EXHIBIT 13.1
SEAGATE TECHNOLOGY, INC.
ANNUAL REPORT TO STOCKHOLDERS
SELECTED FINANCIAL DATA
Fiscal Year Ended June 27, June 28, June 30, July 1, July 2,
In thousands except per share data 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
Net sales $8,940,022 $8,588,350 $7,256,209 $5,865,255 $5,195,276
Gross profit 2,022,255 1,581,001 1,373,385 1,170,821 909,872
Income (loss) from operations 857,585 286,969 459,301 473,097 (195,442)
Income (loss) before extraordinary gain 658,038 213,261 312,548 329,685 (267,605)
Net income (loss) 658,038 213,261 318,719 329,685 (267,605)
Primary income (loss) per share before
extraordinary gain 2.73 1.03 1.60 1.71 (1.50)
Primary net income (loss) per share 2.73 1.03 1.63 1.71 (1.50)
Fully diluted income (loss) per share
before extraordinary gain 2.61 .97 1.43 1.56 (1.50)
Fully diluted net income (loss) per share 2.61 .97 1.45 1.56 (1.50)
Total assets 6,722,879 5,239,635 4,899,832 4,307,937 3,470,970
Long-term debt, less current portion 701,945 798,305 1,066,321 1,176,551 941,882
Stockholders' equity $3,475,666 $2,466,088 $1,936,132 $1,634,700 $1,228,829
Number of shares used in per share
computations:
Primary 241,043 206,876 195,530 192,320 178,374
Fully diluted 258,361 236,272 247,142 235,934 178,374
The 1997 results of operations include a $153,000 charge as a result of the
adverse judgment in the Amstrad PLC litigation. The 1996 results of operations
include a $241,720 restructuring charge as a result of the merger with Conner
Peripherals, Inc. and a $98,687 write-off of in-process research and development
incurred in connection with the acquisition of software companies. The 1995
results of operations include a $73,177 write-off of in-process research and
development incurred in connection with business acquisitions.
Prior periods have been restated to reflect the merger with Conner Peripherals,
Inc. in February 1996 on a pooling of interests basis and a two-for-one stock
split, effected in the form of a stock dividend, in November 1996.
1
Quarterly/1997
Unaudited, in thousands except per share data 1st 2nd 3rd 4th
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Net sales $2,060,825 $2,400,156 $2,501,823 $1,977,218
Gross profit 392,776 541,499 630,834 457,146
Income from operations 173,711 289,473 346,857 47,544
Net income 129,361 212,600 256,750 59,327
Net income per share:
Primary .59 .91 1.01 .23
Fully diluted .53 .84 1.01 .23
Price range per share:
Low 18-1/16 25-7/8 37-3/8 32-1/2
High $ 29-5/16 $ 42-3/4 $ 56-1/4 $ 54-1/4
The results for the first quarter include restructuring reversals of $9,554
related to the completion of certain aspects of the restructuring in connection
with the merger with Conner Peripherals, Inc. at less than originally estimated.
The results for the third quarter include compensation expense and in-process
research and development charges of $13,446 and $2,876, respectively, in
connection with additional amounts paid with respect to the June 1996
acquisition of Holistic Systems Ltd. The results for the fourth quarter include
a $153,000 charge as a result of the adverse judgment in the Amstrad PLC
litigation (See "Management's Discussion and Analysis of Financial Condition and
Results of Operations") and restructuring charges of $2,478 related to certain
software operations.
Quarterly/1996
Unaudited, in thousands except per share data 1st 2nd 3rd 4th
- ------------------------------------------------------------------------------------------------------------------------------------
Net sales $2,140,805 $2,339,691 $2,093,326 $2,014,528
Gross profit 396,100 453,823 337,581 393,497
Income (loss) from operations 168,613 204,984 (214,909) 128,281
Net income (loss) 120,809 148,915 (157,478) 101,015
Net income (loss) per share:
Primary .61 .74 (.78) .46
Fully diluted .52 .63 (.78) .42
Price range per share:
Low 19-9/16 19-5/16 22-15/16 21-1/4
High $ 24-5/16 $ 27 $ 33-9/16 $ 31-1/4
2
The results for the first, second, third and fourth quarters include in-process
research and development charges of $2,817, $3,600, $52,848 and $39,422,
respectively, in connection with business acquisitions and equity investments.
The results for the third quarter include restructuring charges of $241,720 as a
result of the merger with Conner Peripherals, Inc.
Prior periods have been restated to reflect the merger with Conner Peripherals,
Inc. in February 1996 on a pooling of interests basis and a two-for-one stock
split, effected in the form of a stock dividend, in November 1996.
Stock and Dividend Information
The Company's common stock trades on the New York Stock Exchange under
the symbol "SEG." The price range per share, reflected in the above tables, is
the highest and lowest sale prices for the Company's stock as reported by the
New York Stock Exchange during each quarter. The Company's present policy is to
retain its earnings to finance future growth. The Company has never paid cash
dividends and has no present intention to pay cash dividends. At June 27, 1997,
there were approximately 6,388 stockholders of record.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the five-
year summary of selected financial data and the Company's consolidated financial
statements and the notes thereto. All references to years represent fiscal years
unless otherwise noted. In November 1996, the Company effected a two-for-one
stock split in the form of a stock dividend. Prior periods have been restated
to reflect the stock split.
Certain Forward-Looking Information
Certain statements in this Management's Discussion and Analysis ("MD&A"),
elsewhere in this Annual Report to Stockholders and in the Company's Annual
Report on Form 10-K for 1997 into which this MD&A is incorporated are forward-
looking statements based on current expectations, and entail various risks and
uncertainties that could cause actual results to differ materially from those
projected in such forward-looking statements. Certain of these risks and
uncertainties are set forth below under "Foreign Currency Risks," "Factors
Affecting Future Operating Results," elsewhere in this MD&A, elsewhere in this
Annual Report to Stockholders and in the Company's Annual Report on Form 10-K
for 1997. These forward-looking statements include the statements relating to
declining unit sales prices in the first paragraph under "Results of Operations-
1997 vs 1996," the statements relating to customs duties in the third paragraph
under "Results of Operations - 1997 vs 1996," the statements relating to
continued expansion into complementary markets and future write-offs of in-
process research and development, including the charge to operations in
connection with the acquisition of Quinta Corporation, in the seventh paragraph
under "Results of Operations - 1997 vs 1996," the statements relating to the
Amstrad PLC litigation in the ninth paragraph under "Results of Operations -1997
vs 1996," the statements relating to the 1998 effective tax rate in the eleventh
paragraph under "Results of Operations - 1997 vs 1996," the statements relating
to the IRS adjustments in the thirteenth paragraph under "Results of Operations-
1997 vs 1996," the statements regarding the decline in value of the Thai Baht
and Malaysian Ringgit relative to the U.S. Dollar and future movements in
currency exchange rates in the last paragraph of "Disclosures about Market Risk-
Foreign Currency Risk," the statements under "Environmental Matters," the
statements regarding capital expenditures in the third paragraph under
"Liquidity and Capital Resources," the statements regarding continued expansion
into complementary markets in the sixth paragraph under "Liquidity and Capital
Resources," the statements regarding the sufficiency of the Company's resources
in the last paragraph under "Liquidity and Capital Resources," the statements
under "Factors Affecting Future Operating Results," and the statements in the
Litigation and Environmental Matters note to the consolidated financial
statements, among others.
Merger with Conner
Effective February 2, 1996, the Company merged with Conner Peripherals,
Inc. ("Conner"). Conner was involved in the design, manufacture and marketing
of information storage products, including disc drives, tape drives and storage
management software. The merger was accounted for as a pooling of interests and
accordingly
3
all prior period financial statements have been restated as if the merger took
place at the beginning of such periods. Conner had a fiscal year which ended on
the Saturday closest to December 31. Accordingly, Conner's statement of income
for the year ended December 30, 1995 has been combined with Seagate's statement
of income for the year ended June 30, 1995. In order to conform Conner's year
end to Seagate's fiscal year end, the consolidated statement of income for the
year ended June 28, 1996 includes six months (July 1, 1995 through December 31,
1995) for Conner which are also included in the consolidated statement of income
for the year ended June 30, 1995. The comparisons to prior periods below should
be read in light of this fact. See Merger With Conner note to the consolidated
financial statements.
Business
Seagate operates in a single industry segment by designing, manufacturing
and marketing products for storage, retrieval and management of data on computer
and data communications systems. These products include disc drives and disc
drive components, tape drives and software.
The Company designs, manufactures and markets a broad line of rigid
magnetic disc drives for use in computer systems ranging from notebook computers
and desktop personal computers to workstations and supercomputers as well as in
multimedia applications such as digital video and video-on-demand. The Company
sells its products to original equipment manufacturers for inclusion in their
computer systems or subsystems, and to distributors, resellers, dealers and
retailers. In addition, the Company designs, manufactures and markets a full
line of mini-cartridge and Digital Audio Tape ("DAT") products. These products
are dedicated back-up storage peripherals that combine high capacity, high
performance, low cost and reliability to meet the needs of the desktop and
workstation markets.
The Company has pursued a strategy of vertical integration and accordingly
designs and manufactures rigid disc drive components including recording heads,
discs, substrates, motors and custom integrated circuits. It also assembles
certain of the key subassemblies for use in its products including printed
circuit board and head stack assemblies.
The Company has also invested in, and currently intends to continue
investigating opportunities to invest in software activities. The Company
anticipates that users of computer systems will increasingly rely upon
client/server network computing environments and believes that as this reliance
increases, users will demand software that more efficiently and securely stores,
manages and accesses data and transforms it into usable information. As such,
the Company has broadened its core competencies to include software products and
technologies to meet these requirements.
Results of Operations
The following table sets forth certain items in the Company's Consolidated
Statements of Income as a percentage of net sales for each of the three years
ended June 27, 1997.
Percentage of Net Sales
--------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------
Net sales 100% 100% 100%
Cost of sales 77 82 81
---- ---- ----
Gross profit 23 18 19
Product development 5 5 5
Marketing and administrative 6 6 6
Amortization of goodwill and other intangibles - - 1
In-process research and development - 1 1
Restructuring - 3 -
4
Unusual items 2 - -
---- ---- ----
Income from operations 10 3 6
Other income, net - 1 -
---- ---- ----
Income before income taxes and extraordinary gain 10 4 6
Provision for income taxes (3) (1) (2)
Extraordinary gain - - -
---- ---- ----
Net income 7% 3% 4%
==== ==== ====
1997 VS 1996 Net sales in 1997 were 4% higher than those reported in
1996. The increase in net sales over the prior year was primarily due to a
higher level of unit shipments and a shift in mix to the Company's higher priced
products partially offset by a continuing decline in the average unit sales
prices of the Company's products as a result of competitive market conditions.
Net sales decreased to $1,977,218,000 in the fourth quarter of 1997 from
$2,501,823,000 in the third quarter of 1997 as a result of weakness in customer
demand, primarily for the Company's higher performance products. The decreased
sales, together with internal production issues, adversely impacted the
Company's gross margins and results of operations for the fourth quarter of
1997. The rigid disc drive industry in which the Company operates is
characterized by declining unit sales prices over the life of a product and the
Company believes this characteristic will continue.
The increase in gross margin as a percentage of net sales over the
prior year was primarily due to improvements in gross margins for the Company's
desktop disc drive products, as well as a shift in mix to the Company's newer,
higher capacity and higher performance disc drives, particularly those with
capacities greater than 4 gigabytes, and a reduction in certain product costs,
such as material, scrap and warranty costs per unit. These factors were
partially offset by a continuing decline in the average unit sales prices of the
Company's products as a result of competitive market conditions.
The Commission of the European Union is considering a proposal that
would assess duties on so-called multi-media products (e.g., personal computers
with multi-media capabilities) at a rate of 14%. Under the current code, duties
would decline to zero within two years. If this proposal were implemented,
certain high capacity drives of the Company could be subjected to this higher
tariff. The imposition of such higher customs duties would negatively impact
the Company's revenues or increase costs and adversely impact gross margins.
Product development expenses increased by $38,901,000 (9%) compared
with 1996, primarily due to increases in salaries and related costs, materials
and depreciation as well as increasing product development expenses related to
the Company's software products and services.
Marketing and administrative expenses increased by $6,750,000 (1%)
compared with 1996, primarily due to increasing marketing and administrative
expenses related to the Company's software products and services. These
increases in expenses were substantially offset by cost savings in non-software
activities resulting from the combination of the operations of the Company and
Conner pursuant to the February 1996 merger of the two companies. These cost
savings were primarily in the areas of salaries and related costs, outside
services, advertising and promotion, legal expenses and allocated occupancy
costs.
Amortization of goodwill and other intangibles increased by $3,148,000
(7%) compared with 1996, primarily due to the write-offs and write-downs of
certain intangible assets related to past acquisitions of software companies
whose value had become impaired and a full year of amortization in 1997, as
compared with a partial year in 1996, of certain intangible assets arising from
acquisitions of software companies in 1996. The increase in amortization from
1996 was partially offset by write-offs, in 1996, of certain intangible assets
related to past acquisitions of tape drive and software companies whose value
had become impaired. See Acquisitions note to consolidated financial
statements.
