
Company to maintain its 25% effective rate. The difference between the Company's
25% effective tax rate and the U.S. statutory rate is primarily due to income
earned in Singapore where the Company is subject to a lower effective tax rate
resulting from a tax holiday relating to certain of its products. The terms of
the tax holiday provide that profits derived from certain products will be
exempt from tax through 2006, subject to certain conditions.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES Net cash generated from operating activities during fiscal
1998 was $245 million compared to $245 million in fiscal 1997 and $116 million
in fiscal 1996. Cash from operating activities for fiscal 1998 was primarily
attributable to net income of $173 million adjusted by non-cash items including
the cumulative effect of a change in accounting principle of $9 million,
depreciation and amortization of $43 million, provision for doubtful accounts of
$4 million and impairment losses totaling $7 million. Increases in accounts
receivable and inventories were largely offset by decreases in other assets and
prepaid expenses and other and an increase in accounts payable.
Cash from operating activities for fiscal 1997 was primarily attributable to net
income of $108 million adjusted by non-cash items including net write-off of
acquired in-process technology of $89 million and depreciation and amortization
of $29 million. Increases in accounts receivable and prepaid expenses and other
were largely offset by increases in accounts payable and accrued liabilities.
Cash generated from operating activities for fiscal 1996 was primarily a result
of the overall growth of the Company's operations.
INVESTING ACTIVITIES Net cash used for investing activities during fiscal 1998
was $346 million compared to $221 million for fiscal 1997 and $97 million for
fiscal 1996. During fiscal 1998 the Company purchased $240 million of marketable
securities consisting primarily of municipal bonds, corporate bonds and
government securities, all of which are of high investment grade. The Company
also continued to make various building and leasehold improvements to its
facilities and to invest in equipment for product development and manufacturing
to support current and future business requirements. Purchases of property and
equipment of $98 million during fiscal 1998 included $11 million for land
located in Irvine, California. During fiscal 1999, the Company anticipates that
it will invest approximately $70 million in property and equipment to support
its growth. The Company may also make investments in "take or pay" prepayments
to support future wafer requirements or in acquiring complimentary businesses,
products or technologies.
During fiscal 1997, the Company made payments of $107 million, net of cash
acquired, in connection with the acquisitions of Western Digital's Connectivity
Solutions Group, CD-Recordable software technology from Corel, Inc., Data
Kinesis Inc., Sigmax Technologies Inc., Toast CD-R technology for the Macintosh
platform, and certain assets of Skipstone, Inc.. Additionally, the Company
acquired Cogent Data Technologies, Inc. in a transaction accounted for as a
pooling of interest through the issuance of 3 million shares of its common
stock. During fiscal 1997, the Company purchased property and equipment totaling
$88 million and entered into an agreement with Lucent Technologies, Inc.
("Lucent") to sell $21 million of equipment that it had previously purchased in
connection with a separate agreement that ensured availability of certain levels
of wafer capacity from Lucent. The new agreement canceled the initial capacity
agreement and required Lucent to purchase the equipment from the Company in
fiscal 1998.
FINANCING ACTIVITIES During fiscal 1998 financing activities provided $10
million compared to $203 million provided during fiscal 1997 and $5 million
during fiscal 1996. Cash provided by financing activities during fiscal 1998 and
fiscal 1996 was primarily through the issuance of common stock to employees
through its stock option and employee stock purchase plans for $39 million and
$16 million, respectively, offset in both years by repurchases of stock and
payments on debt.
Advance payments totaling $18 million were made in fiscal 1998 against a
promissory note for $35 million in connection with an agreement with Taiwan
Semiconductor Manufacturing Co., Ltd. ("TSMC") whereby the Company will make
advance payments totaling $35 million to secure additional wafer capacity for
future technology through 2001. In addition the Company made payments in fiscal
1998 totaling $3 million related to a term loan and repurchased common stock
totaling $8 million.
3
During fiscal 1997, the Company issued $230 million of 4-3/4% Convertible
Subordinated Notes due February 1, 2004, for which the Company received net
proceeds of $224 million. The notes provide for semi-annual interest payments
each February 1 and August 1, commencing on August 1, 1997. The holders of the
notes will be entitled at any time on or after May 5, 1997 through maturity to
convert the notes into common stock at a conversion price of $51.66 per share.
The notes are redeemable, in whole or in part, at the option of the Company, at
any time on or after February 3, 2000 at declining premiums to par. Debt
issuance costs are being amortized ratably over the term of the notes. During
fiscal 1997, the Company paid a $46 million short term note issued to TSMC in
connection with an agreement to ensure increased wafer capacity for future
technology through 2001. The Company also received proceeds from the issuance of
common stock totaling $28 million under its Stock Option and Employee Stock
Purchase Plans.
The Company has an unsecured $17 million revolving line of credit under which
there were no outstanding borrowings as of March 31, 1998.
In February 1998, the Company entered into an agreement to purchase all of the
outstanding stock of Symbios for approximately $768 million in cash. The
completion of the Symbios acquisition is subject to regulatory approval. The
Company anticipates arranging for two rounds of financing to fund the
acquisition. The first round is expected to be a bank revolving loan for
approximately $500 million to be available upon close of the acquisition.
Following the close, the Company expects to undertake a public debt-offering for
approximately $250 million. The proceeds of the debt offering would generally be
used to pay down the bank loan. There can be no assurance that such financings
will be available on favorable terms, or at all. The Company's liquidity is
affected by various factors, some based on continuing operations of the business
and others related to the industry and global economies. Although the Company's
cash position will fluctuate based on the timing of these factors, the Company
believes that existing working capital combined with expected cash generated
from operations and available sources of financing will be sufficient to meet
its cash requirements throughout fiscal 1999.
CHANGE IN ACCOUNTING POLICY
EITF 97-13 was issued in November 1997 and requires that business process
reengineering costs be expensed as incurred. The transition provisions of EITF
97-13 require that companies that had previously capitalized such business
process reengineering costs charge off any unamortized amounts as the cumulative
effect of a change in accounting principle. The cumulative effect of the change
to the Company was to decrease net income by $9 million.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130 ("SFAS 130") "Reporting Comprehensive
Income," which establishes standards for reporting and displaying comprehensive
income and its components in a full set of general purpose statements. The
disclosure requirements of SFAS 130 are first expected to be reflected in the
Company's first quarter of fiscal 1999 interim financial statements. In June
1997, the FASB issued SFAS No. 131 "Disclosures and Segments of an Enterprise
and Related Information," which establishes annual and interim reporting
standards for an enterprise's business segments and related disclosures about
its products, services, geographic areas and major customers. SFAS 131 will be
first reflected in the Company's fiscal 1999 Annual Report. Adoption of SFAS 130
and SFAS 131 will not impact the Company's consolidated financial position,
results of operations or cash flows.
In October 1997, the American Institute of Certified Public Accountants'
("AICPA") issued Statement of Position ("SOP") 97-2 "Software Revenue
Recognition". This SOP supersedes SOP 91-1 "Software Revenue Recognition" and
provides more stringent guidelines for revenue recognition. Adoption of this
statement is not expected to have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
MARKET RISK DISCLOSURE
At March 31, 1998, the Company's investment portfolio consisted of fixed income
securities, excluding those classified as cash equivalents, of $470 million (see
Note 4 of Notes to Consolidated Financial Statements). These securities, are
subject to interest rate risk and will decline in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10% from levels as of March 31, 1998, the decline in the fair value of the
portfolio would not be material.
4
The Company's long term debt bears interest at a fixed rate while the note
payable to TSMC bears no interest. Accordingly, an immediate 10% change in
interest rates would not result in the Company's long-term debt or note payable
to TSMC having any effect on the Company's results of operations.
