-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DANYOYx2TOilwWpR9AR+V2HYvLC5slGcuXCapC8S8dC3EAHSRY4lkxHucqX65Mii uMSP+HgZRn+5ZYOkdeRiyQ== 0001012870-99-001221.txt : 19990422 0001012870-99-001221.hdr.sgml : 19990422 ACCESSION NUMBER: 0001012870-99-001221 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980703 FILED AS OF DATE: 19990421 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SEAGATE TECHNOLOGY INC CENTRAL INDEX KEY: 0000354952 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 942612933 STATE OF INCORPORATION: DE FISCAL YEAR END: 0628 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 001-11403 FILM NUMBER: 99598371 BUSINESS ADDRESS: STREET 1: 920 DISC DR CITY: SCOTTS VALLEY STATE: CA ZIP: 95066 BUSINESS PHONE: 8314386550 MAIL ADDRESS: STREET 1: 920 DISC DRIVE CITY: SCOTTS VALLEY STATE: CA ZIP: 95066 10-K405/A 1 AMENDMENT #2 TO FORM 10-K FOR PERIOD ENDING 07/03/1998 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ______________________ FORM 10-K/A Amendment No. 2 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended July 3, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 001-11403 SEAGATE TECHNOLOGY, INC. (Exact name of Registrant as specified in its charter) ________________________ Delaware 94-2612933 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 920 Disc Drive Scotts Valley, California 95067 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (831) 438-6550 _________________________ Securities registered pursuant to Section 12(b) of the Act: Title of Each Class Name of Each Exchange ------------------- --------------------- on which Registered ------------------- Common Stock, Par Value $0.01 per share New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K/A or any amendment to this Form 10-K/A. [X] The aggregate market value of the Common Stock held by non-affiliates of the registrant, based upon the closing price of Common Stock on July 3, 1998 as reported by the New York Stock Exchange, was $5.182 billion. Shares of Common Stock held by each officer, each director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of shares outstanding of the registrant's Common Stock as of July 3, 1998 was 244,757,152. DOCUMENTS INCORPORATED BY REFERENCE Parts of the following documents are incorporated by reference into Parts I, II, III and IV of this Form 10-K/A Report: (1) Proxy Statement for registrant's 1998 Annual Meeting of Stockholders (the "Proxy Statement") and (2) registrant's Annual Report to Stockholders for the fiscal year ended July 3, 1998 (the "Annual Report to Stockholder"). PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this Report: 1. Financial Statements. The following Consolidated Financial Statements of Seagate Technology, Inc. and Report of Independent Auditors are incorporated by reference in Item 8: Report of Independent Auditors Consolidated Balance Sheets July 3, 1998 and June 27, 1997. Consolidated Statements of Operations Years Ended July 3, 1998; June 27, 1997; and June 28, 1996. Consolidated Statements of Stockholders' Equity Years Ended July 3, 1998; June 27, 1997; and June 28, 1996. Consolidated Statements of Cash Flows Years Ended July 3, 1998; June 27, 1997; and June 28, 1996. Notes to Consolidated Financial Statements. 2. Financial Statement Schedules. The following consolidated financial statement schedule of Seagate Technology, Inc. is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Seagate Technology, Inc.: II--Valuation and Qualifying Accounts................. 24 Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto. 3. Exhibits: Notes ----- 3.1 Certificate of Incorporation of Registrant, as amended. (A) 3.2 By-Laws of Registrant, as amended. (B) 4.1 Indenture, dated as of March 1, 1997 (the "Indenture"), between Seagate Technology, Inc. (the "Company") and First Trust of California, National Association, as Trustee. (C) 4.2 Officers' Certificate pursuant to Section 301 of the Indenture, without Exhibits, establishing the terms of the Company's senior notes and senior debentures. (C) 4.3 Form of Senior Note. (C) 4.4 Form of Senior Debenture. (C) 10.1 1983 Incentive Stock Option Plan and form of Stock Option Agreement. (E) 10.2 Seagate Technology Employee Stock Purchase Plan, as amended. 10.3 Registrant's Executive Stock Plan. (I) 10.4 Conner Peripherals, Inc. 1986 Incentive Stock Plan. (I) 10.5 Building Agreement for Land At Private Lot A14547 in Yio Chu Kang dated May 30, 1996 between Seagate Technology International and Jurong Town Corporation. (K) 10.6 Lease Agreement dated July 18, 1994 between Universal Appliances Limited and Seagate Technology (Thailand) Limited. (K) 10.7 1991 Incentive Stock Option Plan and Form of Option Agreement, as amended. (K) 10.8 Acquisition Agreement dated as of September 29, 1989 by and among Seagate Technology, Inc. and Control Data Corporation, Imprimis Technology Incorporated and Magnetic Peripherals, Inc. (G) 10.9 Amended and Restated Directors' Option Plan and Form of Option Agreement. (H) 10.10 Amended and Restated Archive Corporation Stock Option and Restricted Stock Purchase Plan--1981. (I) 10.11 Amended and Restated Archive Corporation Incentive Stock Option Plan--1981. (I) 10.12 Conner Peripherals, Inc.