- ------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
September 30, 1999 OR
------------------
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________________
TO________________
Commission file number: 0-13994
Computer Network Technology Corporation
---------------------------------------
(Exact name of registrant as specified in its charter)
Minnesota 41-1356476
- --------------------------- ---------------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
605 North Highway 169, Minneapolis, Minnesota 55441
- ---------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Telephone Number: (612) 797-6000
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to the filing
requirements for at least the past 90 days. Yes X No ___
-----
As of October 31, 1999, the registrant had 23,471,499 shares of $.01 par value
common stock issued and outstanding.
- --------------------------------------------------------------------------------
COMPUTER NETWORK TECHNOLOGY CORPORATION
INDEX
-----
PART I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements (unaudited)
Consolidated Statements of Operations for the three and nine months
ended September 30, 1999 and 1998.............................................................3
Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1998.............................................................................4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and 1998.................................................................. 5
Notes to Consolidated Financial Statements .....................................................6
Item 2. Management's Discussion and Analysis of
Results of Operations ........................................................................8
Liquidity and Capital Resources .............................................................12
PART II. OTHER INFORMATION .............................................................................16
Item 1-5. None
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES .................................................................................................17
2
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
---------------------------- ---------------------------
1999 1998 1999 1998
---------- ------------- --------- ------------
Revenue:
Product sales $ 29,165 $ 23,380 $ 81,299 $ 69,906
Service fees 11,904 9,630 34,539 27,736
---------- ------------- --------- ------------
Total revenue 41,069 33,010 115,838 97,642
---------- ------------- --------- ------------
Cost of revenue:
Cost of product sales 10,596 8,089 28,259 22,935
Cost of service fees 6,822 6,037 19,831 17,672
---------- ------------- --------- ------------
Total cost of revenue 17,418 14,126 48,090 40,607
---------- ------------- --------- ------------
Gross profit 23,651 18,884 67,748 57,035
---------- ------------- --------- ------------
Operating expenses:
Sales and marketing 11,551 9,827 33,855 32,045
Engineering and development 6,274 4,843 18,367 15,905
General and administrative 1,761 1,604 5,228 4,694
---------- ------------- --------- ------------
Total operating expenses 19,586 16,274 57,450 52,644
---------- ------------- --------- ------------
Income from operations 4,065 2,610 10,298 4,391
---------- ------------- --------- ------------
Other income (expense):
Interest income 257 75 483 275
Interest expense (74) (15) (176) (66)
Other, net (83) 185 352 250
---------- ------------- --------- ------------
Other income, net 100 245 659 459
---------- ------------- --------- ------------
Income before income taxes 4,165 2,855 10,957 4,850
Provision for income taxes 1,416 1,056 3,725 1,812
---------- ------------- --------- ------------
Net income $ 2,749 $ 1,799 $ 7,232 $ 3,038
========== ============= ========= ============
Basic:
- -----
Net income per share $ .12 $ .08 $ .31 $ .14
========== ============= ========= ============
Shares 23,441 22,110 22,998 22,090
========== ============= ========= ============
Diluted:
- -------
Net income per share $ .11 $ .08 $ .28 $ .14
========== ============= ========= ============
Shares 25,707 22,554 25,552 22,321
========== ============= ========= ============
See accompanying Notes to Consolidated Financial Statements.