The Company enters into forward exchange contracts to hedge certain firm
commitments denominated in foreign currencies. The Company does not use
derivative financial instruments for trading or speculative purposes. Forward
exchange contracts are denominated in the same currency as the underlying
transaction (primarily Singapore dollars) and the terms of the forward foreign
exchange contracts generally match the terms of the underlying transactions. The
effect of an immediate 10% change in exchange rates on the forward exchange
contracts would not be material to the Company's financial condition or results
of operation.
YEAR 2000
The "Year 2000 issue" arises because most computer systems and programs were
designed to handle only a two-digit year not a four-digit year. When the Year
2000 begins, these computers may interpret "00" as the year 1900 and could
either stop processing date-related computations or could process them
incorrectly. The Company has recently implemented new information systems and
accordingly does not anticipate any internal Year 2000 issues from its own
information systems, databases or programs. However, the Company could be
adversely impacted by Year 2000 issues faced by major distributors, suppliers,
customers, vendors and financial service organizations with which the Company
interacts. The Company has sent surveys to certain third parties to determine
whether they are Year 2000 compliant and is in the process of evaluating and
following up on responses to determine the impact that third parties who are not
Year 2000 compliant may have on the operations of the Company. The Company
believes it is currently being impacted by the redirection of corporate
management information system budgets towards resolving the Year 2000 issue.
Continuation of this trend could lower the demand for the Company's products if
corporate buyers defer purchases of high-end business PCs.
RISK FACTORS
This annual report may contain forward-looking statements regarding future
events or the future performance of the Company. Actual events or results could,
of course, differ materially. Various factors could adversely affect its results
of operations in the future including its dependence on the high-performance
microcomputer, server and peripherals markets, changes in product mix,
competitive pricing pressures, changes in technological standards, dependence on
wafer suppliers and other subcontractors, changes in product costs, certain
risks associated with acquisitions of other companies or businesses that the
Company may make from time to time, issues related to distributors, dependence
on key personnel, risks associated with international operations, risks
associated with implementation and utilization of new systems, and risks
associated with intellectual property or general economic downturns. In
addition, there can be no assurance that the Company will receive regulatory
approval to consummate the Symbios acquisition nor can there be any assurance
that financing required to fund the acquisition will be available on favorable
terms, or at all. For a more complete discussion of these factors, please refer
to the Business section of the Company's Annual Report on Form 10-K for the
fiscal year ended March 31, 1998 and the Company's other public filings it makes
from time to time.
5
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Year Ended March 31, 1998 1997 1996
------------ ------------ ------------
Net revenues $ 1,007,293 $ 933,868 $ 659,347
Cost of revenues 391,100 388,969 275,939
------------ ------------ ------------
Gross profit 616,193 544,899 383,408
------------ ------------ ------------
Operating expenses
Research and development 172,522 128,530 87,628
Sales, marketing, and administrative 218,839 162,979 117,332
Write-off of acquired in-process technology and other
charges -- 92,162 52,313
------------ ------------ ------------
391,361 383,671 257,273
------------ ------------ ------------
Income from operations 224,832 161,228 126,135
------------ ------------ ------------
Interest income 32,899 13,297 12,694
Interest expense (12,402) (2,744) (840)
------------ ------------ ------------
20,497 10,553 11,854
------------ ------------ ------------
Income before income taxes and cumulative effect of a
change in accounting principle 245,329 171,781 137,989
Provision for income taxes 63,452 64,220 34,614
------------ ------------ ------------
Income before cumulative effect of a change in accounting
principle 181,877 107,561 103,375
Cumulative effect of a change in accounting principle, net of
tax benefit 9,000 -- --
------------ ------------ ------------
Net income $ 172,877 $ 107,561 $ 103,375
============ ============ ============
Net income per share:
Basic
Income before cumulative effect of a change in
accounting principle $ 1.61 $ 0.99 $ 0.99
Cumulative effect of a change in accounting principle 0.08 -- --
------------ ------------ ------------
$ 1.53 $ 0.99 $ 0.99
============ ============ ============
Diluted
Income before cumulative effect of a change in
accounting principle $ 1.54 $ 0.93 $ 0.95
Cumulative effect of a change in accounting principle 0.08 -- --
------------ ------------ ------------
$ 1.46 $ 0.93 $ 0.95
============ ============ ============
Shares used in computing net income per share:
Basic 113,172 108,456 104,136
Diluted 118,432 115,596 109,073
============ ============ ============
See accompanying notes.
6
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
As of March 31, 1998 1997
---------- ----------
ASSETS
Current assets
Cash and cash equivalents $ 227,183 $ 318,075
Marketable securities 470,199 230,366
Accounts receivable, net of allowance for doubtful
accounts of $4,185 in 1998 and $5,098 in 1997 132,526 123,303
Inventories 71,297 53,184
Deferred income taxes 46,479 31,982
Prepaid expenses and other 44,286 61,038
---------- ----------
Total current assets 991,970 817,948
Property and equipment, net 194,798 141,599
Other assets 88,461 83,947
---------- ----------
$1,275,229 $1,043,494
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current portion of long-term debt $ 850 $ 3,400
Note payable 17,640 --
Accounts payable 48,047 52,400
Accrued liabilities 73,947 68,519
---------- ----------
Total current liabilities 140,484 124,319
---------- ----------
Long-term debt, net of current portion 230,000 230,850
---------- ----------
Commitments and Contingencies (Note 11)
Stockholders' equity
Preferred stock; $0.001 par value
Authorized shares, 1,000; Series A shares,
250 designated
Outstanding shares, none -- --
Common stock; $0.001 par value
Authorized shares, 400,000
Outstanding shares, 113,981 in 1998 and 111,540 in 1997 114 112
Additional paid-in capital 295,263 251,722
Retained earnings 609,368 436,491
---------- ----------
Total stockholders' equity 904,745 688,325
---------- ----------
$1,275,229 $1,043,494
========== ==========
See accompanying notes.
7
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended March 31, 1998 1997 1996
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 172,877 $ 107,561 $ 103,375
Adjustments to reconcile net income to net cash provided
by operating activities:
Cumulative effect of a change in accounting
principle, net of tax 9,000 -- --
Write-off of acquired in-process technology and other
charges, net of taxes -- 88,691 39,686
Depreciation and amortization 42,896 28,611 17,593
Provision for doubtful accounts 4,000 1,000 250
Write-down of goodwill and minority investments 6,800 -- --
Deferred income taxes (14,497) (13,896) (6,137)
Income tax benefit of employees' stock transactions 12,390 22,144 10,947
Changes in assets and liabilities, net of the effect
of acquisitions:
Accounts receivable (13,223) (36,984) (29,946)
Inventories (18,113) 11,998 (20,516)
Prepaid expenses and other 16,752 (3,878) (3,617)
Other assets 22,130 3,329 (16,952)
Accounts payable (4,353) 25,968 (167)
Accrued liabilities 8,428 10,948 21,969
---------- ---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 245,087 245,492 116,485
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of certain net assets in connection with acquisitions
accounted for under the purchase method of accounting -- (107,214) (31,177)
Investments in property and equipment, net (97,699) (87,959) (41,907)
Investments in marketable securities, net (239,833) (26,083) (24,372)
Purchase of minority investments (8,560) -- --
---------- ---------- ----------
NET CASH USED FOR INVESTING ACTIVITIES (346,092) (221,256) (97,456)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of convertible debt -- 223,905 --
Payments of short-term note (17,640) (46,200) --
Proceeds from issuance of common stock 38,921 28,323 16,512
Repurchases of common stock (7,768) -- (7,765)
Principal payments on debt (3,400) (3,400) (3,400)
---------- ---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 10,113 202,628 5,347
---------- ---------- ----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (90,892) 226,864 24,376
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 318,075 91,211 66,835
---------- ---------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 227,183 $ 318,075 $ 91,211
========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS
Interest paid $ 11,218 $ 641 $ 764
Income taxes paid $ 58,537 $ 67,118 $ 32,869
---------- ---------- ----------
See accompanying notes.