The $2,876,000 charge for in-process research and development in 1997
was incurred in connection with additional amounts paid with respect to the June
1996 acquisition of Holistic Systems Ltd. In August 1997, the Company completed
the acquisition of Quinta Corporation, a developer of ultra-high capacity disc
drive technologies, including a new optically assisted Winchester (OAW)
technology. Pursuant to the purchase agreement, the shareholders of Quinta,
other than Seagate, received cash payments aggregating $230 million upon closing
of the transaction and will be eligible to receive, upon the achievement of
certain product development and early production milestones, additional payments
aggregating $95 million. In April and June 1997, Seagate had invested an
aggregate of $20 million acquiring approximately ten percent (10%) of Quinta's
stock.
5
As a result of this acquisition, the Company will incur a charge to operations
of approximately $217,000,000 in the first quarter of fiscal 1998 for the
write-off of in-process research and development. In addition, the Company
anticipates that its operating expenses, including product development
expenses, marketing and administrative expenses and amortization of goodwill
and other intangibles, will increase as a result of the ongoing operations of
Quinta and the payment of milestone payments if the milestones are achieved.
The Company intends to continue its expansion into software and other
complementary data technology markets and therefore currently intends to
pursue discussions with companies that fit with its strategy. As a result, the
Company expects that it will continue to incur charges for in-process research
and development as it acquires companies.
During fiscal year 1996, the Company recorded restructuring charges
totaling $241,720,000 as a result of the merger with Conner. During 1997, the
Company reversed $9,554,000 of its restructuring reserves as a result of the
completion of certain aspects of the restructuring plan at less than the
originally estimated cost. The reversal consisted of $4,567,000 in severances
and benefits, $3,658,000 in excess facilities and $1,329,000 in other expenses.
Implementation of the restructure plan is substantially complete as of June 27,
1997. Offsetting the $9,554,000 reversal was a $2,478,000 charge for
restructuring costs in the Company's Seagate Software subsidiary.
Unusual items in 1997 consisted of a $153,000,000 charge as a result
of the judgment adverse to the Company in the Amstrad PLC ("Amstrad") litigation
and $13,446,000 for compensation expense in connection with additional amounts
paid with respect to the June 1996 acquisition of Holistic Systems Ltd. Amstrad
initiated a lawsuit against the Company in 1992 concerning the Company's sale of
allegedly defective disc drives to Amstrad. The Company and Amstrad have
appealed the Court's decision. See Litigation and Environment Matters note to
consolidated financial statements.
Net other income decreased by $10,841,000 compared with 1996,
primarily due to an increase in minority interest expense as a result of higher
income in the Company's majority-owned subsidiary in Shenzhen, China, an
increase in amortization of premiums on foreign currency option contracts and
mark-to-market losses on foreign currency forward exchange contracts partially
offset by lower interest expense as a result of the redemption or conversion of
the Company's 5%, 6.5% and 6.75% convertible subordinated debentures.
The provision for income taxes increased by $114,998,000 in 1997,
primarily due to the increase in pretax earnings in 1997 partially offset by a
decrease in the effective tax rate from 36% in 1996 to 26% in 1997. The higher
effective tax rate in 1996 was primarily due to nondeductible charges associated
with the merger with Conner and other acquisitions. Excluding the Amstrad
litigation charge, the effective tax rate was approximately 28% in 1997.
Excluding the restructuring costs, nonrecurring merger-related costs and the
write-off of in-process research and development, the effective tax rate was
approximately 30% in 1996. While the Company expects the fiscal year 1998
effective tax rate before unusual items to approximate 28%, the actual effective
tax rate is expected to differ from this rate due to the acquisition of Quinta
Corporation in August 1997 and certain additional costs the Company may incur in
connection with future acquisitions. See Subsequent Events note to the
consolidated financial statements.
The Company provided income taxes at the U.S. statutory rate in 1997
on approximately 66% of its earnings from foreign subsidiaries compared with
approximately 64% of such earnings in 1996. A substantial portion of the
Company's Far East manufacturing operations in Singapore, Thailand, Malaysia and
China operate free of tax under various tax holidays which expire in whole or in
part during fiscal years 1998 through 2005. The net impact of these tax holidays
was to increase net income by approximately $71,394,000 ($0.28 per share, fully
diluted) in 1997 and approximately $50,398,000 ($0.21 per share, fully diluted)
in 1996.
On June 30, 1997, the Company received a statutory notice of potential
deficiencies from the Internal Revenue Service (IRS) relative to taxable years
1991 through 1993 approximating $38,500,000 plus interest, as well as
approximately $5,700,000 of penalties. The Company believes it has meritorious
defenses to the IRS adjustments but has not yet determined the forum in which it
will contest this proposed deficiency. The Company believes that the likely
outcome of this matter will not have a material adverse effect on its financial
position or results of operations.
1996 VS 1995 Net sales in 1996 were 18% higher than those reported in
1995. The increase was primarily due to a higher level of unit shipments and a
shift in mix to the Company's higher priced products partially offset by a
continuing decline in the average unit sales prices of the Company's products as
a result of competitive market
6
conditions, particularly in the higher capacity products. The rigid disc drive
industry in which the Company operates is characterized by declining unit sales
prices over the life of a product and the Company believes this characteristic
will continue.
The decrease in gross margin as a percentage of net sales over the
prior year was primarily due to a continuing decline in the average unit sales
prices of the Company's products as a result of competitive market conditions
and certain one-time charges incurred as a result of the merger with Conner
partially offset by a shift in mix to the Company's newer, higher-capacity
products and a reduction in certain product costs, such as material, scrap and
warranty costs per unit.
Product development expenses increased by $66,923,000 (19%) compared
with 1995, primarily due to increases in salaries and related costs, increasing
product development expenses related to the Company's software products and
services and an overall increase in the Company's product development efforts.
Marketing and administrative expenses increased by $34,780,000 (8%)
compared with 1995, primarily due to ongoing marketing and administrative
expenses related to the Company's software products and services and increases
in outside services and salaries and related costs partially offset by decreases
in allocated occupancy costs, advertising expenses and the provision for bad
debts.
Amortization of goodwill and other intangibles increased by
$11,015,000 (31%) compared with 1995, primarily due to additional goodwill and
other intangibles arising from various acquisitions of and investments in
businesses in 1996, a full year of amortization in 1996 as compared with a
partial year of amortization in 1995 with respect to certain intangible assets
arising from acquisitions of software companies in 1995, and write-offs in 1996
of certain intangible assets related to the Company's tape drive and software
products and services whose value had become impaired. See Acquisitions note to
consolidated financial statements.
The $98,687,000 charge for in-process research and development in 1996
consists of one-time write-offs primarily incurred in connection with the
acquisition of the minority interest in Arcada Holdings, Inc. and the
acquisitions of Holistic Systems Ltd., OnDemand Software, Inc., Calypso Software
Systems, Inc. and Sytron Corporation.
As a result of the merger with Conner, the Company recorded
restructuring costs of $241,720,000 in 1996. The restructuring costs comprised
$60,714,000 for employee severance benefits, $97,209,000 to write-off or write
down equipment, inventory, intangibles and other assets, $45,138,000 for closure
of duplicate and excess facilities, $23,980,000 for fees of financial advisors,
attorneys and accountants and $14,679,000 for contract cancellations and other
expenses.
Net other income increased by $16,316,000 compared with 1995,
primarily due to a reduction in interest expense as a result of capitalization
of interest on construction of new manufacturing facilities, the conversion or
redemption of certain of the Company's subordinated debentures and higher
interest income earned on the Company's investment portfolio from higher
interest rates, partially offset by increased foreign currency remeasurement
losses.
The provision for income taxes decreased by $56,729,000 in 1996,
primarily due to the decrease in pretax earnings in 1996. The effective tax rate
for both years was approximately 36%. Excluding the restructuring costs,
nonrecurring merger-related costs and the write-off of in-process research and
development, the effective tax rate was 30% in 1996.
The Company provided income taxes at the U.S. statutory rate in 1996
on approximately 64% of its earnings from foreign subsidiaries compared with
approximately 57% of such earnings in 1995. A substantial portion of the
Company's Far East manufacturing operations in Singapore, Thailand, Malaysia and
China operate free of tax under various tax holidays. The net impact of these
tax holidays was to increase net income by approximately $50,398,000 ($0.21 per
share, fully diluted) in 1996 and approximately $59,788,000 ($0.24 per share,
fully diluted) in 1995.
DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK The Company's exposure to market risk for changes in
interest rates relates primarily to the Company's investment portfolio and long-
term debt obligations. The Company does not use derivative financial
instruments in its investment portfolio. The Company places its investments
with high credit quality issuers and, by policy, limits the amount of credit
exposure to any one issuer. As stated in its policy, the Company is averse to
principal loss and ensures the safety and preservation of its invested funds by
limiting default risk, market risk, and reinvestment risk.
7
The Company mitigates default risk by investing in only the safest and
highest credit quality securities and by constantly positioning its portfolio to
respond appropriately to a significant reduction in a credit rating of any
investment issuer or guarantor. The portfolio includes only marketable
securities with active secondary or resale markets to ensure portfolio
liquidity.
The Company has no cash flow exposure due to rate changes for long-
term debt obligations. The Company primarily enters into debt obligations to
support general corporate purposes including capital expenditures and working
capital needs.
The table below presents principal (or notional) amounts and related
weighted average interest rates by year of maturity for the Company's investment
portfolio and debt obligations. All investments mature, by policy, in three
years or less.
Fair Value
-------------
In thousands 1998 1999 2000 2001 2002 Thereafter Total June 27, 1997
- ----------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash equivalents
Fixed rate $ 915,631 $ - $ - $ - $ - $ - $ 915,631 $ 913,056
Average interest rate 5.40% - - - - - 5.40%
Short-term investments
Fixed rate 784,895 170,516 40,279 - - - 995,690 990,067
Average interest rate 5.76% 5.99% 6.36% - - - 5.82%
Variable rate 246,150 - - - - - 246,150 246,195
Average interest rate 5.62% - - - - - 5.62%
Total investment
securities 1,946,676 170,516 40,279 - - - 2,157,471* 2,149,318
Average interest rate 5.57% 5.99% 6.36% - - - 5.62%
LONG-TERM DEBT
Fixed rate - - - - - 700,000 700,000 702,180
Average interest rate - - - - - 7.33% 7.33%
*Includes $8,006 of unaccreted interest to be received at maturity.
FOREIGN CURRENCY RISK The Company transacts business in various foreign
currencies, primarily in emerging market countries in Asia and in certain
European countries. The Company has established a foreign currency hedging
program utilizing foreign currency forward exchange contracts and purchased
currency options to hedge local currency cash flows for payroll, inventory,
other operating expenditures and fixed asset purchases in Singapore, Thailand
and Malaysia. Under this program, increases or decreases in the Company's local
currency operating expenses and other cash outflows are partially offset by
realized gains and losses on the hedging instruments. The goal of this hedging
program is to economically guarantee or lock in the exchange rates on the
Company's foreign currency cash outflows rather than to eliminate the
possibility of short-term earnings volatility. Based on recent volatility in
the Far East foreign currency markets, the Company has temporarily suspended
purchasing foreign currency forward exchange and option contracts for the Thai
Baht, Malaysian Ringgit and Singapore Dollar. The Company does not use foreign
currency forward exchange contracts or purchased currency options for trading
purposes.
Gains and losses related to qualified hedges of firm commitments and
anticipated transactions are deferred and are recognized in income or as
adjustments of carrying amounts when the hedged transaction occurs. All other
forward exchange and option contracts are marked-to-market and unrealized gains
and losses are included in current period net income.
The table below provides information about the Company's derivative
financial instruments, comprised of foreign currency forward exchange contracts
and purchased currency options. The information is provided in U.S. Dollar
equivalent amounts, as presented in the Company's financial statements. For
foreign currency forward exchange contracts, the table presents the notional
amounts (at the contract exchange rates) and the weighted average contractual
foreign currency exchange rates. All instruments mature within twelve months.
8
June 27, 1997
----------------------------------------
Notional Average Estimated
In thousands, except average contract rate Amount Contract Rate Fair Value*
- -------------------------------------------------------------------------------------------------------------------
Foreign currency forward exchange contracts:
Malaysian Ringgit $ 264,000 2.53 $ (1,135)
Singapore Dollar 284,000 1.39 (5,269)
Thai Baht 458,000 26.57 (5,058)
---------- --------
$1,006,000 $(11,462)
Purchased currency options:
Malaysian Ringgit $ 82,000 2.53 $ 822
Singapore Dollar 244,000 1.39 1,079
---------- --------
$ 326,000 $ 1,901
*Equivalent to the unrealized net gain (loss) on existing contracts.
As described above, the goal of the Company's hedging program is to
economically guarantee or lock in the exchange rates on a portion of the
Company's local currency cash flows and not to eliminate all short-term earnings
volatility. Because not all economic hedges qualify as accounting hedges,
unrealized gains and losses may be recognized in income in advance of the actual
foreign currency cash flows. This mismatch of accounting gains and losses and
foreign currency cash flows may be especially pronounced in the first quarter of
fiscal 1998 as a result of the declines in value of the Thai Baht and Malaysian
Ringgit, relative to the U.S. Dollar, subsequent to fiscal year end 1997.