3
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
September 30, December 31,
1999 1998
--------------- ---------------
Assets (unaudited)
Current assets:
Cash and cash equivalents $ 19,163 $ 11,786
Marketable securities 3,680 576
Receivables, net 43,818 30,225
Inventories 12,631 19,241
Deferred tax asset 3,138 3,138
Other current assets 2,180 1,274
--------------- ---------------
Total current assets 84,610 66,240
--------------- ---------------
Property and equipment, net 17,289 16,360
Field support spares, net 3,933 3,739
Deferred tax asset 2,517 2,517
Goodwill and other intangibles, net 4,003 4,737
Other assets 298 434
--------------- ---------------
$ 112,650 $ 94,027
=============== ===============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 9,972 $ 7,565
Accrued liabilities 13,223 14,527
Deferred revenue 9,101 7,235
Current installments of obligations under capital lease 478 326
Current installments of long-term debt 1,000 1,000
--------------- ---------------
Total current liabilities 33,774 30,653
--------------- ---------------
Obligations under capital lease, less current installments 1,481 1,816
Long term debt, less current installments - 1,000
--------------- ---------------
Total liabilities 35,255 33,469
--------------- ---------------
Shareholders' equity:
Undesignated preferred stock, authorized 965
shares, none issued and outstanding - -
Series A junior participating preferred stock,
authorized 35 shares, none issued and
outstanding
Common stock, $.01 par value;
authorized 100,000 shares, issued and
outstanding 23,456 at September 30, 1999 and
22,254 at December 31, 1998 235 223
Additional paid-in capital 64,925 54,921
Unearned compensation (695) (355)
Retained earnings 13,373 6,141
Accumulated other comprehensive income -
foreign currency translation adjustment (443) (372)
--------------- ---------------
Total shareholders' equity 77,395 60,558
--------------- ---------------
$ 112,650 $ 94,027
=============== ===============
See accompanying Notes to Consolidated Financial Statements
4
COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended September 30,
---------------------------------------
1999 1998
------------ -------------
Operating activities:
Net income $ 7,232 $ 3,038
Depreciation and amortization 7,426 6,654
Tax benefits from employee stock transactions 3,000 -
Compensation expense 254 97
Changes in operating assets and liabilities:
Receivables (13,603) 3,764
Inventories 6,610 (4,920)
Other current assets (906) (216)
Accounts payable 2,407 1,681
Accrued liabilities (1,304) (21)
Deferred revenue 1,866 (1,698)
------------ -------------
Cash provided by operating activities 12,982 8,379
------------ -------------
Investing activities:
Additions to property and equipment (5,938) (4,561)
Additions to purchased technology - (538)
Additions to field support spares (1,877) (1,796)
Net purchase and redemption of marketable securities (3,104) 4,797
Other 136 116
------------ -------------
Cash used in investing activities (10,783) (1,982)
------------ -------------
Financing activities:
Prinicpal payments under capital lease obligations (183) (150)
Principal payment on long-term debt (1,000) -
Proceeds from issuance of common stock 6,422 666
Payments for repurchase of common stock - (1,449)
------------ -------------
Cash provided by (used in) financing activities 5,239 (933)
------------ -------------
Effects of exchange rate changes (61) 103
------------ -------------
Net increase in cash and cash equivalents 7,377 5,567
Cash and cash equivalents - beginning of period 11,786 4,790
------------ -------------
Cash and cash equivalents - end of period $ 19,163 $ 10,357
============ =============
See accompanying Notes to Consolidated Financial Statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands)
(1) Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with instructions to Form 10-Q and do not include all the information
and notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and accompanying notes
incorporated by reference in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1998 as filed with the Securities and Exchange
Commission.
(2) Inventories
Inventories, stated at the lower of cost (first-in, first-out method) or market,
consist of:
September 30, December 31,
1999 1998
------------- ------------
Components and subassemblies $ 6,771 $ 9,490
Work in process 1,824 4,095
Finished goods 4,036 5,656
------------ -----------
$ 12,631 $ 19,241
============ ===========
(3) Comprehensive Income
Comprehensive income consists of the following:
Three months ended September 30,
--------------------------------
1999 1998
--------------------------------
Net income $ 2,749 $ 1,799
Translation adjustment, net of tax effect of $0 270 101
-------------------------------
Total comprehensive income $ 3,019 $ 1,900
===============================
Nine months ended September 30,
-------------------------------
1999 1998
-------------------------------
Net income $ 7,232 $ 3,038
Translation adjustment, net of tax effect of $0 (71) 103
-------------------------------
Total comprehensive income $ 7,161 $ 3,141
===============================
6
(4) Segment Information
The Company has two reportable segments consisting of its Network Solutions
Division and Enterprise Integration Solutions Division. The Network Solutions
Division provides products and services that offer high-speed open systems
connectivity, access to legacy data and guaranteed data integrity for
applications such as remote storage, disk mirroring, remote tape vaulting and
disaster recovery. The Enterprise Integration Solutions Division provides
products and services that integrate legacy systems with client/server and
internet technologies, including e-commerce and customer relationship management
applications. The Company's two reportable segments are strategic business units
that offer different products and services. They are managed separately because
each business requires different technology and market strategies. The Company
evaluates performance based on operating profit or loss before special charges
and income taxes.