8
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Common Stock Additional
------------------------- Paid-in Retained
Shares Amount Capital Earnings Total
---------- ---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1995 103,354 $ 103 $ 140,088 $ 231,453 $ 371,644
Sale of common stock under
employee purchase and option plans 2,436 3 16,509 -- 16,512
Issuance of common stock in connection
with acquisition 770 1 17,231 -- 17,232
Income tax benefit of employees'
stock transactions -- -- 10,947 -- 10,947
Repurchases of common stock (520) (1) (1,949) (5,815) (7,765)
Net income -- -- -- 103,375 103,375
---------- ---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1996 106,040 106 182,826 329,013 511,945
Sale of common stock under
employee purchase and option plans 2,814 3 28,320 -- 28,323
Issuance of common stock in connection
with acquisition 2,686 3 18,432 (83) 18,352
Income tax benefit of employees'
stock transactions -- -- 22,144 -- 22,144
Net income -- -- -- 107,561 107,561
---------- ---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1997 111,540 112 251,722 436,491 688,325
Sale of common stock under
employee purchase and option plans 2,791 3 38,918 -- 38,921
Income tax benefit of employees'
stock transactions -- -- 12,390 -- 12,390
Repurchases of common stock (350) (1) (7,767) -- (7,768)
Net income -- -- -- 172,877 172,877
---------- ---------- ---------- ---------- ----------
BALANCE, MARCH 31, 1998 113,981 $ 114 $ 295,263 $ 609,368 $ 904,745
========== ========== ========== ========== ==========
See accompanying notes.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of intercompany transactions and
balances. Certain prior year amounts have been reclassified to conform to the
current year presentation. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates. In March 1998, the Company was reincorporated in the State of
Delaware. The accompanying consolidated financial statements have been
retroactively restated to give effect to the reincorporation.
FOREIGN CURRENCY TRANSLATION
For foreign subsidiaries whose functional currency is the local currency, the
Company translates assets and liabilities to U.S. dollars using year end
exchange rates and translates revenues and expenses using average exchange rates
during the year. Exchange gains and losses arising from translation of foreign
entity financial statements are included as a component of stockholders' equity.
For foreign subsidiaries whose functional currency is the U.S. dollar, certain
assets and liabilities are remeasured at the year end or historical rates as
appropriate. Revenues and expenses are remeasured at the average rates during
the year. Currency transaction gains and losses are recognized in current
operations and have not been material to the Company's operating results in any
period.
CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash equivalents consist of highly liquid investments with original maturities
of three months or less. The Company's marketable securities are classified as
available for sale and, at the balance sheet date, are reported at fair market
value which approximates cost.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
marketable securities, and trade accounts receivable. The Company places its
marketable securities primarily in municipal bonds, corporate bonds and
government securities, all of which are of high investment grade. The Company,
by policy, limits the amount of credit exposure through diversification and
investment in highly rated securities. Sales to customers are denominated in
U.S. dollars. As a result, the Company believes its foreign currency risk is
minimal.
The Company sells its products to original equipment manufacturers and
distributors throughout the world. The Company performs ongoing credit
evaluations of its customers' financial condition and, generally, requires no
collateral from its customers. The Company maintains an allowance for doubtful
accounts based upon the expected collectibility of all accounts receivable.
During fiscal 1998 the Company increased its allowance for bad debts by $4
million to reflect current business conditions in the disk drive market,
otherwise the Company has historically not experienced significant losses on
accounts receivable.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company enters into foreign currency contracts in order to reduce the impact
of certain foreign currency fluctuations. Firmly committed transactions
denominated in foreign currencies are hedged with forward exchange contracts.
Gains and losses related to hedges of firmly committed transactions are deferred
and recognized in income when the hedged transaction occurs. The Company does
not hold or issue derivative financial instruments for trading or speculative
purposes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
For certain of the Company's financial instruments, including cash and cash
equivalents, marketable securities, accounts receivable, notes payable and
accounts payable, the carrying amounts approximate fair value due to their short
maturities. The estimated fair value of the Company's convertible subordinated
notes and forward exchange contracts was $190 million and $8 million,
respectively, at March 31, 1998. The estimated fair values of the convertible
subordinated notes and forward exchange contracts are primarily based on quoted
market prices.
10
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or market.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated or amortized using the
straight-line method over the estimated useful lives of the assets.
CHANGE IN ACCOUNTING POLICY FOR BUSINESS PROCESS REENGINEERING COSTS
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the Financial
Accounting Standards Board issued EITF 97-13 "Accounting for Costs Incurred in
Connection with a Consulting Contract that Combines Business Process
Reengineering and Information Technology Transformation." EITF 97-13 requires
that business process reengineering costs incurred in connection with an overall
information technology transformation project be expensed as incurred. The
transition provisions of EITF 97-13 require that companies that had previously
capitalized such business process reengineering costs charge off any unamortized
amounts as a cumulative effect of a change in accounting principle. The
cumulative effect of the change to the Company was to decrease net income by $9
million (net of tax benefit of $3 million).
Pro forma amounts assuming the new accounting principle was applied during all
periods presented follow with comparison to actual amounts reported:
(In thousands, except per share amounts)
Year Ended March 31,
------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Net Income
As reported $ 172,877 $ 107,561 $ 103,375
Pro forma $ 179,197 $ 101,436 $ 103,180
Net income per share:
Basic
As reported $ 1.53 $ 0.99 $ 0.99
Pro forma $ 1.58 $ 0.94 $ 0.99
Diluted
As reported $ 1.46 $ 0.93 $ 0.95
Pro forma $ 1.51 $ 0.88 $ 0.95
PRODUCT DEVELOPMENT COSTS
The Company's policy is to capitalize internal software development costs
incurred after technological feasibility has been demonstrated. Such internal
software development costs have not been capitalized to date since they were
immaterial.
IMPAIRMENT OF OTHER ASSETS
The Company's other assets include goodwill and minority investments. Goodwill
and minority investments are evaluated periodically for potential impairment
based on the future estimated cash flows of the acquired technology/investment.
Goodwill amortization totaling $9 million, $8 million and $2 million was
included in the Company's consolidated statements of operations during 1998,
1997 and 1996, respectively.
REVENUE RECOGNITION
The Company recognizes revenue upon satisfaction of contractual obligations
which is generally at the time of shipment. The Company records provisions for
estimated returns and allowances at the time of sale.
STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees." The Company's policy is to grant options with an
exercise price equal to the quoted market price of the Company's stock on the
grant date. Accordingly, no compensation cost has been recognized in the
Company's consolidated statements of operations. The Company has provided
additional pro forma disclosures as required under Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation."
11
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income," which establishes standards for reporting and displaying comprehensive
income and its components in a full set of general-purpose statements. The
disclosure requirements of SFAS 130 are first expected to be reflected in the
Company's first quarter of fiscal 1999 interim statements. In June 1997, the
FASB issued SFAS No. 131 ("SFAS 131"), "Disclosures about Segments of an
Enterprise and Related Information," which establishes annual and interim
reporting standards for an enterprise's business segments and related
disclosures about its products, services, geographic areas, and major customers.
SFAS 131 will be first reflected in the Company's fiscal 1999 Annual Report.
Adoption of SFAS 130 and SFAS 131 will not impact the Company's consolidated
financial position, results of operations or cash flows.