--Arcada Holdings, Inc. Stock Option Plan. (J) 10.13 Arcada Holdings, Inc. 1994 Stock Option Plan. (J) 10.14 Separation Agreement and Release between the Registrant and Alan F. Shugart dated as of July 29, 1998. (K) 13.1 Portions of the 1998 Annual Report to Stockholders. * 21.1 Subsidiaries of the Registrant. (K) 23.1 Consent of Ernst & Young LLP, Independent Auditors. * 24.1 Power of Attorney. (K) 27 Financial Data Schedule (K) (A) Incorporated by reference to exhibits filed in response to Item 16, "Exhibits," of the Company's Registration Statement on Form S-3 (File No. 33-13430) filed with the Securities and Exchange Commission on April 14, 1987. (B) Incorporated by reference to exhibits filed in response to Item 14 (a), "Exhibits," of the Company's Form 10-K, as amended, for the year ended June 30, 1990. (C) Incorporated by reference to exhibits filed in response to Item 7(b), "Financial Statements and Exhibits" of the Company's Current Report on Form 8-K dated March 4, 1997. (E) Incorporated by reference to exhibits filed in response to Item 14(a), "Exhibits," of the Company's Form 10-K for the year ended June 30, 1983. (G) Incorporated by reference to exhibits filed in response to Item 7(c), "Exhibits," of the Company's Current Report on Form 8-K dated October 2, 1989. (H) Incorporated by reference to exhibits filed in response to Item 14(a), "Exhibits," of the Company's Form 10-K for the year ended June 30, 1991. (I) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (registration number 333-00697) as filed with the Commission on February 5, 1996. (J) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (registration number 333-01059) as filed with the Commission on February 21, 1996. (K) Previously filed. * Filed herewith. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the quarter ended July 3, 1998. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amended report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. Seagate Technology, Inc. By: * _________________ Stephen J. Luczo Chief Executive Officer, President, Chief Operating Officer and a Director Dated: April 21, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this amended report on Form 10-K has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - ------------------------------------- ------------------------------ ------------------- * President and Chief April 21, 1999 - ------------------------------------- Executive Officer and a (Stephen J. Luczo) Director (Principal Executive Officer) /s/ Charles C. Pope Senior Vice President and April 21, 1999 - ------------------------------------- Chief Financial Officer (Charles C. Pope) (Principal Financial and Accounting Officer) * Co-Chairman of the Board April 21, 1999 - ------------------------------------- (Gary B. Filler) * Co-Chairman of the Board April 21, 1999 - ------------------------------------- (Lawrence Perlman) * Director April 21, 1999 - ------------------------------------- (Kenneth Haughton) * Director April 21, 1999 - ------------------------------------- (Robert A. Kleist) * Director April 21, 1999 - ------------------------------------- (Thomas P. Stafford) * Director April 21, 1999 - ------------------------------------- (Laurel L. Wilkening)
*By: /s/ Charles C. Pope --------------------- Charles C. Pope Attorney-in-fact Notes ----- 3.1 Certificate of Incorporation of Registrant, as amended. (A) 3.2 By-Laws of Registrant, as amended. (B) 4.1 Indenture, dated as of March 1, 1997 (the "Indenture"), between Seagate Technology, Inc. (the "Company") and First Trust of California, National Association, as Trustee. (C) 4.2 Officers' Certificate pursuant to Section 301 of the Indenture, without Exhibits, establishing the terms of the Company's senior notes and senior debentures. (C) 4.3 Form of Senior Note. (C) 4.4 Form of Senior Debenture. (C) 10.1 1983 Incentive Stock Option Plan and form of Stock Option Agreement. (E) 10.2 Seagate Technology Employee Stock Purchase Plan, as amended. 