Three months ended September 30,
---------------------------------
1999 1998
-------------- -------------
Revenue:
Network Solutions Division $ 34,079 $ 24,893
Enterprise Integration Solutions Division 6,990 8,117
-------------- -------------
$ 41,069 $ 33,010
============== =============
Operating Profit (Loss):
Network Solutions Division $ 4,775 $ 1,244
Enterprise Integration Solutions Division (710) 1,366
-------------- -------------
$ 4,065 $ 2,610
============== =============
Nine months ended September 30,
---------------------------------
1999 1998
-------------- -------------
Revenue:
Network Solutions Division $ 93,816 $ 75,921
Enterprise Integration Solutions Division 22,022 21,721
-------------- -------------
$ 115,838 $ 97,642
============== =============
Operating Profit (Loss):
Network Solutions Division $ 10,359 $ 5,858
Enterprise Integration Solutions Division (61) (1,467)
-------------- -------------
$ 10,298 $ 4,391
============== =============
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
RESULTS OF OPERATIONS
The following table sets forth financial data for the periods indicated as a
percentage of total revenue except for gross profit, which is expressed as a
percentage of the related revenue.
Enterprise Integration Solutions Division Network Solutions Division
- -------------------------------------------- ----------------------------------------
Three Months Nine Months Three Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
- ------------------ ----------------- ------------------- -----------------
1999 1998 1999 1998 1999 1998 1999 1998
- -------- ------ ------ ------- -------- ------- ------- -----
Revenue:
59.6 % 68.8 % 62.3 % 65.6 % Product sales 73.4 % 71.5 % 72.0 % 73.3 %
40.4 31.2 37.7 34.4 Service fees 26.6 28.5 28.0 26.7
- -------- ------ ------ ------- -------- ------- ------- -----
100.0 100.0 100.0 100.0 Total revenue 100.0 100.0 100.0 100.0
- -------- ------ ------ ------- -------- ------- ------- -----
Gross profit:
88.6 78.2 89.2 80.2 Product sales 59.5 61.4 60.4 63.9
17.4 41.0 27.6 39.0 Service fees 50.6 36.0 47.3 35.3
- -------- ------ ------ ------- -------- ------- ------- -----
59.8 66.6 66.0 66.0 Total gross profit 57.1 54.1 56.7 56.2
- -------- ------ ------ ------- -------- ------- ------- -----
Operating expenses:
41.5 28.2 38.1 42.0 Sales and marketing 25.3 30.3 27.2 30.2
23.5 16.6 23.2 25.8 Engineering and development 13.7 14.0 14.1 13.5
5.0 5.0 5.0 5.0 General and administrative 4.1 4.8 4.4 4.8
- -------- ------ ------ ------- -------- ------- ------- -----
70.0 49.8 66.3 72.8 Total operating expenses 43.1 49.1 45.7 48.5
- -------- ------ ------ ------- -------- ------- ------- -----
(10.2) 16.8 ( .3) (6.8) Income (loss) from operations 14.0 5.0 11.0 7.7
- 0.1 2.9 0.1 Other income, net 0.3 0.9 0.1 0.6
- -------- ------ ------ ------- -------- ------- ------- -----
(10.2) 16.9 2.6 (6.7) Income (loss) before income taxes 14.3 5.9 11.1 8.3
Provision (benefit) for income
(3.5) 6.2 0.9 (2.6) taxes 4.9 2.2 3.8 3.1
- -------- ------ ------ ------- -------- ------- ------- -----
(6.7) % 10.7 % 1.7 % (4.1) % Net income (loss) 9.4 % 3.7 % 7.3 % 5.2 %
======== ====== ====== ======= ======== ======= ======= =====
8
REVENUE
Revenue from Network Solutions Division products for the three and nine months
ended September 30, 1999 totaled $25.0 million and $67.6 million, respectively,
increases of 41% and 21%, respectively, when compared to the same periods of
1998. Storage Area Networking (SAN) applications for both open systems and
mainframes continue to drive new product revenue. Revenue from SAN product
applications for the three and nine months ended September 30, 1999 totaled
$15.3 million and $40.7 million, respectively, increases of 68% and 74%,
respectively, when compared to the same periods of 1998. Revenue from channel
extension product applications for the three months ended September 30, 1999
totaled $9.7 million, an increase of 12%, when compared to the same period of
1998. For the nine months ended September 30, 1999, channel extension product
application revenue totaled $26.9 million, a decrease of 17% when compared to
the same period of 1998. Despite the increase in the 1999 third quarter, we
anticipate that sales of channel extension products will continue to decline in
the future.