In October 1997, the American Institute of Certified Public Accountants'
("AICPA") issued Statement of Position ("SOP") 97-2 "Software Revenue
Recognition." This SOP supersedes SOP 91-1 "Software Revenue Recognition" and
provides more stringent guidelines for revenue recognition. Adoption of this
statement is not expected to have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
NOTE 2. NET INCOME PER SHARE
Basic net income per share is computed by dividing net income available to
common stockholders (numerator) by the weighted average number of common shares
outstanding (denominator) during the period and excludes the dilutive effect of
stock options. Diluted net income per share gives effect to all dilutive
potential common shares outstanding during a period. In computing Diluted net
income per share, the average stock price for the period is used in determining
the number of shares to be purchased from exercise of stock options. All prior
period net income per share data presented has been restated in accordance with
SFAS 128.
Following is a reconciliation of the numerators and denominators of the Basic
and Diluted net income per share computations for the years ended March 31:
(In thousands, except per share amounts)
1998 1997
-------------------------------------------- --------------------------------------------
Income Shares Per-Share Income Shares Per-Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
BASIC
Net Income available to
common stockholders $172,877 113,172 $ 1.53 $107,561 108,456 $ 0.99
======= =======
EFFECT OF DILUTIVE SECURITIES
Common Stock Equivalents -- 5,260 -- 6,447
4.75% convertible
subordinated notes -- -- 441 693
-------- -------- -------- --------
DILUTED
Net income available to
common stockholders and
assumed conversions $172,877 118,432 $ 1.46 $108,002 115,596 $ 0.93
======== ======== ======= ======== ======== =======
(In thousands, except per share amounts)
1996
--------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ---------
BASIC
Net Income available to
common stockholders $103,375 104,136 $ 0.99
=======
EFFECT OF DILUTIVE SECURITIES
Common Stock Equivalents -- 4,937
4.75% convertible
subordinated notes -- --
-------- --------
DILUTED
Net income available to
common stockholders and
assumed conversions $103,375 109,073 $ 0.95
======== ======== =======
The conversion of 4,452,000 shares of common stock related to the Convertible
Subordinated Notes was not included in the computation of Diluted net income per
share for the year ended March 31, 1998 as the impact is anti-dilutive.
Options to purchase 2,369,000, 203,000 and 619,000 shares of common stock were
outstanding at March 31, 1998, 1997 and 1996 respectively, but were not included
in the computation of Diluted net income per share because the options' exercise
price was greater than the average market price of the common shares.
NOTE 3. ACQUISITIONS
In February 1998, the Company entered into an agreement to purchase all of the
outstanding stock of Symbios, Inc. ("Symbios"), a wholly owned subsidiary of
Hyundai Electronics America for approximately $768 million. Symbios is a
supplier of SCSI devices, OEM storage systems and ASIC solutions. In March 1998,
the Company entered into an agreement to purchase read channel ASIC technology
from Analog Devices, Inc. ("ADI"). The agreement calls for an initial
12
cash payment of $34 million, to be followed by subsequent payments totaling $6
million for research and development services during a transition period, and up
to $20 million in royalties based on sales by the Company of products
incorporating the acquired ADI technology. At March 31, 1998, completion of the
Symbios and ADI acquisitions were subject to regulatory approval under the
Hart-Scott-Rodino Act. Both acquisitions will be accounted for under the
purchase accounting method. The Company will evaluate the allocation of the
purchase price to assets acquired, which include in-process technology that will
be written off, and goodwill which will be amortized over the respective benefit
periods.
During fiscal 1997, the Company acquired complementary businesses and
technologies consisting of Western Digital's Connectivity Solutions Group, CD-R
software technology from Corel, Inc., Data Kinesis, Inc., Sigmax Technology,
Inc., Toast CD-R technology, and certain assets from Skipstone, Inc. for an
aggregate amount of approximately $109 million in cash and $15 million in stock.
These companies design and develop silicon solutions for the SCSI disk drive
market, CD creator for the CD-R software market, software for improving system
performance in file management and RAID applications, CD-ROM controllers for
ATAPI CD-ROM drivers and, CD-R technology for Macintosh platforms. During fiscal
1996, the Company acquired all of the outstanding capital stock of Future Domain
Corporation, Power I/O, Inc., Trillium Research, Inc., and Incat Systems
Software USA, Inc. for an aggregate amount of approximately $35 million in cash
and $17 million in stock.
The Company accounted for these acquisitions using the purchase method of
accounting, and excluding the aggregate $90 million and $52 million write-offs
of acquired in-process technology from these acquisitions for fiscal 1997 and
1996, respectively, the aggregate impact for the respective fiscal year on the
Company's consolidated statements of operations from the acquisition date was
not material. The accounting for the write-off changed in fiscal 1997 due to an
interpretation of SFAS 109 that the Company adopted upon its issuance. In fiscal
1996, the Company was allowed to gross-up the acquired in-process technology and
record a dollar-for-dollar credit through its tax provision.
The allocation of the Company's aggregate purchase price to the tangible and
identifiable intangible assets acquired and liabilities assumed was based
primarily on independent appraisals and estimates of fair value and is
summarized as follows:
(In thousands)
1997 1996
-------- --------
Tangible assets $ 10,979 $ 8,108
In-process technology 90,457 52,313
Goodwill 22,855 8,200
-------- --------
Assets acquired 124,291 68,621
-------- --------
Accounts payable and accrued liabilities -- 3,125
Deferred tax liability -- 12,627
-------- --------
Liabilities assumed -- 15,752
-------- --------
Net assets acquired $124,291 $ 52,869
======== ========
The tangible assets acquired were primarily comprised of inventory and
equipment. Acquired in-process technology was written off in the periods in
which the acquisitions were completed, and the goodwill is being amortized over
respective benefit periods ranging from two to five years.
On August 12, 1996, the Company completed its acquisition of Cogent Data
Technologies, Inc. ("Cogent"). The Company acquired all of the outstanding
capital stock of Cogent in exchange for approximately 3 million shares of its
common stock. Additionally, the Company incurred $2 million in professional fees
related to this acquisition which were included in "write-off of acquired
in-process technology and other." The Company recorded this acquisition using
the pooling of interests method of accounting. Cogent's historical operations,
net assets, and cash flows were not material to the Company's consolidated
financial statements and, therefore, were not reflected in the Company's
consolidated financial results prior to the acquisition. Beginning at the date
of acquisition, the book value of the acquired assets and assumed liabilities as
well as the results of Cogent's operations and cash flows, all of which were not
material to the Company were combined with those of the Company.
13
NOTE 4. MARKETABLE SECURITIES
The Company's portfolio of marketable securities consists of the following:
(In thousands)
1998 1997
-------- --------
Municipal bonds $186,346 $230,366
Corporate bonds 185,665 --
U.S. government securities 98,188 --
-------- --------
$470,199 $230,366
======== ========
At March 31, 1998 and 1997, the net unrealized holding gains and losses on
securities were immaterial. The marketable securities at March 31, 1998 and 1997
by contractual maturity are shown below:
(In thousands)
1998 1997
-------- --------
Mature in one year or less $216,252 $ 83,124
Mature after one year through three years 253,947 147,242
-------- --------
$470,199 $230,366
======== ========
At March 31, 1998, marketable securities totaling $175 million were classified
as cash equivalents and included municipal bonds, corporate bonds and U.S.
government securities of $6 million, $13 million and $156 million, respectively.
At March 31, 1997 marketable securities totaling $17 million, comprising of
municipal bonds, were classified as cash equivalents.