Assuming no further change in the current U.S. Dollar exchange rates for the
Thai Baht and Malaysian Ringgit (Baht 31.5 to U.S. Dollar 1 and Ringgit 2.79 to
U.S. Dollar 1 on August 14, 1997), the mark-to-market adjustment would result in
an unrealized pretax charge of approximately $44 million, to be recognized as
Other Expense at the end of the Company's first quarter of fiscal 1998 ending on
October 3, 1997. The Company's ultimate realized gain or loss with respect to
currency fluctuations will depend on the currency exchange rates and other
factors in effect at the time such contracts mature over the next twelve months.
Although the Company cannot predict future movements in currency exchange rates,
the Company believes that the benefits from recording local currency
expenditures in lower U.S. Dollar terms over the period during which these
foreign currency forward exchange contracts are scheduled to mature should more
than offset the charges to be recorded in the first quarter of fiscal 1998.
OTHER
Gains and losses resulting from the remeasurement of foreign financial
statements into U.S. Dollars did not have a significant effect on the results of
operations for 1997, 1996 or 1995.
The effect of inflation on operating results for 1997, 1996 and 1995 has
been insignificant. The Company believes this is due to the absence of any
significant inflation factors in the industry in which the Company participates.
During the year ended June 28, 1996, the Company implemented Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"), which
did not have a material impact on the financial statements.
In October 1995, the Financial Accounting Standards Board released
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"). SFAS 123 provides an alternative to Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APBO 25") and requires additional disclosures. Effective with the Company's
fiscal year ended June 27, 1997, the Company has continued to account for its
employee stock plans in accordance with the provisions of APBO 25 while
providing the additional disclosures required by SFAS 123. Accordingly, SFAS
123 has no impact on the Company's financial position or results of operations.
ENVIRONMENTAL MATTERS
The United States Environmental Protection Agency ("EPA") and/or similar
state agencies have identified the Company as a potentially responsible party
with respect to environmental conditions at several different sites to which
hazardous wastes had been shipped or from which they were released. These sites
were acquired by the Company from Ceridian Corporation ("Ceridian") (formerly
Control Data Corporation) in fiscal 1990. Other parties
9
have also been identified at certain of these sites as potentially responsible
parties. Many of these parties either have shared or likely will share in the
costs associated with the sites. Investigative and/or remedial activities are
ongoing at such sites.
The Company's portion of the estimated cost of investigation and
remediation of known contamination at the sites to be incurred after June 27,
1997, including the estimated effects of inflation, is approximately
$16,500,000. Through June 27, 1997, the Company had recovered approximately
$4,300,000 from Ceridian through its indemnification and cost-sharing
agreements with Ceridian and, in addition, expects to recover approximately
$9,700,000 from Ceridian over the next 30 years. After deducting the expected
recoveries from Ceridian, the expected aggregate undiscounted liability was
approximately $6,800,000 at June 27, 1997, with payments expected to begin in
1999. The total liability for all sites recorded by the Company after
considering the estimated effects of inflation, reimbursements by Ceridian and
discounting was approximately $3,100,000 at June 27, 1997.
The Company believes that the indemnification and cost-sharing agreements
entered into with Ceridian and the reserves that the Company has established
with respect to its future environmental costs are such that, based on present
information available to it, future environmental costs related to currently
known contamination will not have a material adverse effect on its financial
condition or results of operations.
LIQUIDITY AND CAPITAL RESOURCES
At June 27, 1997, the Company's cash, cash equivalents and short-term
investments totaled $2.284 billion, an increase of $1.110 billion from the prior
year-end balances. This increase was primarily a result of cash provided by
operating activities and the issuance of $700 million principal amount of senior
notes and debentures, offset by the Company's additions to property, equipment
and leasehold improvements and the repurchase by the Company of approximately
13.5 million shares of its common stock. Until required for other purposes, the
Company's cash and cash equivalents are maintained in highly liquid investments
with remaining maturities of 90 days or less at the time of purchase, while its
short-term investments consist of readily marketable debt securities with
remaining maturities of more than 90 days at the time of purchase.
As of June 27, 1997, the Company had committed lines of credit of $82
million that can be used for standby letters of credit or bankers' guarantees.
At June 27, 1997, approximately $78 million had been utilized.
The Company made investments in property and equipment in 1997 totaling
$920 million. This amount comprised $301 million for manufacturing facilities
and equipment related to the Company's subassembly and disc drive final assembly
and test facilities in the United States, Far East and Ireland, $263 million for
manufacturing facilities and equipment for the thin-film head operations in the
United States, Malaysia, Northern Ireland and Thailand, $255 million for
expansion of the Company's thin-film media operations in California, Singapore
and Northern Ireland and $101 million for other purposes. The Company presently
anticipates investments of approximately $1.1 billion in property and equipment
in 1998. The Company plans to finance these investments from existing cash
balances and future cash flows from operations.
During the year ended June 27, 1997, the Company acquired approximately
13.5 million shares of its common stock for approximately $582 million. The
repurchase of these shares nearly completed a stock repurchase program announced
in September 1996 in which up to 14 million shares of the Company's common stock
were authorized to be acquired in the open market. In June 1997, the Company
announced a new stock repurchase program under which up to an additional $600
million worth of its stock may be acquired in the open market.
During the year ended June 27, 1997, the Company called for redemption
all of its 5%, 6.5% and 6.75% debentures. Approximately $788 million principal
amount of the 5%, 6.5% and 6.75% debentures were converted to approximately 38.4
million shares of the Company's common stock and approximately $1.2 million
principal amount of the 6.5% and 6.75% debentures were redeemed. During the
same year, the Company issued senior debt securities totaling $700 million
principal amount with interest rates ranging from 7.125% to 7.875% and
maturities ranging from seven years to forty years.
In August 1997, the Company completed the acquisition of Quinta
Corporation, a developer of ultra-high capacity disc drive technologies,
including a new optically assisted Winchester (OAW) technology. Pursuant to the
purchase agreement, the shareholders of Quinta, other than Seagate, received
cash payments aggregating $230 million upon closing of the transaction and will
be eligible to receive, upon the achievement of certain product development and
early production milestones, additional payments aggregating $95 million. In
April and June 1997, Seagate had invested an aggregate of $20 million acquiring
approximately ten percent (10%) of Quinta's stock. The Company intends to
continue its expansion into software and other complementary data technology
markets and therefore currently intends to pursue discussions with companies
that fit with its strategy. The Company plans to finance this expansion
primarily through cash flows from operations and existing cash balances.
10
The Company believes that its cash balances together with cash flows from
operations and its borrowing capacity will be sufficient to meet its working
capital needs for the foreseeable future.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The data storage industry in which the Company competes is subject to a
number of risks, each of which has affected the Company's operating results in
the past and could impact the Company's future operating results. The demand
for disc drive and tape drive products depends principally on demand for
computer systems and storage upgrades to computer systems, which has
historically been volatile. Changes in demand for computer systems often have
an exaggerated effect on the demand for disc drive and tape drive products in
any given period, and unexpected slowdowns in demand for computer systems
generally cause sharp declines in demand for such products. In addition, the
Company's future success will require, in part, that the market for computer
systems, storage upgrades to computer systems and multimedia applications, such
as digital video and video-on-demand, and hence the market for disc drives,
remain strong. The data storage industry has been characterized by periodic
situations in which the supply of drives exceeds demand, resulting in higher
than anticipated inventory levels and intense price competition. Even during
periods of consistent demand, this industry is characterized by intense
competition and ongoing price erosion over the life of a given drive product.
The Company expects that competitors will offer new and existing products at
prices necessary to gain or retain market share and customers. The Company
expects that price erosion in the data storage industry will continue for the
foreseeable future. This competition and continuing price erosion could
adversely affect the Company's results of operations in any given quarter and
such adverse effect often cannot be anticipated until late in any given quarter.
In addition, the demand of drive customers for new generations of products has
led to short product life cycles that require the Company to constantly develop
and introduce new drive products on a cost-effective and timely basis. The
demand of drive customers for products with ever increasing storage capacity and
more advanced technology has resulted in increased dependence by the Company on
sales of high capacity disc drives. The increased difficulty and complexity
associated with production of higher capacity disc drives increases the
likelihood of reliability, quality or operability problems that could result in
reduced bookings, increased manufacturing rework and scrap costs, increased
service and warranty costs and a decline in the Company's competitive position.
In addition, the Company's operating results have been and may in the future be
subject to significant quarterly fluctuations as a result of a number of other
factors, including the timing of orders from and shipment of products to major
customers, product mix, pricing, delays in the development, introduction and
production of new products, delays or interruptions in the production of
existing products, competing technologies, variations in product cost, component
availability due to single or limited sources of supply, high fixed costs
resulting from the Company's vertical integration strategy, the Company's
ability to attract and retain key technical employees, foreign currency exchange
fluctuations (see "Results of Operations - Disclosures about Market Risk and
Derivatives - Foreign Currency Risk"), increased competition and general
economic and industry fluctuations. For example, net sales decreased to
$1,977,218,000 in the fourth quarter of 1997 from $2,501,823,000 in the third
quarter of 1997 as a result of weakness in customer demand, primarily for the
Company's higher performance products. The decreased sales, together with
internal production issues, adversely impacted the Company's gross margins and
results of operations for the fourth quarter of 1997. The Company's future
operating results may also be adversely affected by an adverse judgment or
settlement in the legal proceedings in which the Company is currently involved.
See Litigation and Environmental Matters note to consolidated financial
statements.
The Company has experienced and expects to continue to experience intense
competition from a number of domestic and foreign companies. These companies
include the other leading independent disc drive manufacturers as well as large
integrated multinational computer manufacturers such as Fujitsu Limited,
International Business Machines Corporation, NEC Corporation and Toshiba
Corporation. Such competition could materially adversely affect the Company's
business, operating results and financial condition. There can be no assurance
that the Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, operating results and financial
condition.
The cost, quality and availability of certain components, including heads,
media, application specific integrated circuits, motors, printed circuit boards
and custom semiconductors are critical to the successful production of disc
drives. The Company's strategy of vertical integration has allowed it to
internally manufacture many of the critical components used in its products.
The Company also relies on independent suppliers for certain components used in
its products. The Company has in the past experienced production delays when
unable to obtain sufficient quantities of certain components. Any prolonged
interruption or reduction in the supply of any key
11
components could have a material adverse effect on the Company's business,
operating results and financial condition. The Company has pursued a strategy of
vertical integration of its manufacturing process in order to reduce costs,
control quality and assure availability and quality of certain components. A
strategy of vertical integration entails a high level of fixed costs and
requires a high volume of production and sales to be successful. During periods
of decreased production, these high fixed costs have had, and could in the
future have, a material adverse effect on the Company's operating results and
financial condition.
The Company has significant offshore operations. Offshore operations are
subject to certain inherent risks, including delays in transportation, changes
in governmental policies, tariffs and import/export regulations, political
unrest, fluctuations in currency exchange rates and geographic limitations on
management controls and reporting. There can be no assurance that the inherent
risks of offshore operations will not adversely affect the Company's business,
operating results and financial condition in the future.
The Company has incorporated its software acquisitions into a single entity
called Seagate Software, Inc. ("SSI") and is offering employees of SSI and
selected employees of the Company an opportunity to acquire an equity interest
in SSI. Acquisitions involve numerous risks, including difficulties in the
assimilation of the operations and products of the acquired businesses and the
potential loss of key employees or customers of the acquired businesses. The
Company intends to continue its expansion into software and other complementary
data technology businesses. As a result, the Company expects that it will
continue to incur charges as it acquires businesses, including charges for the
write-off of in-process research and development. The timing of such write-offs
has in the past and may in the future lead to fluctuations in the Company's
operating results on a quarterly and annual basis. For example, the Company
will incur a charge to operations in the first quarter of fiscal 1998 of
approximately $217 million for the write-off of in-process research and
development in connection with the acquisition of Quinta Corporation.
The Company's operations are dependent on its ability to protect its
computer equipment and the information stored in its databases against damage by
fire, natural disaster, power loss, telecommunications failures, unauthorized
intrusion and other catastrophic events. The Company believes it has taken
prudent measures to reduce the risk of interruption in its operations. However,
there can be no assurance that these measures are sufficient. Any damage or
failure that causes interruptions in the Company's operations could have a
material adverse effect on its business, results of operations and financial
condition.
The Company is currently in the process of transitioning to new computer
software for its financial, accounting, inventory control, order processing and
other management information systems. The successful implementation of these
new systems is crucial to the efficient operation of the Company's business.
There can be no assurance that the Company will implement its new systems in an
efficient and timely manner or that the new systems will be adequate to support
the Company's operations. Problems with installation or initial operation of
the new systems could cause substantial management difficulties in operations
planning, financial reporting and management and thus could have a material
adverse effect on the Company's business, financial condition and results of
operations.