Service revenue for the Network Solutions Division, including maintenance and
professional services, for the three and nine months ended September 30, 1999
totaled $9.1 million and $26.2 million, respectively, increases of 28% and 29%,
respectively, when compared to the same periods of 1998. Professional service
revenue for the three and nine months ended September 30, 1999 totaled $1.1
million and $3.3 million, respectively, increases of 173% and 361%,
respectively, when compared to the same periods of 1998. The growing installed
base of customers using our products accounted for the remaining increase in
service revenue.
Revenue from Enterprise Integration Solutions Division products for the three
and nine months ended September 30, 1999 totaled $4.2 million and $13.7 million,
respectively, decreases of 25% and 4%, respectively, when compared to the same
periods of 1998. Revenue from the sale of Enterprise Application Integration
(EAI) products for the three and nine months ended September 30, 1999 totaled
$2.6 million and $5.2 million, respectively, increases of 467% and 192%,
respectively, when compared to the same periods of 1998. The increase is
primarily due to growing customer demand for products that integrate legacy
applications and networks with new networks and applications so that users can
access business-critical information. Sales of server gateways and tools for the
three and nine months ended September 30, 1999 totaled $1.6 million and $8.5
million, respectively, decreases of 69% and 32%, respectively, when compared to
the same periods of 1998. The acquisition of Intelliframe has not had a
significant impact on 1999 revenue.
Service revenue from the Enterprise Integration Solutions Division, including
maintenance and professional services, for the three and nine months ended
September 30, 1999 totaled $2.8 million and $8.3 million, respectively,
increases of 12% and 11%, respectively, when compared to the same periods of
1998. Professional service revenue for the three and nine months ended September
30, 1999 totaled $1.3 million and $3.4 million, respectively, increases of 105%
and 101%, respectively, when compared to the same periods of 1998.
Revenue generated from the sale of products and services outside the United
States for the three and nine months ended September 30, 1999 totaled $13.1
million and $39.0 million, respectively, increases of 17% for both periods when
compared to the same periods of 1998. The increase is primarily due to growing
demand from international customers for SAN and EAI product applications.
Fluctuations in revenue for the three and nine months ended September 30, 1999
were primarily due to changes in sales volume. Price increases did not have a
significant impact on revenue.
9
We expect continued quarter-to-quarter fluctuations in revenue in both domestic
and international markets. The timing of sizable orders, because of their
relative impact on total quarterly sales, may contribute to such fluctuations.
The level of product sales reported by us in any given period will continue to
be affected by the receipt and fulfillment of sizable new orders in both
domestic and international markets.
GROSS PROFIT
Gross profit margin from the sale of Network Solutions Division products for the
three and nine months ended September 30, 1999 were 60%, compared to 61% and
64%, respectively, for the same periods of 1998. The decrease in gross profit
margin for both periods is primarily due to an increase in UltraNet product
sales that have a slightly lower gross margin than our traditional Channelink
products. The decrease in gross profit margin for the nine months ended
September 30, 1999 can also be attributed to a favorable purchase of raw
materials that was realized in the first half of 1998.