NOTE 5. BALANCE SHEET DETAIL
INVENTORY
(In thousands)
1998 1997
-------- --------
Raw materials $ 17,728 $ 12,958
Work-in-process 18,415 14,370
Finished goods 35,154 25,856
-------- --------
$ 71,297 $ 53,184
======== ========
14
PROPERTY AND EQUIPMENT
(In thousands)
Life 1998 1997
-------------- -------- --------
Land -- $ 41,017 $ 29,698
Buildings and improvements 5-40 years 50,761 26,142
Machinery and equipment 3-5 years 106,173 79,386
Furniture and fixtures 3-8 years 69,040 31,763
Leasehold improvements Life of lease 6,662 6,583
Construction in progress -- 4,578 25,976
-------- --------
278,231 199,548
Accumulated depreciation and amortization (83,433) (57,949)
-------- --------
$194,798 $141,599
======== ========
OTHER ASSETS
(In thousands)
1998 1997
-------- --------
TSMC advance payments (see Note 11) $ 63,840 $ 53,200
Goodwill, net of accumulated amortization
of $19,855 in 1998 and $7,633 in 1997 11,213 23,435
Minority investments 5,100 --
Other 8,308 7,312
-------- --------
$ 88,461 $ 83,947
======== ========
ACCRUED LIABILITIES
(In thousands)
1998 1997
-------- --------
Accrued compensation and related taxes $ 25,273 $ 25,514
Acquisition related 2,374 12,751
Sales and marketing related 11,036 12,464
Tax related 25,208 8,038
Other 10,056 9,752
-------- --------
$ 73,947 $ 68,519
======== ========
15
NOTE 6. LINE OF CREDIT
The Company has available an unsecured $17 million revolving line of credit
which expires on December 31, 1998. As of March 31, 1998, no borrowings were
outstanding under this line of credit. The Company may select its own method of
interest payment on borrowings based upon the bank's CD rate plus one percent,
Eurodollar rate plus one percent, or prime lending rate. A commitment fee of
- -1/4% per annum is payable on the unused line of credit. Under the arrangement,
the Company is restricted from paying dividends in excess of 25% of the prior
fiscal years net income, and the Company is required to maintain certain
financial ratios among other restrictive covenants. The Company was in
compliance with all such covenants as of March 31, 1998.
NOTE 7. LONG-TERM DEBT
In February 1997, the Company issued $230 million of 4-3/4% convertible
subordinated notes due on February 1, 2004. The Company received net proceeds of
$224 million. The notes provide for semi-annual interest payments each February
1 and August 1, commencing on August 1, 1997. The holders of the notes will be
entitled at any time on or after May 5, 1997 through February 1, 2004 to convert
the notes into common stock at a conversion price of $51.66 per share. The notes
are redeemable, in whole or in part, at the option of the Company, at any time
on or after February 3, 2000 at declining premiums to par. Debt issuance costs
are being amortized over the term of the notes.
The Company entered into a $17 million term loan agreement in June 1992 bearing
interest at 7.65%, with principal and interest payable in quarterly installments
of $850,000. All outstanding principal and accrued but unpaid interest is due
and payable in June 1998. Under the arrangement, the Company is restricted from
paying dividends in excess of 25% of the prior fiscal year's net income, and the
Company is required to maintain certain financial ratios among other restrictive
covenants. The Company was in compliance with all such covenants as of March 31,
1998.
NOTE 8. STOCKHOLDERS' EQUITY
1986 EMPLOYEE STOCK PURCHASE PLAN
The Company has authorized 5,600,000 shares of common stock for issuance under
the 1986 Employee Stock Purchase Plan (1986 Plan). Qualified employees may elect
to have a certain percentage (not to exceed 10%) of their salary withheld
pursuant to the 1986 Plan. The salary withheld is then used to purchase shares
of the Company's common stock at a price equal to 85% of the market value of the
stock at the beginning or ending of a three-month offering period, whichever is
lower. Under this Plan, 359,849 and 285,336 shares were issued during fiscal
1998 and 1997, representing approximately $9 million and $7 million in employee
contributions, respectively.
1990 STOCK PLAN
The Company's 1990 Stock Plan allows the Board of Directors to grant to
employees, officers, and consultants options to purchase common stock or other
stock rights at exercise prices not less than 50% of the fair market value of
the underlying common stock on the date of grant. The expiration of options or
other stock rights is not to exceed ten years after the date of grant. To date,
the Company has issued substantially all incentive and non-statutory stock
options under this Plan at exercise prices of 100% of fair market value of the
underlying common stock on the respective dates of grant. Generally, options
vest and become exercisable over a four year period.
16
Option activity under the 1990 Stock Plan is as follows:
Options Outstanding
-------------------------------
Options Weighted Average
Available Shares Exercise Price
----------- ----------- ---------------
BALANCE,MARCH 31, 1995 7,916,254 9,566,500 $ 7.41
Authorized 4,387,800 -- --
Granted (4,589,500) 4,589,500 $22.28
Exercised -- (2,034,262) $ 5.80
Cancelled 482,076 (482,076) $12.78
----------- ----------- ------
BALANCE, MARCH 31, 1996 8,196,630 11,639,662 $13.32
Authorized 9,833,906 -- --
Granted (7,296,738) 7,296,738 $24.69
Exercised -- (2,414,728) $ 8.58
Cancelled 1,555,300 (1,555,300) $19.33
----------- ----------- ------
BALANCE, MARCH 31, 1997 12,289,098 14,966,372 $19.05
Authorized 4,846,065 -- $ --
Granted (15,509,116) 15,509,116 $28.81
Exercised -- (2,393,758) $12.05
Cancelled 10,990,488 (10,990,488) $33.30
----------- ----------- ------
BALANCE, MARCH 31, 1998 12,616,535 17,091,242 $19.69
=========== =========== ======
Options exercisable at:
March 31, 1996 3,913,534 $ 7.90
March 31, 1997 5,397,068 $12.97
March 31, 1998 6,861,531 $16.41
The following table summarizes information about the 1990 Stock Plan at March
31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ----------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AT 3/31/198 CONTRACTUAL LIFE EXERCISE PRICE AT 3/31/98 EXERCISE PRICE
- ---------------- ------------ ---------------- -------------- ----------- --------------
$ 0.37 - $10.00 3,213,690 5.8 $ 7.28 2,796,758 $ 7.59
$10.01 - $20.00 378,424 6.8 $14.65 265,791 $14.30
$20.01 - $30.00 13,463,261 8.4 $22.75 3,788,698 $23.01
$30.01 - $40.00 33,017 9.1 $37.97 10,034 $38.61
$40.01 - $52.50 2,850 9.5 $46.32 250 $41.88
------------ ----------
17,091,242 7.9 $19.69 6,861,531 $16.41
============ ==========
17
1990 DIRECTORS' OPTION PLAN
The 1990 Directors' Option Plan provides for the automatic grant to non-employee
directors of non-statutory stock options to purchase common stock at the fair
market value of the underlying common stock on the date of grant, which is
generally the last day of each fiscal year except for the first grant to any
newly elected director. Each current director receives an option at the end of
each fiscal year for 10,000 shares, which vests quarterly and over a one year
period. Upon joining the board, each new non-employee director receives an
option for 40,000 shares which vests over four years. Prior to March 31, 1997,
annual grants vested over a four year period. All options granted prior to March
31, 1997 expire five years after the date of grant, whereas all subsequent
grants expire ten years after the date of grant.