12
CONSOLIDATED BALANCE SHEETS
June 27, June 28,
In thousands except share data 1997 1996
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $1,047,335 $ 503,754
Short-term investments 1,236,262 670,308
Accounts receivable, net 1,040,835 1,066,519
Inventories 808,280 790,821
Deferred income taxes 253,372 222,355
Other current assets 166,223 145,523
---------- ----------
Total Current Assets 4,552,307 3,399,280
---------- ----------
Property, equipment and leasehold improvements, net 1,786,625 1,399,883
Goodwill and other intangibles, net 199,061 274,046
Other assets 184,886 166,426
---------- ----------
Total Assets $6,722,879 $5,239,635
========== ==========
LIABILITIES
Accounts payable $ 863,141 $ 715,396
Accrued employee compensation 200,360 180,126
Accrued expenses 504,777 305,044
Accrued warranty 197,676 185,708
Accrued income taxes 69,275 49,437
Current portion of long-term debt 1,125 2,425
---------- ----------
Total Current Liabilities 1,836,354 1,438,136
---------- ----------
Deferred income taxes 478,840 351,527
Accrued warranty 190,577 140,670
Other liabilities 39,497 44,909
Long-term debt, less current portion 701,945 798,305
---------- ----------
Total Liabilities 3,247,213 2,773,547
---------- ----------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value-1,000,000 shares
authorized; none issued or outstanding - -
Common stock, $.01 par value-600,000,000 shares authorized;
shares issued-251,890,019 in 1997 and
213,430,184 in 1996 2,519 2,134
Additional paid-in capital 1,902,824 1,132,328
Retained earnings 1,946,963 1,390,322
Deferred compensation (57,439) (57,656)
Treasury common stock at cost, 7,341,645 shares in 1997 (318,617) -
Foreign currency translation adjustment (584) (1,040)
---------- ----------
Total Stockholders' Equity 3,475,666 2,466,088
---------- ----------
Total Liabilities and Stockholders' Equity $6,722,879 $5,239,635
========== ==========
See notes to consolidated financial statements.
13
CONSOLIDATED STATEMENTS OF INCOME
For the years ended June 27, June 28, June 30,
In thousands except per share data 1997 1996 1995
- ----------------------------------------------------------------------------------------------------
Net sales $8,940,022 $8,588,350 $7,256,209
Cost of sales 6,917,767 7,007,349 5,882,824
Product development 459,330 420,429 353,506
Marketing and administrative 493,006 486,256 451,476
Amortization of goodwill and other intangibles 50,088 46,940 35,925
In-process research and development 2,876 98,687 73,177
Restructuring (7,076) 241,720 -
Unusual items 166,446 - -
---------- ---------- ----------
Total Operating Expenses 8,082,437 8,301,381 6,796,908
---------- ---------- ----------
Income from Operations 857,585 286,969 459,301
Interest income 92,843 93,788 89,885
Interest expense (34,840) (55,825) (70,332)
Other, net (24,353) 6,528 8,622
---------- ---------- ----------
Other Income, net 33,650 44,491 28,175
Income before income taxes and extraordinary gain 891,235 331,460 487,476
Provision for income taxes (233,197) (118,199) (174,928)
---------- ---------- ----------
Income before extraordinary gain 658,038 213,261 312,548
Extraordinary gain - - 6,171
---------- ---------- ----------
Net Income $ 658,038 $ 213,261 $ 318,719
========== ========== ==========
Primary net income per share:
Income per share before extraordinary gain $ 2.73 $ 1.03 $ 1.60
Extraordinary gain per share - - .03
---------- ---------- ----------
Primary net income per share $ 2.73 $ 1.03 $ 1.63
========== ========== ==========
Fully diluted net income per share:
Income per share before extraordinary gain $ 2.61 $ .97 $ 1.43
Extraordinary gain per share - - .02
---------- ---------- ----------
Fully diluted net income per share $ 2.61 $ .97 $ 1.45
========== ========== ==========
Number of shares used in per share computations:
Primary 241,043 206,876 195,530
Fully diluted 258,361 236,272 247,142
See notes to consolidated financial statements.
14
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended June 27, June 28, June 30,
In thousands 1997 1996 1995
- -------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 658,038 $ 213,261 $ 318,719
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 606,954 416,879 316,852
Deferred income tax 96,341 (84,533) (709)
In-process research and development 2,876 98,687 73,177
Amstrad litigation charge 153,000 - -
Other 27,938 34,078 (9,408)
Changes in operating assets and liabilities:
Accounts receivable 30,573 (58,183) (335,963)
Inventories (83,709) (259,262) (42,641)
Accounts payable 168,514 (15,609) 232,988
Accrued expenses,compensation and warranty (63,216) 84,567 6,384
Accrued income taxes 72,099 (15,573) 26,337
Other assets and liabilities 160,084 157,389 63,878
----------- ----------- -----------
Net cash provided by operating activities 1,829,492 571,701 649,614
INVESTING ACTIVITIES
Acquisition of property, equipment and
leasehold improvements, net (890,458) (906,937) (489,343)
Purchases of short-term investments (4,473,188) (3,024,487) (2,687,393)
Maturities and sales of short-term investments 3,906,945 3,130,638 2,749,697
Acquisitions of businesses, net of cash acquired - (110,611) (167,752)
Equity investments (44,001) (11,434) (29,811)
Other, net 20,313 37,859 26,364
----------- ----------- -----------
Net cash used in investing activities (1,480,389) (884,972) (598,238)
FINANCING ACTIVITIES
Issuance of long-term debt 698,592 - -
Repayment of long-term debt (8,233) (15,556) (121,219)
Sale of common stock 84,304 96,552 69,085
Purchase of treasury stock (581,721) (123,727) (113,409)
Other, net - (93) -
----------- ----------- -----------
Net cash provided by (used in) financing activities 192,942 (42,824) (165,543)
Effect of exchange rate changes on
cash and cash equivalents 1,536 1,088 (2,268)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents 543,581 (355,007) (116,435)
Elimination of Conner's net cash activity for the
duplicated six months ended December 31, 1995 - (31,906) -
Cash and cash equivalents at the beginning of the year 503,754 890,667 1,007,102
----------- ----------- -----------
Cash and cash equivalents at the end of the year $ 1,047,335 $ 503,754 $ 890,667
=========== =========== ===========
See notes to consolidated financial statements.
15
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended
June 27, 1997, June 28, Foreign
1996 and June 30, 1995 Common Stock Additional Treasury Currency
-------------------- Paid-In Retained Deferred Common Translation
In thousands Shares Amount Capital Earnings Compensation Stock Adjustment Total
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at July 1, 1994 192,040 $1,920 $ 639,191 $1,000,168 $ (5,535) $ - $ (1,044) $1,634,700
Purchase of treasury stock
at cost (113,409) (113,409)
Sale of stock 2,066 21 23,950 (45,456) 90,570 69,085
Amortization of deferred
compensation 2,935 2,935
Income tax benefit from
stock options exercised 23,083 23,083
Foreign currency
translation adjustment (4) 10 6
Unrealized gain on
marketable securities 1,013 1,013
Net income 318,719 318,719
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 30, 1995 194,106 1,941 686,224 1,274,440 (2,600) (22,839) (1,034) 1,936,132
Purchase of treasury
stock at cost (123,727) (123,727)
Sale of stock 6,842 68 76,332 (20,328) 40,480 96,552
Acquisition of Arcada
minority interest 2,554 26 85,062 (13) 85,075
Issuance of restricted
stock, net of cancellations 2,020 20 58,619 (10) (58,619) 10
Amortization of
deferred compensation 3,946 3,946
Income tax benefit from
stock options exercised 47,302 47,302
Conversion of debentures
to common stock 9,230 92 199,656 (38,448) 106,086 267,386
Foreign currency
translation adjustment 4 (6) (2)
Unrealized loss on
marketable securities (1,335) (1,335)
Net income 213,261 213,261
Elimination of Conner
activity for the
duplicated six months
ended December 31, 1995 (1,322) (13) (20,871) (37,245) (383) (58,512)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 28, 1996 213,430 2,134 1,132,328 1,390,322 (57,656) - (1,040) 2,466,088
Purchase of treasury
stock at cost (581,721) (581,721)
Sale of stock 3,635 37 42,229 (70,835) 112,873 84,304
16
Issuance of restricted
stock, net of cancellations 95 1 7,529 (7,479) (7,530) 7,480 1
Amortization of
deferred compensation 7,747 7,747
Income tax benefit from
stock options exercised 52,261 52,261
Conversion of debentures
to common stock 34,730 347 668,477 (23,684) 142,751 787,891
Foreign currency
translation adjustment 456 456
Unrealized gain on
marketable securities 601 601
Net income 658,038 658,038
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at June 27, 1997 251,890 $2,519 $1,902,824 $1,946,963 $(57,439) $(318,617) $ (584) $3,475,666
====================================================================================================================================
See notes to consolidated financial statements.
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS Seagate Technology, Inc. (the "Company") operates
in a single industry segment by designing, manufacturing and marketing products
for storage, retrieval and management of data on computer and data
communications systems. These products include disc drives and disc drive
components, tape drives and software. The Company sells its products to
original equipment manufacturers for inclusion in their computer systems or
subsystems, and to distributors, resellers, dealers and retailers.
ACCOUNTING ESTIMATES 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 financial
statements and accompanying notes. Actual results could differ materially from
those estimates.
The actual results with regard to warranty expenditures could have a
material unfavorable impact on the Company if the actual rate of unit failure or
the cost to repair a unit is greater than what the Company has used in
estimating the warranty expense accrual.
Given the volatility of the markets in which the Company participates,
the Company makes adjustments to the value of inventory based on estimates of
potentially excess and obsolete inventory after considering forecasted demand
and forecasted average selling prices. However, forecasts are subject to
revisions, cancellations, and rescheduling. Actual demand will inevitably
differ from such anticipated demand, and such differences may have a material
effect on the financial statements.
BASIS OF CONSOLIDATION The consolidated financial statements include
the accounts of the Company and its wholly-owned and majority-owned subsidiaries
after eliminations. Total outstanding minority interests are not material for
any period presented.
The Company operates and reports financial results on a fiscal year of 52
or 53 weeks ending on the Friday closest to June 30. Accordingly, fiscal 1997
ended on June 27, 1997, fiscal 1996 ended on June 28, 1996 and fiscal 1995 ended
on June 30, 1995. All fiscal years comprised 52 weeks. Fiscal 1998 will be a 53
week year with the first fiscal quarter having 14 weeks. All references to
years in these notes to consolidated financial statements represent fiscal years
unless otherwise noted.
Certain amounts in prior year financial statements and notes thereto have
been reclassified to conform to current year presentation.
STOCK SPLIT In November 1996, the Company effected a two-for-one stock
split in the form of a stock dividend. Prior periods have been restated to
reflect the stock split.
FOREIGN CURRENCY TRANSLATION The U.S. Dollar is the functional
currency for most of the Company's foreign operations. Gains and losses on the
translation into U.S. Dollars of amounts denominated in foreign currencies are
included in net income for those operations whose functional currency is the
U.S. Dollar and as a separate component of stockholders' equity for those
operations whose functional currency is the local currency.
DERIVATIVE FINANCIAL INSTRUMENTS The Company enters into foreign currency
forward exchange and option contracts to manage exposure related to certain
foreign currency commitments, certain foreign currency denominated balance sheet
positions and anticipated foreign currency denominated expenditures. The
Company does not enter into derivative financial instruments for trading
purposes. Foreign currency forward exchange contracts designated and effective
as hedges of firm commitments and option contracts designated and effective as
hedges of firm commitments or anticipated transactions are treated as hedges for
accounting purposes. Gains and losses related to qualified accounting hedges of
firm commitments or anticipated transactions are deferred and are recognized in
income or as adjustments to the carrying amounts when the hedged transaction
occurs. All other foreign currency forward exchange and option contracts are
marked-to-market and unrealized gains and losses are included in current period
net income as a component of other income (expense).
Premiums on foreign currency option contracts used to hedge firm
commitments and anticipated transactions are amortized on a straight-line basis
over the life of the contract. Forward points on foreign currency
18
forward exchange contracts which qualify as hedges of firm commitments are
recognized in income or as adjustments to the carrying amount when the hedged
transaction occurs.
The Company may, from time to time, adjust its foreign currency hedging
position by taking out additional contracts or by terminating or offsetting
existing foreign currency forward exchange and option contracts. These
adjustments may result from changes in the Company's underlying foreign currency
exposures or from fundamental shifts in the economics of particular exchange
rates, as has occurred recently with the Thai Baht and the Malaysian Ringgit.
(See Subsequent Events note.) For foreign currency forward exchange and option
contracts qualifying as accounting hedges, gains or losses on terminated
contracts and offsetting contracts are deferred and are recognized in income or
as adjustments to the carrying amount of the hedged item in the period the
hedged transaction occurs. For foreign currency forward exchange and option
contracts not qualifying as accounting hedges, gain and losses on terminated
contracts, or on contracts that are offset, are recognized in income in the
period of contract termination or offset.
REVENUE RECOGNITION AND PRODUCT WARRANTY Revenue from sales of
products is generally recognized upon shipment to customers. The Company
warrants its products against defects in design, materials and workmanship
generally for three to five years depending upon the capacity category of the
disc drive, with the higher capacity products being warranted for the longer
periods. A provision for estimated future costs relating to warranty expense is
recorded when products are shipped.
INVENTORY Inventories are valued at the lower of standard cost
(which approximates actual cost using the first-in, first-out method) or market.