Gross profit margin from Network Solutions Division services for the three and
nine months ended September 30, 1999 were 51% and 47%, respectively, compared to
36% and 35%, respectively, for the same periods of 1998. The improvement in
gross profit margin is attributable to new incremental revenue from professional
services, which offers a higher gross margin than our traditional service
business.
Gross profit margin from the sale of Enterprise Integration Solutions Division
products for the three and nine months ended September 30, 1999 were 89%,
compared to 78% and 80%, respectively, for the same periods of 1998. The
increase in gross profit margin for the three and nine months ended September
30, 1999 can be attributed to lower margin hardware sales accounting for a
smaller percentage of total product revenue.
Gross profit margin from Enterprise Integration Solutions Division services for
the three and nine months ended September 30, 1999 were 17% and 28%,
respectively, compared to 41% and 39%, respectively, for the same periods of
1998. The decline in service gross margin is primarily due to the drop-off in
the server gateways and tools install base.
Actual gross profit margins on product sales for the balance of 1999 will depend
on a number of factors, including the mix of products, acceptance of our new
products, particularly in the SAN and EAI markets, the relative amount of
products sold through sales channels other than our direct sales force,
primarily OEM sales, and the level of price competition.
OPERATING EXPENSES
Sales and marketing expenses related to our Network Solutions Division for the
three and nine months ended September 30, 1999 increased by $1.1 million and
$2.6 million, respectively, increases of 15% and 11%, respectively, when
compared to the same periods of 1998. The increase resulted from the additional
expense associated with the higher level of product sales.
10
Engineering and development expense primarily relates to costs associated with
development of new products and enhancements to existing products. Engineering
and development expense related to our Network Solutions Division for the three
and nine months ended September 30, 1999 increased by $1.1 million and $3.0
million, respectively, increases of 33% and 29%, respectively, when compared to
the same periods of 1998. The increases are primarily due to the continued
development of our UltraNet family of products that provide customers with
additional applications to satisfy their growing need for SAN capabilities.
Engineering and development and sales and marketing expense for our Enterprise
Integration Solutions Division increased by $901,000 or 25% for the three months
ended September 30, 1999, when compared to the same period of 1998. The increase
relates to engineering costs associated with the development of our Process
Dynamics product and development of a sales and marketing force for EAI product
sales. At the present time, we anticipate that Process Dynamics will be
generally available in the first half of 2000. For the nine months ended
September 30, 1999, these same expenses decreased by $1.2 million or 8%, when
compared to the same period of 1998. The decrease is due to the completion of
our initiatives in 1998 to reduce headcount and expense associated with this
division.
General and administrative expenses for the three and nine months ended
September 30, 1999 increased by $157,000 and $534,000, respectively, increases
of 10% and 11%, respectively, when compared to the same periods of 1998. The
increase is primarily attributable to the additional expense associated with the
higher level of revenue for the three and nine months ended September 30, 1999,
when compared to the same periods of 1998.
The operating margin as a percentage of total revenue for our Network Solutions
Division for the three and nine months ended September 30, 1999 was 14% and 11%,
respectively, compared to 5% and 8%, respectively, for the same periods of 1998.
Operating margin as a percentage of total revenue for our Enterprise Integration
Solutions Division for the three and nine months ended September 30, 1999 was a
negative 10% and 0%, respectively, compared to 17% and a negative 7%,
respectively, for the same periods of 1998. The decrease in operating margin in
the third quarter of 1999 for the Enterprise Integration Solutions Division
resulted from a faster than expected decline in revenue from the sale and
support of our traditional server gateways and tools products.
OTHER
Other income for the three and nine months ended September 30, 1999 totaled
$100,000 and $659,000, respectively, compared to $245,000 and $459,000,
respectively, for the same periods of 1998. Other income for the nine months
ended September 30, 1999 includes a $667,000 gain from our receipt of a payment
relating to the sale of our vision product line. We presently anticipate, but
cannot be assured, that two additional payments of $667,000 and $630,000 will be
received and recognized as other income in March 2000 and March 2001,
respectively.