Option activity under the 1990 Directors' Option Plan is as follows:
Options Outstanding
------------------------------
Options Weighted Average
Available Shares Exercise Price
--------- -------- ----------------
BALANCE, MARCH 31, 1995 880,000 462,500 $ 8.26
Granted (300,000) 300,000 $23.12
Exercised -- (110,000) $ 4.10
--------- -------- ------
BALANCE, MARCH 31, 1996 580,000 652,500 $15.80
Authorized 800,000 -- $ --
Granted (70,000) 70,000 $37.25
Exercised -- (113,750) $ 6.73
--------- -------- ------
BALANCE, MARCH 31, 1997 1,310,000 608,750 $19.96
Granted (120,000) 120,000 $29.83
Exercised -- (101,250) $ 9.32
--------- -------- ------
BALANCE, MARCH 31, 1998 1,190,000 627,500 $23.56
========= ======== ======
Options exercisable at:
March 31, 1996 187,500 $ 7.52
March 31, 1997 248,750 $14.10
March 31, 1998 342,500 $22.03
The following table summarizes information about the 1990 Directors' Option Plan
at March 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- -----------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AT 3/31/98 CONTRACTUAL LIFE EXERCISE PRICE AT 3/31/98 EXERCISE PRICE
--------------- ----------- ---------------- -------------- ----------- --------------
$ 6.25 - $10.00 67,500 0.9 $ 9.19 67,500 $ 9.19
$10.01 - $20.00 87,500 2.0 $16.50 62,500 $16.50
$20.01 - $30.00 362,500 4.3 $22.45 142,500 $23.07
$30.01 - $40.00 70,000 8.9 $37.25 70,000 $37.25
$40.01 - $50.00 40,000 9.5 $49.38 -- $ --
---------- ----------
627,500 4.5 $23.56 342,500 $22.03
========== ==========
18
PRO FORMA INFORMATION
Pro forma information regarding net income and earnings per share is required to
be determined as if the Company had accounted for its Employee Purchase Plan,
1990 Stock Plan, and 1990 Directors' Option Plan, collectively called "options"
under the fair value method of SFAS 123. The fair value of options granted in
fiscal 1997 and fiscal 1998 reported below has been estimated at the date of
grant using a Black-Scholes option pricing model with the following weighted
average assumptions:
1990 Directors'
Employee Stock Purchase Plan 1990 Stock Plan Option Plan
---------------------------- ---------------------------- ---------------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ---- ---- ---- ----
Expected life (in years) 0.25 0.25 0.25 4 4 4 4.12 4.12 4.12
Risk-free interest rate 5.4% 5.2% 5.5% 5.4% 6.0% 5.9% 5.4% 6.0% 5.9%
Volatility 52% 44% 44% 52% 44% 44% 52% 44% 44%
Dividend yield -- -- -- -- -- -- -- -- --
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
the Company's options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in the opinion of management, the
existing models do not necessarily provide a reliable single measure of fair
value of its options. The weighted average estimated fair value of Employee
Stock Purchase Plan grants during 1998, 1997 and 1996 was $6.84, $6.65 and $4.46
per share, respectively. The weighted average estimated fair value of shares
granted under the 1990 Stock Plan during 1998, 1997 and 1996 was $18.44, $12.24
and $8.95, respectively. The weighted average estimated fair value of shares
granted under the 1990 Directors' Plan during 1998, 1997 and 1996 was $13.56,
$14.80 and $9.81, respectively.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for earnings per share
information):
1998 1997 1996
-------- -------- --------
Pro forma net income $127,351 $ 83,305 $ 97,956
Pro forma Basic net income per share $ 1.13 $ 0 .77 $ 0.94
Pro forma Diluted net income per share $ 1.08 $ 0 .72 $ 0.90
The effects on pro forma disclosures of applying SFAS 123 are not likely to be
representative of the effects on pro forma disclosures of future years, since it
is applicable only to options granted subsequent to March 31, 1995. The pro
forma effect of SFAS 123 will not be fully reflected until fiscal 1999.
REPRICING OF STOCK OPTIONS
During the fourth quarter of fiscal 1998, the Company approved the cancellation
and reissuance of outstanding options under the Company's stock option plans.
Under the program, holders of outstanding options with exercise prices in excess
of $22.31 per share were given the choice of retaining these options or of
obtaining in substitution new options for the same number of shares. The new
options are exercisable at a price of $22.31 per share, the fair market value of
the common stock on the reissue date. The new options maintain the vesting
schedule established by the canceled option, except that vesting is suspended
for six months while vesting for officers of the Company participating in the
stock repricing is suspended for twelve months.
RIGHTS PLAN
The Company has reserved 250,000 shares of Series A Preferred Stock for issuance
under the 1996 Rights Agreement which was amended and restated as of December 5,
1996. Under this plan, stockholders have received one Preferred Stock Purchase
Right ("Right") for each outstanding share of the Company's common stock. Each
Right will entitle stockholders to
19
buy one one-thousandth of a share of Series A Preferred Stock at an exercise
price of $180.00 per right. The Rights trade automatically with shares of the
Company's common stock. The Rights are not exercisable until ten days after a
person or group announces acquisition of 20% or more of the Company's
outstanding common stock or the commencement of a tender offer which would
result in ownership by a person or group of 20% or more of the then outstanding
common stock.
The Company is entitled to redeem the Rights at $0.01 per Right anytime on or
before the tenth day following such an acquisition or tender offer. This
redemption period may be extended by the Company in some cases. If, prior to
such redemption, the Company is acquired in a merger or other business
combination, a party acquires 20% or more of the Company's common stock, a 20%
stockholder engages in certain self-dealing transactions, or the Company sells
50% or more of its assets, each right will entitle the holder to purchase from
the surviving corporation, for $180.00 per share, common stock having a then
current market value of $360.00 per share.
The Series A Preferred Stock purchasable upon exercise of the Rights will not be
redeemable. Each share of Series A Preferred Stock will be entitled to an
aggregate dividend of 1,000 times the dividend declared per common stock. In the
event of liquidation, the holders of the Series A Preferred Stock will be
entitled to a preferential liquidation payment equal to 1,000 times the per
share amount to be distributed to the holders of the common stock. Each share of
Series A Preferred Stock will have 1,000 votes, voting together with the common
stock. In the event of any merger, consolidation or other transaction in which
the common stock are changed or exchanged, each share of Series A Preferred
Stock will be entitled to receive 1,000 times the amount received per common
stock. These rights are protected by customary anti-dilution provisions.
SHARES RESERVED FOR FUTURE ISSUANCE
At March 31, 1998, the Company has reserved the following shares of authorized
but unissued common stock:
1986 Employee Stock Purchase Plan 1,093,189
1990 Stock Plan 29,707,777
1990 Directors' Option Plan 1,817,500
Conversion of subordinated notes 4,452,187
----------
37,070,653
==========
STOCK REPURCHASE
In January 1998, the Company's board of directors authorized the purchase of up
to 10 million shares of the Company's common stock in the open market. During
fiscal 1998, the Company repurchased and retired approximately 350,000 shares of
its common stock from the open market for approximately $8 million. The
transactions were recorded as reductions to common stock and additional paid-in
capital.
NOTE 9. INCOME TAXES
The components of income before income taxes for the years ended March 31 are as
follows:
(In thousands)
1998 1997 1996
-------- -------- --------
Domestic $ 95,400 $ 74,866 $ 57,882
Foreign 149,929 96,915 80,107
-------- -------- --------
Income before income taxes $245,329 $171,781 $137,989
-------- -------- --------
The split of domestic and foreign income was impacted by the acquisition related
write-offs of in-process technology and other charges, which reduced domestic
income by $92 million for 1997 and $52 million for 1996.