10.3 Registrant's Executive Stock Plan. (I) 10.4 Conner Peripherals, Inc. 1986 Incentive Stock Plan. (I) 10.5 Building Agreement for Land At Private Lot A14547 in Yio Chu Kang dated May 30, 1996 between Seagate Technology International and Jurong Town Corporation. (K) 10.6 Lease Agreement dated July 18, 1994 between Universal Appliances Limited and Seagate Technology (Thailand) Limited. (K) 10.7 1991 Incentive Stock Option Plan and Form of Option Agreement, as amended. (K) 10.8 Acquisition Agreement dated as of September 29, 1989 by and among Seagate Technology, Inc. and Control Data Corporation, Imprimis Technology Incorporated and Magnetic Peripherals, Inc. (G) 10.9 Amended and Restated Directors' Option Plan and Form of Option Agreement. (H) 10.10 Amended and Restated Archive Corporation Stock Option and Restricted Stock Purchase Plan--1981. (I) 10.11 Amended and Restated Archive Corporation Incentive Stock Option Plan--1981. (I) 10.12 Conner Peripherals, Inc.--Arcada Holdings, Inc. Stock Option Plan. (J) 10.13 Arcada Holdings, Inc. 1994 Stock Option Plan. (J) 10.14 Separation Agreement and Release between the Registrant and Alan F. Shugart dated as of July 29, 1998. (K) 13.1 Portions of the 1998 Annual Report to Stockholders. * 21.1 Subsidiaries of the Registrant. (K) 23.1 Consent of Ernst & Young LLP, Independent Auditors. * 24.1 Power of Attorney. (K) 27 Financial Data Schedule (K) (A) Incorporated by reference to exhibits filed in response to Item 16, "Exhibits," of the Company's Registration Statement on Form S-3 (File No. 33-13430) filed with the Securities and Exchange Commission on April 14, 1987. (B) Incorporated by reference to exhibits filed in response to Item 14 (a), "Exhibits," of the Company's Form 10-K, as amended, for the year ended June 30, 1990. (C) Incorporated by reference to exhibits filed in response to Item 7(b), "Financial Statements and Exhibits" of the Company's Current Report on Form 8-K dated March 4, 1997. (E) Incorporated by reference to exhibits filed in response to Item 14(a), "Exhibits," of the Company's Form 10-K for the year ended June 30, 1983. (G) Incorporated by reference to exhibits filed in response to Item 7(c), "Exhibits," of the Company's Current Report on Form 8-K dated October 2, 1989. (H) Incorporated by reference to exhibits filed in response to Item 14(a), "Exhibits," of the Company's Form 10-K for the year ended June 30, 1991. (I) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (registration number 333-00697) as filed with the Commission on February 5, 1996. (J) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-8 (registration number 333-01059) as filed with the Commission on February 21, 1996. (K) Previously filed. * Filed herewith. (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the quarter ended July 3, 1998. EX-13.1 2 PORTIONS OF THE 1998 ANNUAL REPORT TO STOCKHOLDERS 1 EXHIBIT 13.1 SEAGATE TECHNOLOGY, INC. ANNUAL REPORT TO STOCKHOLDERS SELECTED FINANCIAL DATA SEAGATE TECHNOLOGY 1998
Fiscal Year Ended July 3, June 27, June 28, June 30, July 1, In millions, except per share data 1998 1997 1996 1995 1994 ========================================================================================================= Revenue $6,819 $8,940 $8,588 $7,256 $5,865 Gross margin 989 2,022 1,581 1,373 1,171 Income (loss) from operations (686) 858 287 459 473 Income (loss) before extraordinary gain (530) 658 213 313 330 Net income (loss) (530) 658 213 319 330 Basic income (loss) per share before extraordinary gain (2.17) 2.82 1.07 1.64 1.76 Basic net income (loss) per share (2.17) 2.82 1.07 1.67 1.76 Diluted income (loss) per share before extraordinary gain (2.17) 2.62 .97 1.44 1.56 Diluted net income (loss) per share (2.17) 2.62 .97 1.47 1.56 Total assets 5,645 6,723 5,240 4,900 4,308 Long-term debt, less current portion 704 702 798 1,066 1,177 Stockholder's equity $2,937 $3,476 $2,466 $1,936 $1,635 Number of shares used in per share computations: Basic 243.6 233.6 199.7 190.6 186.9 Diluted 243.6 257.9 236.1 244.7 235.8
The 1998 results of operations include a $347 million restructuring charge, a $223 million write-off of in-process research and development incurred primarily in connection with the acquisition of Quinta Corporation, a $76 million charge for mark-to-market adjustments on certain of the Company's foreign currency forward exchange contracts and a $22 million reduction in the charge recorded in 1997 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"). The 1997 results of operations include a $153 million charge as a result of the adverse judgment in the Amstrad PLC litigation. The 1996 results of operations include a $242 million restructuring charge as a result of the merger with Conner Peripherals, Inc. and a $99 million 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 million 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, a two-for-one stock split, effected in the form of a stock dividend, in November 1996, and Statement of Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings Per Share," adopted in the second quarter of fiscal 1998.