PROPERTY, EQUIPMENT, AND LEASEHOLD IMPROVEMENTS Land, equipment,
buildings and leasehold improvements are stated at cost. Equipment and buildings
are depreciated using the straight-line method over the estimated useful lives
of the assets. Leasehold improvements are amortized using the straight-line
method over the shorter of the estimated life of the asset or the remaining term
of the lease.
ADVERTISING EXPENSE The cost of advertising is expensed as
incurred. Advertising costs were not significant in 1997, 1996 or 1995.
STOCK-BASED COMPENSATION In October 1995, the Financial Accounting
Standards Board released Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 provides an
alternative to Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APBO 25") and requires additional disclosure. SFAS 123
is effective for the Company's fiscal year ended June 27, 1997. The Company has
elected to continue to account for its employee stock plans in accordance with
the provisions of APBO 25 while providing the additional disclosures required by
SFAS 123. Accordingly, SFAS 123 had no impact on the Company's financial
position or results of operations.
IMPAIRMENT OF LONG-LIVED ASSETS The Company adopted Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121") during
the year ended June 28, 1996. The adoption of SFAS 121 did not have a material
impact on the Company's financial position or results of operations.
NET INCOME PER SHARE Primary net income per share is based on the
weighted average number of shares of common stock and common stock equivalents
outstanding during the year. Common stock equivalents consist of stock options.
Fully diluted net income per share further assumes the conversion of the
Company's convertible subordinated debentures for the period they were
outstanding, unless such assumed conversion would result in anti-dilution.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share," ("SFAS 128")
which is required to be adopted in the Company's fiscal quarter ended January 2,
1998. At that time, the Company will be required to change the method currently
used to compute net income per share and to restate all prior periods. Under
the new requirements for calculating primary net income per share, the dilutive
effect of stock options will be excluded. If SFAS 128 had been effective for
1997 and 1996 it would have resulted in an increase in primary earnings per
share of $ .09 and $ .04, respectively. The impact of SFAS 128 on the
calculation of fully diluted earnings per share for those years would not have
been material.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS The Company considers
all highly liquid investments with a remaining maturity of 90 days or less at
the time of purchase to be cash equivalents. Cash equivalents are carried at
cost, which approximates fair value. The Company's short-term investments
primarily comprise readily marketable debt securities with remaining maturities
of more than 90 days at the time of purchase. Where the remaining maturity is
more than one year the securities are classified as short-term investments as
the Company's intention is to convert them into cash within one year. Mortgage
backed securities, included in U.S. Government Obligations, are classified by
contractual maturity based upon the weighted average life of the securities.
19
The Company has classified its entire investment portfolio as available-
for-sale. Available-for-sale securities are stated at fair value with unrealized
gains and losses included in stockholders' equity. The amortized cost of debt
securities is adjusted for amortization of premiums and accretion of discounts
to maturity. Such amortization is included in interest income. Realized gains
and losses are included in other income (expense). The cost of securities sold
is based on the specific identification method.
CONCENTRATION OF CREDIT RISK The Company's customer base for disc
drive products is concentrated with a small number of systems manufacturers.
Financial instruments which potentially subject the Company to concentrations of
credit risk are primarily accounts receivable, cash equivalents and short-term
investments. The Company performs ongoing credit evaluations of its customers'
financial condition and, generally, requires no collateral from its customers.
The allowance for noncollection of accounts receivable is based upon the
expected collectibility of all accounts receivable. The Company places its cash
equivalents and short-term investments in investment grade, short-term debt
instruments and limits the amount of credit exposure to any one commercial
issuer.
FINANCIAL INSTRUMENTS
The following is a summary of available-for-sale securities at June 27,
1997:
Gross Gross
Amortized Unrealized Unrealized
In thousands Cost Gain Loss Fair Value
- -------------------------------------------------------------------------------------------------------------------------
Money market mutual funds $ 181,746 $ - $ - $ 181,746
U.S. government obligations 364,360 101 (238) 364,223
Repurchase agreements 150,000 - - 150,000
Commercial paper 615,595 - (8) 615,587
Auction rate preferred stock 227,150 - - 227,150
Euro/Yankee time deposits 416,759 - - 416,759
Municipal bonds 77,605 132 (35) 77,702
Corporate bonds 116,250 97 (196) 116,151
---------- ------ ------- ----------
Total $2,149,465 $ 330 $ (477) $2,149,318
========== ====== ======= ==========
Included in short-term investments $1,236,262
Included in cash and cash equivalents 913,056
----------
Total $2,149,318
==========
The following is a summary of available-for-sale securities at June 28,
1996:
Gross Gross
Amortized Unrealized Unrealized
In thousands Cost Gain Loss Fair Value
- -------------------------------------------------------------------------------------------
Money market mutual funds $ 111,522 $ - $ - $ 111,522
U.S. government obligations 164,810 83 (577) 164,316
Commercial paper 298,868 842 (1) 299,709
Auction rate preferred stock 121,123 - (23) 121,100
Euro/Yankee time deposits 85,918 3 - 85,921
Municipal bonds 90,463 61 (223) 90,301
Corporate bonds 126,131 111 (598) 125,644
---------- ------ ------- ----------
Total $ 998,835 $1,100 $(1,422) $ 998,513
========== ====== ======= ==========
Included in short-term investments $ 670,308
20
Included in cash and cash equivalents 328,205
----------
Total $ 998,513
==========
The gross realized gains and losses on the sale of available-for-sale
securities were immaterial for the years ended June 27, 1997 and June 28, 1996.
The fair value of the Company's investment in debt securities, by
contractual maturity, is as follows (in thousands):
June 27, 1997 June 28, 1996
------------- -------------
Due in less than 1 year $1,529,479 $534,258
Due in 1 to 3 years 210,943 231,633
---------- --------
Total $1,740,422 $765,891
========== ========
FAIR VALUE DISCLOSURES The carrying value of cash and cash equivalents
approximates fair value. The fair values of short-term investments, convertible
subordinated debentures (see Long-Term Debt and Lines of Credit footnote) and
foreign currency forward exchange and option contracts are estimated based on
quoted market prices .
The carrying values and fair values of the Company's financial instruments
are as follows:
In thousands June 27, 1997 June 28, 1996
- -------------------------------------------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
- -------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents $1,047,335 $1,047,335 $ 503,754 $ 503,754
Short-term investments 1,236,262 1,236,262 670,308 670,308
5% convertible subordinated debentures, due 2003 - - (270,750) (469,413)
6.50% convertible subordinated debentures, due 2002 - - (309,335) (324,802)
6.75% convertible subordinated debentures, due 2001 - - (209,141) (211,232)
7.125% senior notes, due 2004 (200,000) (199,710) - -
7.37% senior notes, due 2007 (200,000) (200,518) - -
7.45% senior debentures, due 2037 (200,000) (202,018) - -
7.875% senior debentures, due 2017 (100,000) (99,934) - -
Italian Lira debentures, 14.65% to 15.25% (983) (983) (8,755) (8,755)
Foreign currency forward exchange and option contracts (2,159) (9,560)* (804) 3,302
Other borrowings (148) (148) (335) (335)
*See Subsequent Events note.
DERIVATIVE FINANCIAL INSTRUMENTS The Company enters into foreign currency
forward exchange and option contracts to manage exposure related to certain
foreign currency commitments and anticipated foreign currency denominated
expenditures. The Company does not enter into derivative financial instruments
for trading
21
purposes. At June 27, 1997, the Company had outstanding foreign currency forward
exchange and purchase option contracts with notional amounts totaling
approximately $1,006,000,000 and $326,000,000, respectively. These contracts,
which mature at various periods over the next twelve months, are hedges of cash
flow requirements in the Singapore Dollar, Malaysian Ringgit and Thai Baht. (See
Subsequent Events note.)
While the contract or notional amounts of the Company's forward exchange
and option contracts provide one measure of the volume of these transactions,
they do not represent the amount of the Company's exposure to credit risk. The
amounts potentially subject to credit risk (arising from the possible inability
of counterparties to meet the terms of their contracts) are generally limited to
the amounts, if any, by which the counterparties' obligations exceed the
obligations of the Company. The Company controls credit risk through credit
approvals, limits and monitoring procedures. Credit rating criteria used by the
Company for off-balance sheet transactions are similar to those which it uses
for investments.
ACCOUNTS RECEIVABLE
Accounts receivable are summarized below:
In thousands 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
Accounts receivable $1,101,248 $1,133,175
Less allowance for noncollection (60,413) (66,656)
---------- ----------
$1,040,835 $1,066,519
========== ==========
INVENTORIES
Inventories are summarized below:
In thousands 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
Components $ 358,667 $ 295,169
Work-in-process 134,198 138,854
Finished goods 315,415 356,798
---------- ----------
$ 808,280 $ 790,821
========== ==========
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consisted of the following:
Estimated
In thousands Useful Life 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Land $ 15,399 $ 15,560
Equipment 1-1/2 - 4 years 1,918,381 1,505,567
Building and leasehold improvements Life of lease - 30 years 762,397 556,026
Construction in progress 362,267 327,385
----------- -----------
3,058,444 2,404,538
Less accumulated depreciation and amortization (1,271,819) (1,004,655)
----------- -----------
$ 1,786,625 $ 1,399,883
=========== ===========
Equipment and leasehold improvements include assets under capitalized
leases. Lease amortization is included in depreciation expense. Depreciation
expense was $451,109,000, $330,213,000, and $246,883,000 in 1997, 1996, and
1995, respectively.
22
GOODWILL AND OTHER INTANGIBLES
Goodwill represents the excess of the purchase price of acquired companies
over the estimated fair value of the tangible and specifically identified
intangible net assets acquired. In accordance with SFAS 121, the carrying value
of these intangibles and related goodwill is reviewed if the facts and
circumstances suggest that they may be impaired. If this review indicates these
assets' carrying value will not be recoverable, as determined based on the
undiscounted net cash flows of the entity acquired over the remaining
amortization period, the Company's carrying value is reduced to its estimated
fair value (generally based on an estimate of discounted future net cash flows).
Goodwill and other intangibles are being amortized on a straight-line basis over
periods ranging from two to fifteen years. Accumulated amortization was
$161,044,000 and $201,721,000 as of June 27, 1997 and June 28, 1996,
respectively.
LONG-TERM DEBT AND LINES OF CREDIT
Long-term debt consisted of the following:
In thousands 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
5% convertible subordinated debentures $ - $270,750
6.50% convertible subordinated debentures - 309,335
6.75% convertible subordinated debentures - 209,141
7.125% senior notes, due 2004 200,000 -
7.37% senior notes, due 2007 200,000 -
7.45% senior debentures, due 2037 200,000 -
7.875% senior debentures, due 2017 100,000 -
Italian Lira debentures, 14.65% to 15.25% notes and loans
due through 1999 983 8,755
Capitalized lease obligations with interest at 14% to 19.25% collateralized
by certain manufacturing equipment and buildings 1,939 2,414
Other borrowings 148 335
-------- --------
703,070 800,730
Less current portion 1,125 2,425
-------- --------
$701,945 $798,305
======== ========
At June 27, 1997, future minimum principal payments on long-term debt and
capitalized lease obligations were as follows:
In thousands
- -------------------------------------------------------------------------------------------------
1998 $ 1,125
1999 126
2000 165
2001 232
2002 315
After 2002 701,107
--------
$ 703,070
==========
During 1996 and 1997, the Company called for redemption all its 6.5%,
6.75%, 5% and 6.75% Convertible Subordinated Debentures due 2002, 2001, 2003 and
2012, respectively. Approximately $1,053,500,000 principal amount of the
debentures were converted to approximately 50.8 million shares of the Company's
common stock and approximately $2,300,000 principal amount of the debentures
were redeemed. None of the 5% debentures were redeemed.
23
The Company's 7.125% senior notes due 2004, 7.37% senior notes due 2007 and
7.875% senior debentures due 2017 are redeemable at the option of the Company at
any time, at a redemption price equal to the greater of (I) 100% of their
principal amount plus accrued interest or (ii) the sum of the present values of
the remaining scheduled payments of principal and interest discounted to the
date of redemption at a discount rate (the "discount rate") as set forth in the
indenture governing the notes and debentures plus 10 basis points. The
Company's 7.45% senior debentures due 2037 are redeemable at the option of the
Company at any time, at a redemption price equal to the greater of (i) 100% of
their principal amount plus accrued interest, (ii) the sum of the present values
of the remaining scheduled payments of principal and interest discounted to the
date of redemption at the discount rate plus 10 basis points, calculated as if
the principal amount were payable in full on March 1, 2009, or (iii) the sum of
the present values of the remaining scheduled payments of principal and interest
discounted to the date of redemption at the discount rate plus 10 basis points.
In addition, the Company's 7.45% senior debentures due 2037 will be redeemable
on March 1, 2009, at the option of the holders thereof, at 100% of their
principal amount, together with interest payable to the date of redemption. The
Company's 7.125% senior notes due 2004, 7.37% senior notes due 2007 and 7.875%
senior debentures due 2017 will not be redeemable at the option of the holders
thereof prior to maturity. These securities were issued in an offering
registered under the Securities Act of 1933.