11
We recorded a provision for income taxes for the three and nine months ended
September 30, 1999 at an effective rate of 34%, compared to 37% for the same
periods of 1998. Fluctuations in our effective income tax rate are primarily due
to the amount of non-deductible foreign losses and fluctuations in the level of
benefit from our foreign sales corporation.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our operations through the private and public sale
of equity securities, bank borrowings under lines of credit, capital and
operating leases and cash generated by operations.
Cash, cash equivalents and marketable securities as of September 30, 1999
totaled $22.8 million, an increase of $10.5 million since December 31, 1998.
Operations and proceeds from the exercise of stock options provided cash for the
nine months ended September 30, 1999 of $13.0 million and $6.4 million,
respectively. Uses of cash for the nine months ended September 30, 1999 included
the purchase of property and equipment and field support spares totaling $7.8
million. We also made a $1.0 million installment payment during the first
quarter of 1999 relating to our 1998 purchase of IntelliFrame.
On November 3, 1999, we announced a three-year agreement with Storage Tek under
which we will manufacture and provide continuation engineering for Storage Tek's
DXE/RDS Channel Extension product line, and Storage Tek will resell our UltraNet
wide-area networking products. In connection with this agreement, we will
purchase certain inventories and fixed assets from Storage Tek for approximately
$4 million, which will be paid from existing cash on-hand.
Expenditures for capital equipment and field support spares have been, and will
likely continue to be, a significant capital requirement. Our principal business
operations are currently located in two separate facilities that have leases
expiring in November 1999 and May 2001. We have leased a new building for our
principal business operations with occupancy scheduled for the 1999 fourth
quarter. Our annual pre-tax operating costs for the new building, on an ongoing
basis, will be approximately $1.5 million higher than our current facility
costs. The increase is due to the need for additional square footage. The lease
rate for our new building is less than the cost to renew the lease at our
current facility which expires in November 1999. We anticipate that our capital
requirements to furnish and equip the new building will be approximately $1.5
million. We are actively trying to sublet our existing facility that has been
leased through May 2001. We may be required to record a charge in the fourth
quarter of 1999 if it appears that our sublease income from this facility will
be less than our remaining non-cancelable lease obligation. We believe that our
current balances of cash, cash equivalents and marketable securities, when
combined with anticipated cash flows form operations, will be adequate to fund
our operating plans and meet our currently anticipated aggregate capital
requirements, at least for the next twelve months.
We believe that inflation has not had a material impact on our operations or
liquidity to date.
12
YEAR 2000
We are aware of the issues relating to the year 2000 and continue to assess the
impact that year 2000 issues will have on our business. We have also initiated
corrective action with respect to the year 2000 issues uncovered during our
assessment. The following information outlines the current status of our plans
regarding year 2000 issues.
OUR STATE OF READINESS
We have established a cross functional team that has been charged with assessing
our year 2000 readiness and identifying year 2000 related issues that could
impact our business. The activities include a review of all year 2000 issues
relating to our internal business systems, products and third party suppliers
and vendors.
We have assessed our internal information systems to determine if they will meet
our needs into and beyond the year 2000. Based on this assessment, we determined
that one of our primary internal business systems was not year 2000 compliant.
We spent approximately $2.3 million on new hardware, software and services in
1998 to acquire and implement a new year 2000 compliant business system which
was installed and became operational in January 1999. Our old non-compliant
business system was fully depreciated by the end of 1998. We are continuing to
test and assess our internal information and business systems to ensure year
2000 compliance.
The primary purpose of our products is to carry data between systems. We define
year 2000 readiness for our products to mean that, as a result of date
transition relating to the year 2000, our products will not fail in their task
of transmitting data, or corrupt the data stream that they carry. A secondary
issue relates to the cosmetic appearance of displays and status reports produced
by our products. Our products utilize dates for logging alerts, messages,
displays and reporting network traffic. These functions are ancillary to the
products' primary operation of data transmission, and therefore are excluded
from our definition of year 2000 readiness. We are committed to making displays
and reports from our products clear and accurate. We tested our products for
cosmetic appearance at the same time we tested our products for year 2000
readiness. The dates presented in certain versions of our software products are
shown as two digits or contain other report anomalies. The appearance related
anomalies have been or will be corrected in subsequent versions of our products
that are scheduled to ship prior to January 1, 2000. We have identified certain
year 2000 issues in some ancillary network management software that we provide,
and have notified those affected customers that upgrades are available. Our cost
to provide these upgrades is minimal.