QUARTERLY/1998 Unaudited, in millions except per share data 1st 2nd 3rd 4th ------------ Revenue $ 1,896 $ 1,673 $ 1,675 $ 1,575 Gross margin 295 192 204 298 Income (loss) from operations (200) (277) (221) 12 Net income (loss) (240) (183) (129) 22 Net income (loss) per share: Basic (.98) (.75) (.53) .09 Diluted (.98) (.75) (.53) .09 Price range per share: Low $34-1/8 $18-7/16 $ 17-3/4 $19-7/16 High $45-3/4 $ 40-5/8 $27-3/16 $ 29-5/8
2 The results for the first quarter include a $216 million write-off of in-process research and development incurred primarily in connection with the acquisition of Quinta Corporation and a $63 million charge for mark-to-market adjustments on certain of the Company's foreign currency forward exchange contracts. The results for the second quarter include a $205 million restructuring charge, a $22 million reduction in the $153 million charge recorded in 1997 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 a $13 million charge for mark-to-market adjustments on certain of the Company's foreign currency forward exchange contracts. The results for the third quarter include a $142 million restructuring charge. The results for the fourth quarter include a $7 million write-off of in-process research and development incurred in connection with the acquisition of Eastman Software Storage Management Group, Inc. in June 1998. Prior periods have been restated to reflect SFAS 128, "Earnings Per Share," adopted in the second quarter of fiscal 1998.
QUARTERLY/1997 Unaudited, in millions except per share data 1st 2nd 3rd 4th Revenue $ 2,061 $ 2,400 $ 2,502 $ 1,977 Gross margin 393 541 631 457 Income from operations 174 289 347 48 Net income 129 213 257 59 Net income per share: Basic .61 .94 1.04 .24 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 the reversal of restructuring charges of $10 million related to the completion of certain aspects of the restructuring in connection with the merger with Conner Peripherals, Inc. at a lower cost than originally estimated. The results for the third quarter include compensation expense and in-process research and development charges of $13 million and $3 million, 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 million 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 $3 million related to certain software operations. Prior periods have been restated to reflect a two-for-one stock split, effected in the form of a stock dividend, in November 1996 and SFAS 128, "Earnings Per Share," adopted in the second quarter of fiscal 1998. 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 July 3, 1998, there were 7,821 stockholders of record of the Company's common stock. 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SEAGATE TECHNOLOGY 1998 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/A for the Fiscal Year Ended July 3, 1998 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/A for 1998. These forward-looking statements include the statements relating to continued price erosion in the first paragraph under "Results of Operations - 1998 vs 1997," the statements relating to continued expansion into complementary markets and write-offs of in- process research and development in the sixth paragraph under "Results of Operations - 1998 vs 1997," the statements relating to the 1999 effective tax rate in the tenth paragraph under "Results of Operations - 1998 vs 1997," the statements relating to the IRS adjustments in the last paragraph under "Results of Operations - 1998 vs 1997," 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 under "Disclosures about Market Risk - Foreign Currency Risk," 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 note to the consolidated financial statements, among others. 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 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 markets a broad line of Travan, Digital Audio Tape (DAT) and Advanced Intelligent Tape (AIT) products. These products are dedicated back- up storage peripherals designed to meet the needs of market segments ranging from desktop PCs to midrange servers. 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. 4 Business Combinations - In Process Research and Development The Company has a history of acquisitions and during the three most recent fiscal years acquisitions included Quinta Corporation and Eastman Storage Software Management Group in fiscal 1998, and Arcada Holdings, Inc., Holistic Systems, Calypso Software Systems, Inc., and OnDemand Software, Inc. in fiscal 1996. No significant acquisitions occurred in fiscal 1997. In connection with these acquisitions, the Company has recognized significant write-offs of in- process research and development. The completion of the underlying in-process projects acquired within each acquisition was the most significant and uncertain assumption utilized in the valuation analysis of the in-process research and development. Such uncertainties could give rise to unforeseen budget over runs and/or revenue shortfalls in the event that the Company is unable to successfully complete a certain R&D project. The Company is primarily responsible for estimating the fair value of the purchased R&D in all acquisitions accounted for under the purchase method. The nature of research and development projects acquired, the estimated time and costs to complete the projects and significant risks associated with the projects for the largest acquisitions are described below. Quinta Corporation - ------------------ Quinta's research and development efforts revolve around Optically Assisted Winchester ("OAW") technology. OAW refers to Quinta's newly designed recording technology that, upon completion, would be implemented into Winchester hard disc drives. OAW combines traditional magnetic recording technology with Winchester hard disc drives and optical recording capabilities; optical recording