During the year ended June 30, 1995, the Company purchased at a discount
certain of its 6.5% and 6.75% convertible subordinated debentures with a face
value of $56,102,000. The Company also prepaid and retired the remaining
$41,666,000 of its outstanding Series A and Series B senior notes with a
prepayment fee of $1,100,000. As a result of these transactions, the Company
recorded a net extraordinary gain for the year of $6,171,000 (net of applicable
income taxes of $4,288,000) or $0.02 per share on a fully diluted basis.
As of June 27, 1997, the Company had committed lines of credit of $82
million which can be used for standby letters of credit or bankers' guarantees.
At June 27, 1997, approximately $78 million had been utilized.
EMPLOYEE PROFIT SHARING AND EXECUTIVE BONUS PLANS
The Company allocates a certain percentage of adjusted quarterly pretax
profits to its Employee Profit Sharing Plan which is currently distributed to
employees, excluding officers, employed for the full quarter. The Company also
allocates a certain percentage of adjusted quarterly pretax profits to its
Executive Bonus Plan. Distributions to corporate officers under this plan are
subject to the discretion of the Board of Directors. Charges to operations for
distributions to employees and/or corporate officers under these Plans during
1997, 1996 and 1995 were $114,970,000, $72,723,000 and $62,891,000,
respectively.
STOCK-BASED BENEFIT PLANS
STOCK OPTION PLANS Options granted under the Company's stock option plans are
granted at fair market value, expire ten years from the date of the grant and
generally vest in four equal annual installments, commencing one year from the
date of the grant.
Following is a summary of stock option activity for the three years ended
June 27, 1997:
Options Outstanding
---------------------------------------------
Number Weighted Average
of Shares Exercise Price
- --------------------------------------------------------------------------------------------------------
Balance July 1, 1994 25,595,748 $10.03
Granted 6,803,274 $13.72
Exercised (7,440,738) $ 6.80
Canceled (3,590,654) $15.27
----------
Balance June 30, 1995 21,367,630 $11.45
Granted 11,057,982 $22.30
24
Exercised (6,168,230) $ 8.71
Canceled (3,257,684) $14.27
Elimination of Conner Activity for
the duplicated six months ended December 31, 1995 700,326 $14.13
----------
Balance June 28, 1996 23,700,024 $16.91
Granted 5,966,688 $36.31
Exercised (5,213,201) $12.15
Canceled (2,481,741) $20.42
----------
Balance June 27, 1997 21,971,770 $22.92
==========
Options available for grant were 5,126,775 at June 27, 1997; 9,031,638 at
June 28, 1996; and 11,089,072 at June 30, 1995. On July 29, 1997, the Board of
Directors approved an amendment to the 1991 Incentive Stock Option Plan to
increase the number of shares of common stock reserved for issuance thereunder
by 15,000,000, subject to stockholder approval at the 1997 Annual Meeting of
Stockholders. At June 27, 1997, options to purchase 6,413,380 shares of common
stock were exercisable. The following tables summarize information about
options outstanding at June 27, 1997.
Outstanding Options
-------------------------------------------------
Weighted Average
Number Contractual Life Weighted Average
Range of exercise prices of Shares (in years) Exercise Price
- -------------------------------------------------------------------------------
$ .24 - $11.00 3,129,003 5.6 $ 6.87
$11.03 - $21.88 6,962,991 7.2 $14.87
$21.92 - $29.31 7,501,394 8.6 $26.93
$29.38 - $51.75 4,378,382 9.6 $40.31
----------
Total 21,971,770 7.9 $22.92
========== === ======
Exercisable Options
--------------------
Number Weighted Average
Range of exercise prices of Shares Exercise Price
- -------------------------------------------------------------------------------
$ .24 - $11.00 2,339,837 $ 6.95
$11.03 - $21.88 2,818,441 $14.07
$21.92 - $29.31 1,209,983 $27.76
$29.38 - $51.75 45,119 $32.16
----------
Total 6,413,380 $14.18
==========
EXECUTIVE STOCK PLAN The Company has an Executive Stock Plan under which
senior executives of the Company are granted the right to purchase shares of the
Company's common stock at $.01 per share. The difference between the fair market
value of the shares on the measurement date and the exercise price is recorded
as deferred compensation and is charged to operations over the vesting period of
five or ten years. In November 1995, the Company's Board of Directors granted
1,604,000 shares under the plan, subject to stockholder approval of certain
amendments to the plan. These amendments included the addition of 2,000,000
shares to be issued under the plan. In February 1996, such stockholder approval
was obtained. Subsequently in May 1996, an additional
25
416,500 shares were granted under the plan. In 1997, 249,500 shares were
granted and 85,000 shares were repurchased under the terms of the plan. At June
27, 1997, 315,000 shares were available for future grants. In addition, the
Company has a Restricted Stock Plan which also has a deferred compensation
component. Under this plan the deferred compensation is amortized over a period
of seven years. There are two employees remaining in the plan and no shares are
available for future grant. The aggregate amount charged to operations for
amortization of deferred compensation under both plans was $7,746,567,
$3,946,000 and $2,935,000 in 1997, 1996, and 1995, respectively.
STOCK PURCHASE PLANS The Company also maintains an Employee Stock Purchase
Plan. A total of 13,600,000 shares of common stock have been authorized for
issuance under the Purchase Plan. The Purchase Plan permits eligible employees
who have completed thirty days of employment prior to the inception of the
offering period to purchase common stock through payroll deductions at the lower
of 85% of the fair market value of the common stock at the beginning or at the
end of each six-month offering period. Under the plan, 1,053,651, 1,128,886 and
2,007,692 shares of common stock were issued in 1997, 1996 and 1995,
respectively.
Common stock reserved for future issuance under the Company's Employee
Stock Purchase Plan aggregated 2,773,763 shares at June 27, 1997.
PRO FORMA INFORMATION In October 1995, the Financial Accounting Standards
Board released Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123"). SFAS 123 provides an alternative to
APB Opinion 25, "Accounting for Stock Issued to Employees" ("APBO 25") and
requires additional disclosures. The Company has elected to follow APBO 25 in
accounting for stock options granted (including shares issued under the Stock
Purchase Plans, collectively called "stock options"). Under APBO 25 the Company
generally recognized no compensation expense with respect to such options.
Pro forma information regarding net income and earnings per share is
required by SFAS 123 for stock options granted after June 30, 1996 as if the
Company had accounted for its stock options under the fair value method of SFAS
123. The fair value of the Company's stock options was estimated using a Black-
Scholes option valuation model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options which have no
vesting restrictions and are fully transferable. In addition, the Black-Scholes
model requires the input of highly subjective assumptions, including the
expected stock price volatility. Because the Company's stock options granted to
employees 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 management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its stock
options granted to employees. The fair value of the Company's stock options
granted to employees was estimated assuming no expected dividends and the
following weighted average assumptions:
Stock Option Employee Stock
Plan Shares Purchase Plan Shares
--------------------- ----------------------
1997 1996 1997 1996
- ----------------------------------------------------------------------------
Expected life (in years) 3.5 3.5 .5 .5
Risk-free interest rate 6.2% 5.6% 5.4% 5.4%
Volatility .45 .45 .46 .46
The weighted average exercise price and weighted average fair value of
stock options granted in 1997 under the Company's Stock Option Plans was $36.31
and $14.57 per share, respectively. The weighted average purchase price and
weighted average fair value of shares granted in 1997 under the Company's
Employee Stock Purchase Plans was $32.88 and $8.89, respectively.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting period (for stock options) and
the six month purchase period for stock purchases under the Stock Purchase Plan.
The Company's pro forma information follows:
26
In thousands 1997 1996
- ---------------------------------------------------------------
Pro forma net income $609,815 $194,537
Pro forma primary net income per share $ 2.56 $ .95
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.
Because SFAS 123 is applicable only to options granted subsequent to June 30,
1995, the pro forma effect will not be fully reflected until 1999.
INCOME TAXES
The provision for income taxes consisted of the following:
In thousands 1997 1996 1995
________________________________________________________________________________
Current Tax Expense
Federal $121,445 $167,586 $133,494
State 6,157 28,123 27,773
Foreign 9,254 7,023 14,370
-------- -------- --------
136,856 202,732 175,637
-------- -------- --------
Deferred Tax Expense
Federal 65,556 (76,075) (1,902)
State 14,205 (8,405) (5,330)
Foreign 16,580 (53) 6,523
-------- -------- --------
96,341 (84,533) (709)
-------- -------- --------
Provision for Income Taxes $233,197 $118,199 $174,928
======== ======== ========
The income tax benefit related to the exercise of stock options reduces
taxes currently payable and is credited to additional paid-in capital. Such
amounts approximated $52,261,000, $47,302,000 and $23,083,000 for 1997, 1996 and
1995, respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of the Company's deferred tax assets and liabilities were as follows:
In thousands June 27, 1997 June 28, 1996
- -----------------------------------------------------------------------------------------
DEFERRED TAX ASSETS
Accrued warranty $165,903 $112,501
Inventory valuation accounts 32,895 46,176
Receivable reserves 29,472 31,727
Accrued compensation and benefits 36,199 29,596
Depreciation 23,222 22,611
Restructuring reserves 12,273 32,976
Other reserves and accruals 47,078 23,652
Acquisition related items 29,444 14,489
Net operating loss and tax credit carryforwards 30,829 44,714
Other assets 8,558 5,185
-------- --------
Total Deferred Tax Assets 415,873 363,627
Valuation allowance (57,120) (37,498)
-------- --------
Net Deferred Tax Assets 358,753 326,129
-------- --------
27
DEFERRED TAX LIABILITIES
Unremitted income of foreign subsidiaries (561,340) (416,848)
Acquisition related items (20,418) (25,946)
Other liabilities (2,463) (12,507)
--------- ---------
Total Deferred Tax Liabilities (584,221) (455,301)
--------- ---------
Net Deferred Tax Liabilities $(225,468) $(129,172)
========= =========
AS REPORTED ON THE BALANCE SHEET
Deferred Income Tax Asset $ 253,372 $ 222,355
Deferred Income Tax Liability (478,840) (351,527)
--------- ---------
Net Deferred Tax Liability $(225,468) $(129,172)
========= =========
The valuation allowance has been provided for deferred tax assets related
to certain foreign net operating loss carryforwards and future tax benefits
associated with the acquisition of certain software companies. The valuation
allowance increased by $19,622,000 and $15,062,000 in 1997 and 1996,
respectively.
The Company, as of June 27, 1997, has domestic and foreign net operating
loss carryforwards of approximately $82,000,000 expiring in 1999 through 2012 if
not used to offset future taxable income.
The differences between the provision for income taxes at the U.S.
statutory rate and the effective rate are summarized as follows:
In thousands 1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
Provision at U.S. statutory rate $311,932 $116,012 $170,617
State income taxes net of federal income tax benefit 19,049 10,472 14,408
Benefit from net earnings of foreign subsidiaries considered
to be permanently invested in non-U.S. operations (97,087) (59,120) (67,118)
Foreign income taxes (845) 800 16,698
Write-off of in-process research and development - 30,440 24,626
Restructuring - 18,008 -
Valuation reserve 19,622 15,062 1,524
Other (19,474) (13,475) 14,173
-------- -------- --------
Provision for Income Taxes $233,197 $118,199 $174,928
======== ======== ========
A substantial portion of the Company's Far East manufacturing
operations in Singapore, Thailand, China and Malaysia operate free of tax under
various tax holidays which expire in whole or in part during fiscal years 1998
through 2005. Certain tax holidays may be extended if specific conditions are
met. The net impact of these tax holidays was to increase net income by
approximately $71,394,000 ($0.28 per share, fully diluted) in 1997,
approximately $50,398,000 ($0.21 per share, fully diluted) in 1996 and
approximately $59,788,000 ($0.24 per share, fully diluted) in 1995. Cumulative
undistributed earnings of the Company's Far East subsidiaries for which no
income taxes have been provided aggregated approximately $1,439,412,000 at June
27, 1997. These earnings are considered to be permanently invested in non-U.S.
operations. Additional state and federal taxes of approximately $574,515,000
would have to be provided if these earnings were repatriated to the U.S.
On June 30, 1997, the Company received a statutory notice of potential
deficiencies from the Internal Revenue Service (IRS) relative to taxable years
1991 through 1993 approximating $38,500,000 plus interest, as well as
approximately $5,700,000 of penalties. The Company believes it has meritorious
defenses to the IRS adjustments but has not yet determined the forum in which it
will contest this proposed deficiency. The Company believes that the likely
outcome of this matter will not have a material adverse effect on its financial
position or results of operations.
28
Certain of the Company's foreign and state tax returns for various
fiscal years are under examination by taxing authorities. Conner's federal
income tax returns for the fiscal years 1991 and 1992 are under examination by
the IRS. The Company believes that adequate amounts of tax have been provided
for any final assessments which may result from these examinations.
MERGER WITH CONNER
On February 2, 1996, the Company and Conner Peripherals, Inc. ("Conner")
merged after approval by the stockholders of both companies. To effect the
combination, Seagate issued 48,956,044 shares of its common stock in exchange
for all the outstanding common stock of Conner and issued options to purchase
4,939,160 shares of Seagate common stock in exchange for all the outstanding
options to purchase Conner common stock. The merger has been accounted for as a
pooling of interests and, accordingly, all periods prior to the merger presented
in the accompanying consolidated financial statements have been restated to
include the accounts and operations of Conner. Conner was involved in the
design, manufacture and marketing of information storage products including disc
drives, tape drives and storage management software.