We are also conducting an assessment of our key vendors and suppliers to ensure
that no interruption of material, service or product functionality occurs due to
year 2000 date transitions. Our assessment is ongoing and a completion date has
not been identified. However, we believe that alternate vendors could be
utilized to replace the products and services that are currently provided by our
key suppliers and vendors.
To date, the cost of the new business system and the allocation of employee
resources have been the only costs incurred by us to address year 2000
readiness. Based on the assessment activities completed to date, we do not
believe that we will incur significant extra expense relating to year 2000
issues.
13
YEAR 2000 RELATED RISKS
A worst case scenario relative to the year 2000 issue would be the discovery of
additional year 2000 deficiencies in our products that require significant extra
time and expense to correct. In addition, sales could be materially impacted in
1999 or 2000 if customers were to stop, or significantly reduce, procurement of
new equipment for their data centers and networks until after the start of the
year 2000. A critical year 2000 deficiency by a key supplier, coupled with a
failure to locate a suitable alternative source of supply, could have a material
impact on our business.
There can be no assurance that conversion of the company's hardware and software
will be successful, that key third parties will have successful conversion
programs, that the Company's products do not contain undetected errors or
defects associated with year 2000 date functions, or that other factors relating
to year 2000 compliance, including but not limited to litigation, will not have
a material adverse effect on the Company's business, results of operations or
financial condition.
CONTINGENCY PLANS
We believe that we are addressing all known year 2000 related risks. While we do
not believe that developing a remediation plan for the worst case year 2000
risks noted above is practical, we are attempting to mitigate further risk by
continuing to test and assess our products, and the products and services of our
key suppliers and vendors, for year 2000 readiness. We continually work to
identify suitable alternative sources of supply for key products and services to
mitigate the risks relative to the year 2000 and other business interruption
issues. We intend to address any additional year 2000 related risks as they
become known.
ADDITIONAL INVENTORY PURCHASES
Two of our suppliers may not be year 2000 compliant. As a result, we are
purchasing additional inventory of approximately $500,000 from those suppliers
in advance of the year 2000. We believe this additional inventory allows us to
continue to operate without any disruption or delay caused by those suppliers'
potential failure to be year 2000 compliant. We anticipate that this additional
inventory will be consumed in the ordinary course of business during 2000.
NEW EUROPEAN CURRENCY
On January 1, 1999, eleven of the fifteen member countries of the European Union
established fixed conversion rates between their existing currencies and the
euro, a new European currency, and adopted the euro as their common legal
currency. Either the euro or a participating country's present currency will be
accepted as legal tender from January 1, 1999 to January 1, 2002, from which
date forward only the euro will be accepted. We have a significant number of
customers located in European Union countries participating in this conversion.
The conversion may have competitive implications for our pricing and marketing
strategies, which could be material in nature; however, any such impact is not
known at this time. Our new business system implemented as of January 1999 is
capable of handling the new euro currency. There is no assurance, however, that
all problems related to the conversion will be foreseen and corrected, or that
no material disruptions of our business will occur.
14
MARKET RISK
We have no derivative financial instruments in our cash, cash equivalents and
marketable securities. We mainly invest our cash, cash equivalents and
marketable securities in investment grade, highly liquid investments, consisting
of money market instruments, bank certificates of deposit and investments in
commercial paper.
At September 30, 1999, our marketable securities include a $727,000 investment
in a Standard & Poors 500 stock price index fund, which was purchased to
directly offset any investment gains or losses owed to participant's under our
executive deferred compensation plan.