technology enables greater data storage capacity. By integrating advanced optical features along with a highly fine and sophisticated tracking and delivery system within the head design, OAW would multiply the areal density of disc drives. Through August 8, 1997, the acquisition date, Quinta had demonstrated significant achievements in developing its technology. However, further technological milestones were required before technological feasibility could be achieved. Quinta's development process consists of the following development milestones: (i) route light (optical fiber), (ii) flying head use, (iii) recording media, (iv) mirror creation and demonstration (two stage servo), (v) complete assembly, (vi) form factor containment, (vii) design verification test, (viii) customer qualification, and (ix) delivery. Future products were expected to include fixed and removable drives and cartridges. Seagate Technology expected to introduce products incorporating Quinta's OAW technology within 12 months of the acquisition date. At the time of completing the Quinta acquisition, the Company estimated that additional R&D spending of $9.4 million and $3.9 million in fiscal 1998 and 1999, respectively, would be required to complete the project. Since that time, Seagate has redirected its efforts so that the Company is focused less on the development of a specific product and more on the advancement of optical technology in general. As such, the spending elements associated with the development of optical technology are embedded in the R&D budgets of the Company's product design centers and component technology organizations. At the present time the Company has no immediate plans to release a storage device which makes specific use of Quinta's "Optically Assisted Winchester" technology. Delay in releasing such a storage device is not expected to materially affect the Company's future earnings. Eastman Software Storage Management Group - ----------------------------------------- Eastman Software SMG ("Eastman") was acquired in June 1999. Eastman develops a hierarchical storage management product for Microsoft's Windows NT platform and its two primary products are OPEN/stor for Windows NT and AvailHSM for NetWare. By integrating Eastman's product line, Seagate will be able to convert its Storage Migrator product into a stand-alone HSM application for Windows NT environments. As of the date of acquisition, Seagate abandoned the AvailHSM product and technology due to dated features and functionality; the valuation analysis did not include a fair value for the AvailHSM product. As for OPEN/stor at the date of acquisition, Seagate planned to phase out the product over the following 12 to 15 months. Seagate's purpose for the acquisition was for the next generation technologies that were underway at Eastman, referenced by project names Sakkara and Phoenix. These projects were complete re-writes of Eastman's prior generation technology that would allow the product to be sold stand-alone upon completion. The anticipated release dates for Sakkara and Phoenix were the 2nd quarter of fiscal year 1999 and the 4th quarter of fiscal year 1999, respectively. As of the date of acquisition, Seagate anticipated the costs to complete both Sakkara and Phoenix at 5 approximately $1.8 million. Since the acquisition date, no changes have been made to the original estimated release dates for all the projects acquired from Eastman. Arcada Software, Inc. - --------------------- Seagate purchased the outstanding minority interests of Arcada Holdings, Inc. ("Arcada") in February 1996 in connection with the pooling-of-interests with Conner Peripherals, Inc. Arcada's technology at the date of acquisitions was comprised of three main categories: (i) Desktop, (ii) NetWare, and (iii) Windows NT. The majority of the original underlying code and base technology for the NetWare and Windows NT product families was completed in the 1990 time frame. The technologies, as of the date of valuation, were in need of significant re- development to add features and utilities to the products such as disc grooming, hierarchical storage management, upgraded graphical user interfaces, file and server replication, and server mirroring in order to continue to meet increasingly complex user needs. As of the date of acquisition, Company management anticipated the costs to complete the Desktop, NetWare, and Windows NT technologies at approximately $6.8 million, $4.5 million, and $7.5 million, respectively. Since the acquisition date, all the projects originally acquired from Arcada were completed and commercially released prior to the end of the fourth quarter of fiscal 1997. Holistic Systems Ltd. - --------------------- Holistic Systems, Ltd. ("Holistic") was acquired in June 1996. Holistic's sole software product is Holos, a product that enables users to develop and utilize the wide variety of applications found in large scale management information systems. As of the date of acquisition, Holistic was in the process of developing the next generation of Holos, version 6.0, which was planned for release during the fourth quarter of fiscal 1997. As of the date of acquisition, Holistic had undergone or was in the process of undergoing the re-write of the front-end code of the system from C to C++, the re-write of the back-end code of the system in C, and the creation of the Holos product to be object oriented. The estimated cost to complete, at the date of acquisition, was approximately $3.5 million. Since the acquisition date, the project originally acquired from Holistic was completed and commercially released as planned in the fourth quarter of fiscal 1997. RESULTS OF OPERATIONS The following table sets forth certain items in the Company's Consolidated Statements of Operations as a percentage of revenue for each of the three years in the period ended July 3, 1998.