Because of differing fiscal year ends of the two companies, the
consolidated statement of income for fiscal year 1995 combines Seagate's twelve
months ended June 30, 1995 with Conner's twelve months ended December 31, 1995.
The consolidated balance sheets combine Seagate's fiscal year ended June 30,
1995 with Conner's year ended December 31, 1995. Combined and separate results
of the Company and Conner for the periods prior to the acquisition were as
follows:
Years Ended
------------------------------
In thousands June 28, 1996 June 30, 1995
- ----------------------------------------------------------------------------
Net Sales:
Prior to December 30, 1995:
Seagate $3,016,590 $4,539,570
Conner 1,463,906 2,716,639
Combined results after December 29, 1995 4,107,854 -
---------- ----------
$8,588,350 $7,256,209
========== ==========
Extraordinary Gain:
Prior to December 30, 1995:
Seagate $ - $ -
Conner - 6,171
Combined results after December 29, 1995 - -
---------- ----------
$ - $ 6,171
========== ==========
Net Income:
Prior to December 30, 1995:
Seagate $ 232,473 $ 259,651
Conner 37,251 59,068
Combined results after December 29, 1995 (56,463) -
---------- ----------
$ 213,261 $ 318,719
========== ==========
The combined net loss after December 29, 1995 (see table above) of
$56,463,000 includes a $168,425,000 restructuring charge, net of related tax
effect, as a result of the merger with Conner and a $88,779,000 write-off of in-
process research and development, net of related tax effect, incurred in
connection with the acquisitions of software companies.
The two companies maintained a majority of similar accounting practices.
However, as a result of certain differing accounting practices relating to the
capitalization of fixed assets and inventory, certain adjustments to net assets
were made to conform accounting practices of the two companies. None of these
adjustments was material to any period presented.
Previously, Conner's fiscal year ended on the Saturday closest to December
31. To change Conner's fiscal year end to conform with Seagate's June 28, 1996
fiscal year end, the operating results of Conner for the six months ended
December 31, 1995 are included in the consolidated statement of income for both
fiscal years 1996 and 1995. The Conner results of operations for the six months
ended December 30, 1995 were as follows:
29
Six Months Ended
In thousands December 30, 1995
- ----------------------------------------------
Net sales $1,463,906
Operating expenses 1,403,098
Other income (expense) (4,501)
Net income 37,251
ACQUISITIONS
In connection with the merger with Conner, on February 16, 1996, the
Company acquired the minority interest in Arcada Holdings, Inc. ("Arcada"),
formerly a majority-owned subsidiary of Conner. Seagate acquired the minority
interest in Arcada by exchanging 2,553,340 shares of Seagate common stock and
options to purchase 1,813,936 shares of Arcada common stock (equivalent to
approximately $85,075,000, net of the exercise proceeds of the options acquired,
based on a market value of $20.37 per share of Seagate common stock) for all the
outstanding common stock and options to purchase common stock of Arcada. Arcada
developed, marketed and supported data protection and storage management
software products that operate across multiple desktop and client/server
environments. This acquisition was accounted for as a purchase and, accordingly,
the results of operations of the minority interest have been included in the
consolidated financial statements from the date of acquisition of such minority
interest. Goodwill and other intangibles arising from the acquisition are being
amortized on a straight-line basis over periods ranging from two to seven years.
As a result of the acquisition, the Company incurred a one-time write-off of in-
process research and development of $43,900,000.
During the year ended June 28, 1996, the Company acquired Sytron
Corporation, a storage management software company, OnDemand Software, Inc. and
Calypso Software Systems, Inc., both network management software companies,
Holistic Systems Ltd., an information management software company, and Stormex,
S.A. de C.V., a media substrate manufacturer. These acquisitions were accounted
for as purchases and, accordingly, the results of operations of the acquired
businesses have been included in the consolidated financial statements from the
date of acquisition. The total cost of all businesses acquired for cash in 1996
was $110,611,000, net of cash acquired, excluding $20,800,000 of payments held
in escrow pending the outcome of certain contingencies relating to the
acquisition of Holistic Systems Ltd. In 1997, $18,000,000 of the $20,800,000
held in escrow was paid out. Goodwill and other intangibles arising from the
acquisitions are being amortized on a straight-line basis over periods ranging
from one to seven years. As a result of the 1996 acquisitions, the Company
incurred one-time write-offs of in-process research and development totaling
$98,687,000. As a result of the payments out of escrow in fiscal year 1997 to
former stockholders of Holistic, the Company incurred one-time write-offs of
compensation expense and in-process research and development of $13,446,000 and
$2,876,000, respectively. The compensation expense is included in unusual items
on the consolidated statement of income. The operations of the acquired
companies prior to the date of acquisition were not material to the Company's
net sales or net income.
In 1996, the Company increased its investment in SanDisk Corporation, a
flash memory manufacturer, by $10,086,000. Goodwill arising from the equity
investment in SanDisk Corporation is being amortized on a straight-line basis
over seven years.
RESTRUCTURING
During 1996, the Company recorded restructuring charges totaling
$241,720,000 as a result of the merger with Conner. The restructuring charges
were incurred for the reduction of personnel whose duties were made redundant,
write-off or write down of equipment, inventory, intangibles and other assets,
closure of duplicate and excess facilities, fees of financial advisors,
attorneys and accountants and contract cancellations and other expenses. In
connection with the restructure, the Company currently expects a total workforce
reduction of approximately 1,370 employees. Of that number, the employment of
1,313 employees has been terminated.
During 1997, the Company reversed $9,554,000 of its restructuring reserves
as a result of the completion of certain aspects of the restructuring plan at
less than the originally estimated cost. In addition, certain reclassifications
were made among certain categories of the restructure reserve, primarily between
employee termination benefits, and facilities and equipment. This was due to
modifications to the Company's estimates of costs associated with certain
specific aspects of the restructure plan as the plan approached completion. As
of June 27, 1997, the implementation of the restructure plan was substantially
complete.
30
The following table summarizes the Company's restructuring activity for the
two years ended June 27, 1997:
Equipment, Contract
Inventory, Cancellations
Severances Excess Intangibles Professional and Other
and Benefits Facilities and Other Assets Fees Expenses Total
------------- ----------- ----------------- ------------- -------------- ---------
Reserve balances,
June 30, 1995 $ 293 $ 3,239 $ 1,518 $ - $ - $ 5,050
1996 restructuring charges 60,714 45,138 97,209 23,980 14,679 241,720
Cash charges (27,737) (1,338) (963) (20,795) (4,614) (55,447)
Non-cash charges (917) (12,451) (85,721) - (273) (99,362)
Elimination of Conner
activity for the six
months ended
December 31, 1995 813 731 (89) - - 1,455
-------- -------- -------- -------- ------- --------
Reserve balances,
June 28, 1996 33,166 35,319 11,954 3,185 9,792 93,416
Cash charges (17,999) (10,262) - (1,930) (6,185) (36,376)
Non-cash charges - (4,655) (19,080) - 69 (23,666)
Adjustments and
reclassifications (14,837) (8,733) 11,530 (1,255) 3,741 (9,554)
-------- -------- -------- -------- ------- --------
Reserve balances,
June 27, 1997 $ 330 $ 11,669* $ 4,404 $ - $ 7,417 $ 23,820
======== ======== ======== ======== ======= ========
* Primarily relates to future lease payments on facilities that will no longer
be utilized.
BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in a single industry segment by designing,
manufacturing and marketing products for storage, retrieval and management of
data on computer and data communications systems. These products include disc
drives and disc drive components, tape drives and software.
The following tables summarize the Company's operations in different
geographic areas:
Year Ended June 27, 1997 United Far Adjustments and
In thousands States East Eliminations Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Sales to unaffiliated customers $5,215,820 $ 3,724,202 $ - $8,940,022
Transfers between geographic areas 1,398,410 6,462,389 (7,860,799) -
---------- ----------- ------------- ----------
Total net sales $6,614,230 $10,186,591 $(7,860,799) $8,940,022
========== =========== ============= ==========
Income from operations $ 44,370 $ 813,215 $ - $ 857,585
Other income (expense), net (3,708) 37,358 - 33,650
---------- ----------- ------------- ----------
31
Income before income taxes $ 40,662 $ 850,573 $ - $ 891,235
========== =========== ============= ==========
Identifiable assets $3,049,707 $ 3,673,172 $ - $6,722,879
========== =========== ============= ==========
Adjustments and
Year Ended June 28, 1996 United Far Eliminations
In thousands States East Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Sales to unaffiliated customers $5,888,205 $2,700,145 $ - $8,588,350
Transfers between geographic areas 1,272,067 6,247,630 (7,519,697) -
---------- ---------- ------------------- ----------
Total net sales $7,160,272 $8,947,775 $(7,519,697) $8,588,350
- ------------------------------------- ========== ========== =================== ==========
Income (loss) from operations $ (76,805) $ 363,774 $ - $ 286,969
Other income (expense), net (63) 44,554 - 44,491
---------- ---------- ------------------- ----------
Income (loss) before income taxes $ (76,868) $ 408,328 $ - $ 331,460
========== ========== =================== ==========
Identifiable assets $2,310,876 $2,928,759 $ - $5,239,635
========== ========== =================== ==========
Adjustments
Year Ended June 30, 1995 United Far and
In thousands States East Eliminations Consolidated
- -------------------------------------------------------------------------------------------------------------------------
Sales to unaffiliated customers $5,167,408 $2,088,801 $ - $7,256,209
Transfers between geographic areas 1,120,720 4,217,003 (5,337,723) -
---------- ---------- ------------------- ----------
Total net sales $6,288,128 $6,305,804 $(5,337,723) $7,256,209
========== ========== =================== ==========
Income from operations $ 74,871 $ 384,430 $ - $ 459,301
Other income (expense), net (25,143) 53,318 - 28,175
---------- ---------- ------------------- ----------
Income before income taxes and
extraordinary gain $ 49,728 $ 437,748 $ - $ 487,476
========== ========== =================== ==========
Identifiable assets $3,052,136 $1,847,696 $ - $4,899,832
========== ========== =================== ==========
Sales and transfers between geographic areas are accounted for at prices
which, in general, provide a profit after coverage of all manufacturing costs.
Income from operations is net sales less operating expenses. The identifiable
assets by geographic area are those assets used in the Company's operations in
each area.
The Company's European operations include sales offices and distribution
warehouses. The sales offices and distribution warehouses do not qualify as
revenue-producing operations in accordance with Statement of
32
Financial Accounting Standards No. 14, "Financial Reporting for Segments of a
Business Enterprise" ("SFAS 14") and thus do not qualify to be disclosed as a
separate geographic area. The distribution warehouses merely facilitate sales
for the Singapore and Thailand manufacturing operations and are thus included in
the Far East geographic area in the tables above. Other European operations that
do qualify as revenue-producing operations do not meet the materiality criteria
of SFAS 14 and thus are not disclosed as a separate geographic area.
In 1997, one customer accounted for more than 10% of consolidated net sales
for a total of $995,466,000. No customer accounted for 10% or more of
consolidated net sales in 1996 or 1995.
Net foreign currency transaction gains (losses) included in the
determination of net income were $(2,427,000), $(7,794,000), and $4,287,000 for
1997, 1996 and 1995, respectively.
LITIGATION AND ENVIRONMENTAL MATTERS
BUSINESS LITIGATION Amstrad PLC ("Amstrad") initiated a lawsuit against the
Company in London, England on December 11, 1992 concerning the Company's sale of
allegedly defective disc drives to Amstrad. The Company replied to the
allegations made against it by Amstrad by denying all material points of
Amstrad's claim and asserted affirmative defenses. Trial began April 16, 1996
and concluded on July 31, 1996. The Court issued a final judgment on July 9,
1997 and awarded Amstrad approximately $144,000,000 in damages plus costs,
including Amstrad's legal fees, the amount of which will be determined by the
Court at a later date. The Company and Amstrad have appealed the judge's
decision. In June 1997, the Company accrued the damages of $144,000,000 plus
estimated additional costs of $9,000,000 for a total amount of $153,000,000 in
Accrued Expenses. Approximately $145,000,000 was paid in July 1997 and is
currently held in escrow pending the Court's final decision.
Prior to initiating its case against the Company in London, England,
Amstrad had previously filed an action against the Company in the Superior Court
of Santa Cruz County, California in September 1991. That Santa Cruz County
Superior Court action was dismissed with prejudice and judgment of dismissal was
entered on July 24, 1997. Amstrad has filed an objection to this judgment and
has filed a motion seeking to set aside the judgment in order to pursue a claim
for additional damages against the Company. That motion will be vigorously
opposed by the Company.
SECURITIES LITIGATION In 1991, a series of lawsuits was filed in Federal Court
for the Northern District of California against the Company, alleging violations
of the federal securities laws on behalf of a class of purchasers of the
Company's securities. The parties agreed to settle this series of lawsuits and
the settlement was approved by the U.S. District Court on June 24, 1997. One
member of the plaintiff class appealed from the order approving the settlement.
This appeal is currently pending in the United States Court of Appeals for the
Ninth Circuit. Because of this appeal, the settlement is not yet final.