We are exposed to certain market risks related to fluctuations in foreign
exchange rates because some sales transactions, and the assets and liabilities
of our foreign subsidiaries, are denominated in foreign currencies, primarily
French francs, the euro and British pounds sterling. We have hedged a portion
our risk by purchasing forward exchange contracts for 1.3 million British pounds
sterling that settle at various times through January 31, 2000.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS No. 133), effective for us on January
1, 2001, establishes new standards for recognizing all derivatives as either
assets or liabilities, and measuring those instruments at fair value. Currently,
we do not anticipate that SFAS No. 133 will have a material impact on our
financial position or results of operations.
FORWARD LOOKING STATEMENTS
Certain statements in this Form 10-Q, other documents filed with the Securities
and Exchange Commission, our press releases and oral statements made by or with
the approval of our executive officers contain forward looking statements under
the Private Securities Litigation Reform Act of 1995. These forward looking
statements may include statements about our anticipated receipt of orders and
their impact on quarterly sales, business strategy, expectations regarding
future revenue levels, timing of and plans for the introduction or phase-out of
products or services, enhancements of existing products or services, plans for
hiring additional personnel, entering into strategic partnerships, and other
plans, objectives, expectations and intentions that are not historical fact.
The words "may," "should," "expect," "plan," "anticipate," "believe,"
"estimate," "predict," "intend," "potential" or "continue" and similar
expressions are generally intended to identify forward-looking statements. These
forward-looking statements involve risks and uncertainties. Actual results could
differ materially from those expressed or implied by these forward-looking
statements as a result of certain risk factors, including but not limited to (i)
competitive factors, including pricing pressures, (ii) variability in quarterly
sales, (iii) economic trends in various geographic markets; (iv) relationships
with our strategic partners; (v) year 2000 issues; (vi) unanticipated risks
associated with introducing new products and features, including Process
Dynamics; (vii) technological change affecting our products and (viii) other
events and other important factors disclosed previously and from time to time in
our other filings with the U.S. Securities and Exchange Commission. We assume no
obligation to update any forward-looking statements. These statements are only
predictions. Although we believe that the expectations reflected in the forward-
looking statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
15
PART II. OTHER INFORMATION
Item 1-5. None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits filed herewith.
3A. Second Restated Articles of Incorporation of the
Corporation. (Incorporated by reference to Exhibits
3(i)-1 and 3(i)-2 to current report on Form 8-K dated May
25, 1999.)
3B. By-laws of the Company. (Incorporated by reference to
Exhibit 3(ii)-1 to current report on Form 8-K dated May
25, 1999.)
4. Form of Certificate of Designations, Preferences and
Rights of Series A Junior Participating Preferred Stock.
(Incorporated by reference to Exhibit A of Exhibit 1 to
Form 8-A dated July 29, 1998.)
11. Statement Re: Computation of Net Income per Basic and
Diluted Share.
27. Financial Data Schedule.
(b) No reports on Form 8-K were filed during the quarter ended
September 30, 1999.
16
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned duly authorized officers.
COMPUTER NETWORK TECHNOLOGY CORPORATION
(Registrant)
Date: November 11, 1999 By: /s/ Gregory T. Barnum
------------------------
Gregory T. Barnum
Chief Financial Officer
(Principal financial officer)
By: /s/ Jeffrey A. Bertelsen
------------------------
Jeffrey A. Bertelsen
Corporate Controller and Treasurer
(Principal accounting officer)
17
EXHIBIT INDEX
-------------
3A. Second Restated Articles of Incorporation of the Corporation.
(Incorporated by reference to Exhibits 3(i)-1 and 3(i)-2 to current report
on Form 8-K dated May 25, 1999.)
3B. By-laws of the Company. (Incorporated by reference to Exhibit 3(ii)-1 to
current report on Form 8-K dated May 25, 1999.)
4. Form of Certificate of Designations, Preferences and Rights of Series A
Junior Participating Preferred Stock. (Incorporated by reference to
Exhibit A of Exhibit 1 to Form 8-A dated July 29, 1998.)
11. Statement Re: Computation of Net Income per Basic and Diluted Share......................Electronically Filed
27. Financial Data Schedule................................................................. Electronically Filed