PERCENTAGE OF REVENUE 1998 1997 1996 ---- ---- ---- Revenue 100% 100% 100% Cost of sales 85 77 82 ------ ------ ------ Gross margin 15 23 18 Product development 9 5 5 Marketing and administrative 7 6 6 Amortization of goodwill and other intangibles 1 - - In-process research and development 3 - 1 Restructuring 5 - 3 Unusual items - 2 - ------ ------ ------ Income (loss) from operations (10) 10 3 Other income, net - - 1 ------ ------ ------ Income (loss) before income taxes (10) 10 4 Benefit (provision) for income taxes 2 (3) (1) ------ ------ ------ Net income (loss) 7% (8)% 3% ============================================================================================================
1998 vs 1997---Revenue in 1998 was 24% lower than that reported in 1997. The decrease in revenue from the prior year was due primarily to a continuing decline in the average unit sales prices of the Company's products as a result of intensely competitive market conditions, a lower level of unit shipments reflecting continuing weakness in demand for the Company's disc drive products and a shift in mix away from the Company's higher priced products. The price 6 erosion accounted for $1.6 billion of the revenue decline while volume issues accounted for $0.4 billion. The Company expects that price erosion in the data storage industry will continue for the foreseeable future. This competition and continuing price erosion may adversely affect the Company's results of operations in any given quarter and such an adverse effect often cannot be anticipated until late in any given quarter. The decrease in gross margin as a percentage of revenue from the prior year was primarily due to a continuing decline in the average unit sales prices of the Company's disc drive products, particularly its desktop products, as a result of intensely competitive market conditions, lower consolidated revenue and a shift in mix away from the Company's higher performance disc drives, partially offset by reductions in manufacturing costs. In 1997 desktop gross margins improved over 1996 primarily due to strong demand for these products. This strong demand resulted in most of the Company's desktop disc drive products going on allocation and thus stabilizing prices. In 1998 the situation changed. There was excess capacity in the industry for desktop disc drives which resulted in severe price erosion. Because of these factors, as well as poor time-to- market performance with respect to the Company's products, desktop gross margins declined substantially in 1998. Gross margin as a percentage of revenue has improved each quarter for the last three quarters ending January 1, 1999. Disc drive gross margins are expected to improve slightly in the quarter ending April 2, 1999, and to continue to improve in the future as the Company's time to market for disc drive products improves, cost structures are enhanced and manufacturing and operational efficiencies improve. The Company's overall average unit sales price on its disc drive products was $219, $206, $208 and $229 for the four quarters of fiscal 1998, respectively. Additionally, there was an increase in revenue (34%) of the Company's Seagate Software, Inc. subsidiary ("Seagate Software") which subsidiary's products generally have higher gross margins. Excluding the gross margin of Seagate Software, the Company's gross margins would have been 11% and 22% in 1998 and 1997, respectively. Product development expenses increased by $126 million (27%) compared with 1997, primarily due to increases of $39 million in salaries and related costs, $26 million in allocated occupancy costs and $19 million in payments or accruals for such payments to former shareholders of Quinta Corporation ("Quinta"), acquired by the Company in August 1997, for achievement of certain product development milestones, and an overall increase in the Company's product development efforts. The Company's product development activities include efforts to improve its time-to-market performance, the development of ultra-high capacity disc drive technologies, including a new optically-assisted Winchester (OAW) technology being developed by Quinta and development efforts related to its software and tape drive products. These increases in expenses were partially offset by substantially reduced employee profit sharing and executive bonuses in 1998. Marketing and administrative expenses increased by $9 million (2%) compared with 1997, primarily due to increases of $22 million in advertising and promotion expenses, $21 million in marketing and administrative expenses related to the Company's software products and services, particularly those of Seagate Software's Information Management Group and $17 million in salaries and related costs. These increases in expenses were partially offset by decreases of $21 million in allocated occupancy costs, $15 million in employee profit sharing and executive bonuses, $10 million in legal expenses and $6 million in the provision for bad debts. The Company expects to take an $8 million to $10 million charge in the first quarter of fiscal 1999 associated with a separation agreement entered into between Alan F. Shugart, the Company's former Chief Executive Officer, and the Company in July 1998. Amortization of goodwill and other intangibles decreased by $10 million (20%) compared with 1997, primarily due to the inclusion in amortization expense of the write-down of goodwill and the write-offs and write-downs in 1997 of certain intangible assets related to past acquisitions of software companies whose value had become permanently impaired and the resultant subsequent $13 million reduction in amortization expense, partially offset by additional amortization of $2 million related to goodwill and intangibles arising from the Company's additional investment in Dragon Systems, Inc. ("Dragon") in September 1997. Of the $223 million charge for the write-off of in-process research and development, $214 million was a result of the August 1997 acquisition of Quinta and $7 million was a result of the June 1998 acquisition of Eastman Software Storage Management Group, Inc. ("ESSMG"). In April and June 1997, Seagate invested an aggregate of $20 million to acquire approximately ten percent (10%) of Quinta's stock. In August 1997, the Company completed the acquisition of Quinta. Pursuant