In 1993, a series of lawsuits was filed in Federal Court for the
Northern District of California against Conner Peripherals, Inc. As a result of
the merger with Conner the Company assumed the defense of this litigation.
These class action lawsuits allege violations of the federal securities laws and
seek damages on behalf of a class of purchasers of Conner's securities. The
parties have agreed to settle this series of lawsuits. The settlement received
approval from the District Court during the last fiscal quarter of 1997. One
member of the plaintiff class appealed from the order approving the settlement.
This appeal is currently pending in the United States Court of Appeals for the
Ninth Circuit. Because of this appeal, the settlement is not yet final.
The Company believes that the final settlement of the 1991 and 1993
lawsuits will not have a material adverse effect on the Company's financial
condition or results of operations.
PATENT LITIGATION In November 1992, Rodime, PLC ("Rodime") filed a complaint
in Federal Court for the Central District of California, alleging infringement
of U.S. Patent No. B1 4,638,383 and various state law unfair competition claims.
It was the opinion of the Company's patent counsel that the Company's products
do not infringe any valid claims of the Rodime patent in suit and thus the
Company refused Rodime's offer of a license for its patents. Other companies,
however, such as IBM, Hewlett-Packard and a number of Japanese companies have
reportedly made payments to and taken licenses from Rodime. In 1995, the Court
granted the Company's motions for summary judgment finding that all of the
Company's accused products, with the exception of the ST157, did not infringe
any claims of the Rodime patent, and that the majority of the claims in the
Rodime patent were invalid as a matter of law. The ST157 is no longer in
production. This case was reassigned to a different judge in July 1996. On
October 21, 1996, the judge granted in part Seagate's motion for summary
judgment on intervening rights,
33
finding that the Company has no liability for any ST157 family products made
before November 29, 1988, the date when Rodime's reexamined patent was issued.
A patent law expert and a technical expert were appointed as advisors
to the Court, both of whom recommended an interpretation of the remaining
patent claims which, if adopted by the Court, may result in a judgment that the
Company's ST157 family products do not infringe. The Court received evidence on
February 25, 1997 regarding claim interpretation and the parties submitted post
hearing briefs. On July 3, 1997, the Court issued an Order in which it adjudged
that the Company's ST157 did not infringe the asserted claims of Rodime's patent
and that summary judgment be entered in favor of Seagate. However, the Court
also indicated that it would "proceed with an advisory jury trial if either
party so requests." It continues to be the opinion of the Company's patent
counsel that the Company's products do not infringe any valid or enforceable
claims of Rodime's patent. The Company intends to vigorously defend itself
against the remaining charges of infringement of Rodime's patent and Rodime's
other claims against the Company.
On October 5, 1994, a patent infringement action was filed against the
Company by an individual, James M. White, in the U.S. District Court for the
Northern District of California for alleged infringement of U.S. Patent Nos.
4,673,996 and 4,870,519. Both patents relate to air bearing sliders. Prior to
the filing of the lawsuit, the Company filed a Petition for Reexamination of
U.S. Patent No. 4,673,996 with the United States Patent and Trademark Office
("PTO") and this Petition was granted shortly after the lawsuit was filed.
Subsequently, the Company filed a Petition for Reexamination of U.S. Patent No.
4,870,519. This second petition was also granted by the PTO. The District
Court stayed the action pending the outcome of the Reexaminations. Both patents
have completed reexamination and the stay of the action has been lifted. Mr.
White's lawyers filed a motion seeking a preliminary injunction to stop the sale
of certain of the Company's products. The Court heard arguments on the motion
on June 26, 1997 and denied the motion on July 1, 1997. It is the opinion of
the Company's patent counsel that the Company's products subject to the motion
for a preliminary injunction and charged with infringement do not infringe any
valid claims of the patents involved in the suit. The Company intends to
vigorously defend itself against any and all charges of infringement of these
patents.
On December 16, 1996, a patent infringement action was filed against
the Company by an individual, Virgle Hedgcoth, in the U.S. District Court for
the Northern District of California, San Jose Division, for alleged infringement
of U.S. Patent Nos. 4,735,840, 5,082,747 and 5,316,864. These patents relate to
sputtered magnetic thin-film recording discs for computers and their
manufacture. The Company answered the complaint denying infringement, alleging
that the patents are invalid and unenforceable, and counterclaiming for
declaratory judgment that a fourth Hedgcoth patent, No. 4,894,133, is invalid,
unenforceable and not infringed. Additionally, on July 1, 1997 Mr. Hedgcoth
filed a patent infringement action against the Company in the same Court for
alleged infringement of a fourth patent, U.S. Patent No. 5,262,970, issued May
6, 1997. It is the opinion of the Company's patent counsel that the Company's
products do not infringe any valid or enforceable claims of the patents in the
two actions, and that the claims of the patents in the two actions are invalid
or unenforceable. The Company intends to vigorously defend itself against any
and all charges of infringement of Mr. Hedgcoth's patents.
Papst Licensing, GmbH, has given the Company notice that it believes
certain former Conner Peripherals, Inc. disc drives infringe several of its
patents covering the use of spindle motors in disc drives. It is the opinion of
the Company's patent counsel that the former Conner disc drives do not infringe
any claims of the patents and that the alleged claims of the patents are
invalid. The Company also believes that subsequent to the merger with Conner
Peripherals, the Company's earlier paid-up license under Papst's patents
extinguishes any ongoing liability. The Company also believes it enjoys the
benefit of a license under Papst's patents since Papst Licensing had granted a
license to motor vendors of Conner Peripherals.
In the normal course of business, the Company receives and makes
inquiry with regard to other possible intellectual property matters including
alleged patent infringement. Where deemed advisable, the Company may seek or
extend licenses or negotiate settlements.
ENVIRONMENTAL MATTERS The United States Environmental Protection Agency
("EPA") and/or similar state agencies have identified the Company as a
potentially responsible party with respect to environmental conditions at
several different sites to which hazardous wastes had been shipped or from which
they were released. These sites were acquired by the Company from Ceridian
Corporation ("Ceridian") (formerly Control Data Corporation) in fiscal 1990.
Other parties have also been identified at certain of these sites as potentially
responsible parties. Many of these parties either have shared or likely will
share in the costs associated with the sites. Investigative and/or remedial
activities are ongoing at such sites.
34
The Company's portion of the estimated cost of investigation and
remediation of known contamination at the sites to be incurred after June 27,
1997 is approximately $16,500,000. Through June 27, 1997, the Company had
recovered approximately $4,300,000 from Ceridian through its indemnification and
cost-sharing agreements with Ceridian and, in addition, expects to recover
approximately $9,700,000 from Ceridian over the next 30 years. After deducting
the expected recoveries from Ceridian, the expected aggregate undiscounted
liability was approximately $6,800,000 at June 27, 1997, with expected payments
by the Company of approximately $146,000 in 1999, $460,000 in 2000, $394,000 in
2001 and the remainder after 2001.
Approximately $15,700,000 of the $16,500,000 total estimated costs
described above is attributable to one site in Omaha, Nebraska. In 1994, the
Company sold the Omaha property; however, the Company retains responsibility for
and has indemnified the buyer with respect to all environmental contamination
existing on the site at the time of sale. IT Corporation, a nationally known
environmental consulting firm, has provided consulting services to Ceridian and
the Company for the Omaha site for several years and has assisted the Company in
estimating the liability related to the cost of remediation. This estimated
liability is based on a plan of investigation and remediation developed by IT
Corporation pursuant to a Consent Order entered into by the Company and the EPA
in 1990. The extent of the contamination in the groundwater has been
investigated and generally defined. According to the plan, the likely
technology for remediation of groundwater at the facility will be pumping and
treatment, while remediation of soils will most likely be accomplished by soil
vapor extraction. A substantial portion of the Omaha liability was discounted
by applying a risk free rate of 6% to the expected payments to be made by the
Company over the next 30 years. None of the liabilities for any of the other
sites has been discounted. The total liability for all sites recorded by the
Company after considering the estimated effects of inflation, reimbursements by
Ceridian and discounting was approximately $3,100,000 at June 27, 1997.
The Company believes that the indemnification and cost-sharing
agreements entered into with Ceridian and the reserves that the Company has
established with respect to its future environmental costs are such that, based
on present information available to it, future environmental costs related to
currently known contamination will not have a material adverse effect on its
financial condition or results of operations.
The Company is involved in a number of other judicial and
administrative proceedings incidental to its business. Although occasional
adverse decisions (or settlements) may occur, the Company believes that the
final disposition of such matters will not have a material adverse effect on the
Company's financial position or results of operations.
COMMITMENTS
LEASES The Company leases certain property, facilities and equipment under
noncancelable lease agreements. Land and facility leases expire at various dates
through 2082 and contain various provisions for rental adjustments including, in
certain cases, a provision based on increases in the Consumer Price Index. All
of the leases require the Company to pay property taxes, insurance and normal
maintenance costs.
Future minimum lease payments for operating leases with initial or
remaining terms of one year or more were as follows at June 27, 1997:
Operating
In thousands Leases
- -------------------------------------------------------------------------------------------------
1998 $ 57,137
1999 59,809
2000 35,282
2001 27,877
2002 20,929
After 2002 182,734
--------
$383,768
========
Total rent expense for all land, facility and equipment operating leases
was approximately $50,986,000, $44,781,000 and $49,313,000 for 1997, 1996 and
1995, respectively.
35
CAPITAL EXPENDITURES The Company's commitments for construction of
manufacturing facilities and equipment approximated $199,700,000 at June 27,
1997.
SUPPLEMENTAL CASH FLOW INFORMATION
In thousands 1997 1996 1995
- -------------------------------------------------------------------------------------------------
Cash Transactions:
Cash paid for interest $ 25,649 $ 64,422 $ 74,670
Cash paid for income taxes 58,507 207,767 152,642
Non-Cash Transactions:
Conversion of debentures $787,891 $265,500 $ -
SUBSEQUENT EVENTS
The goal of the Company's hedging program is to economically guarantee or
lock in the exchange rates on a portion of the Company's local currency cash
flows and not to eliminate all short-term earnings volatility. Because not all
economic hedges qualify as accounting hedges, unrealized gains and losses may be
recognized in income in advance of the actual foreign currency cash flows. This
mismatch of accounting gains and losses and foreign currency cash flows may be
especially pronounced in the first quarter of fiscal 1998 as a result of the
declines in value of the Thai Baht and Malaysian Ringgit, relative to the U.S.
Dollar, subsequent to fiscal year end 1997. Assuming no further change in the
U.S. Dollar exchange rates for the Thai Baht and Malaysian Ringgit (Baht 31.5 to
U.S. Dollar 1 and Ringgit 2.79 to U.S. Dollar 1 on August 14, 1997), the mark-
to-market adjustment would result in an unrealized pretax charge of
approximately $44 million, to be recognized as Other Expense at the end of the
Company's first quarter of fiscal 1998 ending on October 3, 1997. The Company's
ultimate realized gain or loss with respect to currency fluctuations will depend
on the currency exchange rates and other factors in effect at the time such
contracts mature over the next twelve months. Although the Company cannot
predict future movements in currency exchange rates, the Company believes that
the benefits from recording local currency expenditures in lower U.S. Dollar
terms over the period during which these foreign currency forward exchange
contracts are scheduled to mature should more than offset the charges to be
recorded in the first quarter of fiscal 1998. Based on recent volatility in the
Far East foreign currency markets, the Company has temporarily suspended
purchasing foreign currency forward exchange and option contracts for the Thai
Baht, Malaysian Ringgit and Singapore Dollar.
In August 1997, the Company completed the acquisition of Quinta
Corporation, a developer of ultra-high capacity disc drive technologies,
including a new optically assisted Winchester (OAW) technology. Pursuant to the
purchase agreement, the shareholders of Quinta, other than Seagate, received
cash payments aggregating $230 million upon closing of the transaction and will
be eligible to receive, upon achievement of certain product development and
early production milestones, additional payments aggregating $95 million. In
April and June 1997, Seagate had invested an aggregate of $20 million acquiring
approximately ten percent (10%) of Quinta's stock. As a result of this
acquisition, the Company will incur a charge to operations in the first quarter
of fiscal 1998 of approximately $217 million for the write-off of in-process
research and development.
36
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Seagate Technology, Inc.
We have audited the accompanying consolidated balance sheets of Seagate
Technology, Inc. as of June 27, 1997 and June 28, 1996, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended June 27, 1997. These consolidated
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 financial statements of Seagate Peripherals,
Inc. (formerly Conner Peripherals, Inc.) and subsidiaries, which statements
reflect net income constituting approximately 19.4% of the related 1995
consolidated financial statement total. Those financial statements were audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to data included for Seagate Peripherals, Inc. (formerly
Conner Peripherals, Inc.) and subsidiaries, is based solely on the report of the
other auditors.
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 and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits, and for 1995, the report of other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Seagate
Technology, Inc. at June 27, 1997 and June 28, 1996, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended June 27, 1997, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
San Jose, California
July 9, 1997, except for the second paragraph of the Business Litigation note,
as to which the date is July 24, 1997, the third paragraph of the Stock Option
Plans note, as to which the date is July 29, 1997, and the Subsequent Events
note, as to which the date is August 15, 1997.
37