20
The components of the provision for income taxes for the years ended March 31
are as follows:
(In thousands)
1998 1997 1996
-------- -------- --------
Federal
Current $ 46,362 $ 45,363 $ 22,066
Deferred (11,552) (10,025) (4,263)
-------- -------- --------
34,810 35,338 17,803
-------- -------- --------
Foreign
Current 21,520 21,418 15,074
Deferred (319) (1,961) (1,491)
-------- -------- --------
21,201 19,457 13,583
-------- -------- --------
State
Current 10,067 11,335 3,611
Deferred (2,626) (1,910) (383)
-------- -------- --------
7,441 9,425 3,228
-------- -------- --------
Provision for income taxes $ 63,452 $ 64,220 $ 34,614
======== ======== ========
The tax benefit associated with dispositions from employee stock plans reduces
taxes currently payable for 1998 by $12 million ($22 million and $11 million for
1997 and 1996, respectively). These benefits were recorded directly to
stockholders' equity
Significant components of the Company's deferred tax assets as of March 31 are
as follows
(In thousands)
1998 1997
-------- --------
Non-deductible reserves $ 16,024 $ 10,601
State taxes 2,054 1,922
Compensatory accruals 9,320 7,815
Various expense accruals 11,299 6,363
Capitalized technology 7,156 5,700
Other 626 (419)
-------- --------
Net deferred tax assets $ 46,479 $ 31,982
======== ========
The provision for income taxes differs from the amount computed by applying the
federal statutory tax rate to income before taxes for the years ended March 31
as follows:
1998 1997 1996
------ ------ ------
Federal statutory rate 35.0% 35.0% 35.0%
State taxes, net of federal benefit 2.3 2.7 2.7
Foreign subsidiary income at other
than the U.S. tax rate (10.9) (11.9) (11.8)
Tax-exempt interest income (1.7) (1.2) (2.1)
Acquisition write-off -- 12.4 --
Other 1.2 0.4 1.3
------ ------ ------
Effective income tax rate 25.9% 37.4% 25.1%
====== ====== ======
21
The Company's effective tax rate for fiscal 1998 was 26% compared to 37% and 25%
for fiscal 1997 and 1996. The Company's fiscal 1997 effective tax rate was 25%
exclusive of the effect of the book write-offs of in-process technology which
are not deductible for tax purposes. In prior years, the tax effect of similar
book write-offs were included in the cost of the purchased technology.
The Company's manufacturing subsidiary in Singapore is currently operating under
a tax holiday. If certain conditions are met, the tax holiday provides that
profits derived from certain products will be exempt from Singapore tax through
fiscal 2006. In addition, profits derived from the Company's remaining products
will be taxed at a lower rate than the Singapore statutory rate of 26%, through
fiscal 1999. As of March 31, 1998, the Company had not accrued income taxes on
$408 million of accumulated undistributed earnings of its Singapore subsidiary,
as these earnings will be reinvested indefinitely.
NOTE 10. SEGMENT INFORMATION
Adaptec operates predominately in one industry segment and provides solutions
that enhance bandwidth communication between servers, PC's, peripherals and
networks. The Company focuses its worldwide marketing efforts on major OEM
customers through its direct sales force located in the United States, Europe,
and Far East and also sells through distributors and sales representatives in
each of these geographic areas.
Income from operations consists of net revenues less cost of revenues and
operating expenses incurred in supporting the revenues of each geographic area.
The Company's write-offs of acquired in-process technology are included in the
corporate income from operations. All of the Company's identifiable assets are
used to support the operations in each geographic area. Corporate assets include
cash and cash equivalents, marketable securities, deferred tax assets, and
certain other assets. Intercompany sales are made at arms-length prices, and
revenues for the European subsidiaries consist mainly of commissions earned in
connection with obtaining foreign orders.
(In thousands)
Singapore, Adjustments
United Far East, and Consolidated
States Other Europe Corporate Eliminations Total
-------- --------- -------- ---------- ------------ ------------
Fiscal 1998
Revenues
Sales to customers $704,334 $302,457 $ 502 $ -- $ -- $1,007,293
Intercompany sales between
geographic areas 18,331 519,036 21,742 -- (559,109) --
-------- -------- -------- ---------- ---------- ----------
Net revenues $722,665 $821,493 $ 22,244 $ -- $ (559,109) $1,007,293
======== ======== ======== ========== ========== ==========
Income from operations $ 79,634 $144,086 $ 1,112 $ -- $ -- $ 224,832
Identifiable assets $388,557 $274,840 $ 4,105 $ 755,831 $ (148,104) $1,275,229
Fiscal 1997
Revenues
Sales to customers $782,622 $150,395 $ 851 $ -- $ -- $ 933,868
Intercompany sales between
geographic areas 4,261 546,678 11,188 -- (562,127) --
-------- -------- -------- ---------- ---------- ----------
Net revenues $786,883 $697,073 $ 12,039 $ -- $ (562,127) $ 933,868
======== ======== ======== ========== ========== ==========
Income from operations $157,936 $ 95,473 $ (19) $ (92,162) $ -- $ 161,228
Identifiable assets $352,312 $295,333 $ 3,242 $ 589,716 $ (197,109) $1,043,494
Fiscal 1996
Revenues
Sales to customers $609,060 $ 49,211 $ 1,076 $ -- $ -- $ 659,347
Intercompany sales between
geographic areas 7,205 399,036 6,175 -- (412,416) --
-------- -------- -------- ---------- ---------- ----------
Net revenues $616,265 $448,247 $ 7,251 $ -- $ (412,416) $ 659,347
======== ======== ======== ========== ========== ==========
Income from operations $100,838 $ 76,942 $ 668 $ (52,313) $ -- $ 126,135
Identifiable assets $201,128 $259,179 $ 2,644 $ 322,910 $ (139,375) $ 646,486
22
EXPORT REVENUES
The following table represents export revenues by geographic region as a
percentage of total revenues:
1998 1997 1996
---- ---- ----
Singapore, Far East, Other 38% 39% 32%
Europe 22% 22% 24%
---- ---- ----
60% 61% 56%
---- ---- ----
MAJOR CUSTOMERS
In fiscal 1998 and 1997, no customer accounted for more than 10% of net
revenues. In fiscal 1996, sales to one distributor represented 10% of net
revenues.
NOTE 11. COMMITMENTS AND CONTINGENCIES
The Company leases certain office facilities, vehicles, and certain equipment
under operating lease agreements that expire at various dates through fiscal
2009. As of March 31, 1998, the minimum future payments on existing leases
totaled $21 million. Rent expense was approximately $7 million, $6 million, and
$4 million during fiscal 1998, 1997 and 1996, respectively. The Company has a
commitment denominated in Singapore dollars related to the construction of the
Company's manufacturing facility in Singapore. To minimize the foreign currency
exposure related to this commitment, the Company entered into several forward
exchange contracts to purchase 13 million Singapore dollars. The maturities of
these instruments are less than 12 months. Deferred gains or losses are not
material.
During fiscal 1998, 1997, and 1996, the Company entered into agreements with
Taiwan Semiconductor Manufacturing Co., Ltd. ("TSMC") to ensure availability of
a portion of the Company's silicon wafer requirement for both current and future
technologies. The agreement runs through 2001 providing the Company with a
guarantee of increased capacity for wafer fabrication in return for advance
payments totaling $35 million, $15 million and $66 million in fiscal 1998, 1997,
and 1996, respectively. The advance payments that are expected to be utilized in
the next 12 months are classified in prepaid expenses and the remaining advanced
payments are classified in other assets and will be realized by the Company at
specified amounts over the agreement period. In fiscal 1998, the Company signed
a non-interest bearing promissory note for the $35 million advance payment. At
March 31, 1998, $18 million remained outstanding, and is due in June 1998. There
can be no assurance that the Company will be able to satisfy its future wafer
needs from current or alternative manufacturing sources. This could result in
possible loss of sales or reduced margins.
During fiscal 1997, the Company entered into an agreement with Lucent
Technologies, Inc. ("Lucent") to sell $21 million of equipment that it had
previously purchased in connection with a separate agreement that ensured
availability of certain levels of wafer capacity from Lucent. The new agreement
canceled the initial capacity agreement and required Lucent to purchase the
equipment from the Company in fiscal 1998.