to the purchase agreement with Quinta, the shareholders of Quinta, other than Seagate, received cash payments aggregating $230 million upon the closing of the acquisition and were eligible to receive additional cash payments aggregating $95 million upon the achievement of certain product development and early production milestones. Of the $95 million, $19 million was paid or accrued in fiscal 1998. In July 1998, the Company 7 and Quinta amended the purchase agreement to eliminate the product development and early production milestones and provide that the former shareholders of Quinta will be eligible to receive the remaining $76 million and the $14 million that had been accrued but unpaid in fiscal 1998. In the first quarter of fiscal 1999, the Company expects to take a charge to operations for the remaining $76 million. The Company recognizes the uncertainty associated with the completion of purchased in-process research and development. Such uncertainties could give rise to unforeseen budget overruns and/or revenue shortfalls in the event that the Company is unable to successfully complete a given research and development project. See Acquisitions note to the consolidated financial statements. 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. The Company recorded restructuring charges of $205 million in the second quarter of 1998 and $142 million in the third quarter of 1998. The aggregate charges of $347 million reflect steps the Company is taking to align worldwide operations with current market conditions by reducing existing capacity in all areas of the Company and improving the productivity of its operations and the efficiency of its development efforts by consolidating manufacturing and R&D operations. Actions include exiting production of mobile products; early discontinuation of several other products; closing and selling the Clonmel, Ireland drive manufacturing facility; closing and subleasing the San Jose and Moorpark, CA design center facilities; aborting production expansion projects in Cork, Ireland; and divesting the Company of the new Philippines manufacturing facility, which was nearing completion. The restructuring charges were comprised of employee related costs for severance of $57 million; facilities costs for facilities the Company is no longer using for current activities which include lease termination and holding costs of $24 million for facilities located in California and the Far East, and the write-off or write-down of owned and leased facilities located in California, the Philippines and Ireland of $54 million; write-off or write-down of $137 million for excess manufacturing, assembly and test equipment and tooling formerly utilized primarily in California, Singapore, Thailand and Ireland; write-off of intangibles and other assets including $9 million for capital equipment deposits and $2 million for goodwill associated with permanently impaired equipment; contract cancellations comprised of $43 million for costs incurred to cancel outstanding purchase commitments existing prior to the plan of restructure; and other costs comprised of the repayment of various grants to the Industrial Development Agency of Ireland of $7 million and a contingency of $14 million for adjustments to estimates used when the restructuring charge was recorded. The fiscal year 1998 aggregated restructuring reserve included asset write- offs or write-downs of tangible assets totaling $200 million and intangible assets totaling $2 million. During the quarter ended January 2, 1998, forecasted production needs were much lower than the current capacity of the Company and the Company recognized that the recent oversupply in the marketplace was not a short-term anomaly. This oversupply was as a result of competitors in the drive industry completing expansion plans at the same time that customer demand flattened out in addition to efficiency improvements achieved in the Company's manufacturing processes. In this period, the Company also decided to discontinue production of all or a portion of products within the Elite, Bali, Cuda, Explorer and Phoenix/Futura product families, rendering test and manufacturing equipment unique to those products as excess. Prior to this period, there was no indication of permanent impairment of the assets associated with the recent excess capacity of the Company or the products to be discontinued. These assets included owned facilities that the Company is vacating, manufacturing, assembly and test equipment and tooling unique to production of discontinued products and excess equipment as a result of consolidating facilities and leasehold improvements for leased facilities to be vacated. Discounted future cash flows and evaluations of the resale market for certain assets were used to estimate fair value. The Clonmel, Ireland facility was sold in May 1998 and the majority of the other tangible assets have been disposed of or sold. The remaining assets are the Philippines facility, two manufacturing facilities in Thailand and the manufacturing equipment located at these facilities. The Philippines facility remains vacant and the Company continues to actively seek a buyer. The Company is marketing vacated leased facilities for sublease unless the remaining lease term is so short as to make a sublease impractical. Two manufacturing facilities continue to be utilized until a satisfactory agreement can be made with an external vendor to supply parts currently manufactured at these locations. The Company is actively seeking such an agreement. Until such time as a supplier is qualified, the Company is continuing to depreciate the two manufacturing facilities and the equipment at those locations. When these assets are identified as available for sale, no further depreciation will be recorded. 