Several class action lawsuits have been filed in the United States District
Court for the Northern District of California against the Company and certain of
its officers and directors. The actions all allege that the Company made false
and misleading statements at various times during the period between April 1997
and January 1998 in violation of the federal securities laws. The complaints do
not set forth purported damages. In addition, a number of derivative actions
have been filed in the Superior Court of the State of California against the
Company and certain of its officers and directors alleging that the individual
defendants improperly profited from transactions in the Company's stock during
the same time period referenced by the class action lawsuits. The Company
believes the lawsuits and derivative actions are without merit and intends to
defend itself vigorously.
The IRS is currently auditing the Company's income tax returns for fiscal 1994
to 1996. No proposed adjustments have been received for these years. The Company
believes sufficient taxes have been provided in prior years and that the
ultimate outcome of the IRS audits will not have a material adverse impact on
the Company's financial position or results of operations.
23
NOTE 12. RELATED PARTY TRANSACTIONS AND SUBSEQUENT EVENTS
During fiscal 1998, the Company invested $5 million in Series A Preferred Stock
representing a 19.9% interest in Ridge Technologies ("Ridge" ). In conjunction
with this investment, the Chairman and CEO of the Company became a director of
Ridge. During fiscal 1998, the Company incurred $900,000 in research and
development expenditures related to consulting services provided by Ridge. In
February 1998, the Company guaranteed a $7 million line of credit on behalf of
Ridge in exchange for a warrant to purchase up to 200,000 shares of Ridge common
stock. On May 21, 1998, the Company acquired Ridge in a stock transaction valued
at approximately $21 million and assumed stock options valued at approximately
$13 million.
The Chairman and CEO of the Company is a director of Analog Devices, Inc.
("ADI"). In April 1998, the Company received regulatory approval to purchase
read channel ASIC technology from ADI (see Note 3).
During fiscal 1998, the Company invested $1 million in, and entered into a
development and license agreement with, a venture stage company whose founder
and CEO is a director of the Company. Two other directors of the Company are
also directors of the start up company.
NOTE 13. COMPARATIVE QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data is as follows:
(In thousands, except per share amounts)
Quarters
--------------------------------------------------
First Second Third Fourth Year
-------- -------- -------- -------- ----------
FISCAL 1998
Net revenues $271,442 $278,088 $254,163 $203,600 $1,007,293
Gross profit $163,948 $173,558 $158,859 $119,828 $ 616,193
Net income $ 59,689 $ 62,719 $ 27,075 $ 23,394 $ 172,877
Net income per share
Basic $ 0.53 $ 0.56 $ 0.24 $ 0.21 $ 1.53
Diluted $ 0.51 $ 0.52 $ 0.23 $ 0.20 $ 1.46
Weighted average shares outstanding
Basic 112,008 112,931 113,666 114,083 113,172
Diluted 122,181 123,902 124,444 116,558 118,432
FISCAL 1997
Net revenues $202,014 $215,043 $251,703 $265,108 $ 933,868
Gross profit $115,968 $122,493 $148,564 $157,874 $ 544,899
Net income $ 17,914 $ 1,237 $ 41,584 $ 46,826 $ 107,561
Net income per share
Basic $ 0.17 $ 0.01 $ 0.38 $ 0.42 $ 0.99
Diluted $ 0.16 $ 0.01 $ 0.36 $ 0.39 $ 0.93
Weighted average shares outstanding
Basic 106,040 106,817 110,011 110,956 108,456
Diluted 111,343 113,640 116,786 120,614 115,596
- ----------
* The first, second, third and fourth quarters of fiscal 1997 include write-offs
of acquired in-process technology, net of taxes, totaling $25 million, $42
million, $12 million, and $11 million, respectively.
24
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Adaptec, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows and of stockholders' equity
present fairly, in all material respects, the financial position of Adaptec,
Inc. and its subsidiaries at March 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
March 31, 1998, 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 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 our audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for business process reengineering costs in
1998.
San Jose, California
April 29, 1998, except for Note 12 which is as of May 21, 1998
25
LEGAL PROCEEDINGS
Several putative securities class actions have been filed in the United
States District Court for the Northern District of California against Adaptec,
Inc. and certain of its officers and directors. The actions, Murphy, et al. v.
Adaptec, Inc., et al., No. C 98-00224-CAL (N.D. Cal.)(filed January 21, 1998),
Raiken et al. v. Adaptec, Inc., et al. No. C 98-0282-SI (N.D. Cal.)(filed Jan
26, 1998), Shaheen et al. v. Adaptec, Inc. No. C 98-0355-BZ (N.D. Cal.)(filed
January 30, 1998), Haarman et al. v. Adaptec, Inc. et al. No. C 98-00538-CRB
(N.D. Cal)(filed February 20, 1998) and Hammond et al. v. Adaptec, Inc. No. C
98-20072-JW (N.D. Cal)(amended action filed February 10, 1998), all allege that
the Company made false and misleading statements at various time during the
period between April 1997 and January 1998 in violation of the federal
securities laws. The complaints do not set forth purported damages. The Company
believes the lawsuits are without merit and intends to defend itself vigorously.
26
SELECTED FINANCIAL DATA (In thousands, except per share amounts)
Quarters
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA
YEAR ENDED MARCH 31,
Net revenues $1,007,293 $ 933,868 $ 659,347 $ 466,194 $ 372,245
Cost of revenues 391,100 388,969 275,939 205,596 189,526
- --------------------------------------------------------------------------------------------------------------------------------
Gross profit $ 616,193 $ 544,899 $ 383,408 $ 260,598 $ 182,719
- --------------------------------------------------------------------------------------------------------------------------------
Operating expenses
Research and development $ 172,522 $ 128,530 $ 87,628 $ 60,848 $ 39,993
Sales, marketing, and administrative 218,839 162,979 117,332 81,966 65,591
Write-off of acquired in-process technology
and other charges -- 92,162 52,313 -- --
- --------------------------------------------------------------------------------------------------------------------------------
$ 391,361 $ 383,671 $ 257,273 $ 142,814 $ 105,584
- --------------------------------------------------------------------------------------------------------------------------------
Cumulative effect of a change in accounting
principle, net of tax benefit $ 9,000 $ -- $ -- $ -- $ --
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 172,877 $ 107,561* $ 103,375* $ 93,402 $ 58,950
================================================================================================================================
Net income per share
Basic $ 1.53 $ 0.99 $ 0.99 $ 0.90 $ 0.57
Diluted $ 1.46 $ 0.93 $ 0.95 $ 0.87 $ 0.55
Weighted average shares outstanding
Basic 113,172 108,456 104,136 103,371 103,023
Diluted 118,432 115,596 109,073 106,942 107,170
- --------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA AS OF MARCH 31,
Working capital $ 851,486 $ 693,629 $ 334,989 $ 294,058 $ 243,451
Total assets $1,275,229 $1,043,494 $ 646,486 $ 435,708 $ 358,475
Long-term debt, net of current portion $ 230,000 $ 230,850 $ 4,250 $ 7,650 $ 11,050
Stockholders' equity $ 904,745 $ 688,325 $ 511,945 $ 371,644 $ 297,616
* Includes the after-tax effect of write-offs associated with acquired
in-process technology.
COMMON STOCK PRICES AND DIVIDENDS
The Company's common stock is traded in the over-the-counter market under the
NASDAQ symbol ADPT. The following table sets forth the range of the high and low
prices by quarter as reported by NASDAQ National Market System.
1998 1997
------------------- -------------------
High Low High Low
First quarter $40 5/8 $30 1/8 $30 3/4 $22 5/16
Second quarter 51 3/8 38 29 13/16 17 1/2
Third quarter 54 1/4 33 7/8 41 1/8 28 5/8
Fourth quarter 39 1/2 19 7/16 46 7/8 32 1/8
At March 31, 1998, there were 1,018 holders of record of the Company's common
stock. The Company has not paid cash dividends on its common stock and does not
currently plan to pay cash dividends to its stockholders in the near future.