8 As a result of employee terminations and write-off or write-down of equipment and facilities in connection with implementing the fiscal year 1998 restructuring plan, the Company estimates that annual salary and depreciation expense will be reduced by approximately $170 million and $70 million, respectively. The Company anticipates that the implementation of the restructuring plan will be substantially complete by the end of December 1998. Certain lease termination and holding costs related to vacated facilities continue to be incurred and charged against the restructuring reserve until the leases expire or the facilities are subleased. Amstrad PLC ("Amstrad") initiated a lawsuit against the Company in 1992 concerning the Company's sale of allegedly defective disc drives to Amstrad. On November 6, 1997, the Company and Amstrad settled all of the outstanding disputes. The settlement resulted in a $22 million reduction in 1998 against the $153 million charge recorded in 1997. The $22 million reduction and the $153 million charge are included in unusual items in the Consolidated Statements of Operations for 1998 and 1997, respectively. Net other income in 1998 decreased by $51 million, compared with 1997, primarily due to charges for mark-to-market adjustments in 1998 of $76 million on certain of the Company's foreign currency forward exchange contracts for the Thai baht and the Malaysian ringgit offset by $10 million of other foreign currency transaction gains. Additionally there was an increase in interest expense of $16 million due to higher average levels of long-term debt outstanding. These decreases in net other income were partially offset by a decrease of $10 million in the charge for minority interest as a result of lower income in the Company's majority-owned subsidiary in Shenzhen, China, an $8 million gain on sales of the Company's investment in Overland Data, Inc. and a $6 million increase in interest income. The Company recorded a $174 million benefit from income taxes at an effective rate of 25% in 1998 compared with a $233 million provision for income taxes at an effective rate of 26% in 1997. The change in income taxes was primarily due to the loss from operations incurred in 1998. Excluding the acquisition of Quinta, certain non-recurring restructuring costs and the reversal of certain Amstrad litigation charges, the effective tax rate was approximately 28% in 1998. Excluding the Amstrad litigation charge, the effective tax rate was approximately 28% in 1997. While the Company expects the 1999 effective tax rate before unusual items to approximate 28%, the actual effective tax rate may vary from this rate if, for example, the Company incurs charges in connection with future acquisitions. The Company provided income taxes at the U.S. statutory rate of 35% in 1998 on substantially all of its earnings from foreign subsidiaries compared with approximately 66% of such earnings in 1997. A substantial portion of the Company's Far East manufacturing operations at plant locations in Singapore, Thailand, China and Malaysia operate free of tax under various tax holidays. The tax holiday in Singapore expires in June 2005. The tax holidays in Chockchai, Wellgrow and Korat, Thailand expire in June 2001, February 2004 and September 2004, respectively. The tax holidays in Shenzen and Wuxi, China expire in December 1998 and December 2000, respectively. The tax holidays in Penang and Perai, Malaysia expire in June 1999 and December 1999, respectively. The tax holidays had no impact on the net loss in 1998. The net impact of these tax holidays was to increase net income by approximately $71 million ($0.28 per share, diluted) in 1997. The Company received a statutory notice of deficiency dated June 27, 1997 from the Internal Revenue Service relative to taxable years 1991 through 1993 assessing potential deficiencies approximating $39 million plus interest and approximately $6 million of penalties. The proposed adjustments to taxable income relate primarily to re-allocations of income and expenses between the Company and its Far East subsidiaries, the timing for deduction of accrued domestic expenses and reserves and the allowable amount of domestic tax credits. No assets have been levied as a result of the statutory notice of deficiency. The Company petitioned the United States Tax Court on September 24, 1997 for a re-determination of the deficiencies. The Company believes that the outcome of this matter will not have a material adverse effect on its financial position or results of operations. The Company received a statutory notice of deficiency dated June 12, 1998 from the Internal Revenue Service relative to Conner's taxable years 1991 and 1992 assessing potential deficiencies approximating $11 million plus interest. The proposed adjustments to taxable income relate primarily to re-allocations of income and expenses between the Company and its Far East subsidiaries and the timing for deduction of accrued domestic expenses and reserves. No assessments have been levied as a result of the statutory notice of deficiency. The Company believes it has meritorious defenses to the Internal Revenue Service adjustments but has not yet determined the forum in which it 9 will contest the proposed deficiencies. The Company believes that the outcome of this matter will not have a material adverse effect on its financial position or results of operations. 1997 VS 1996 Revenue in 1997 was 4% higher than that reported in 1996. The increase in revenue 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. Volume issues accounted for $1.6 billion of the revenue increase while price erosion accounted for the $1.3 billion offset. Revenue decreased to $1.977 billion in the fourth quarter of 1997 from $2.502 billion 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 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. The increase in gross margin as a percentage of revenue 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 manufacturing costs. 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. Product development expenses increased by $39 million (9%) compared with 1996, primarily due to increases of $17 million in salaries and related costs, $11 million in materials, $8 million in depreciation and $6 million in product development expenses related to the Company's software products and services. Marketing and administrative expenses increased by $7 million (1%) compared with 1996, primarily due to an increase of $62 million in 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 consisted primarily of decreases of $13 million in salaries and related costs, $12 million in outside services, $6 million in advertising and promotion expenses, $6 million in legal expenses, $6 million in allocated occupancy costs, $4 million in commissions and $4 million in telephone expenses. Amortization of goodwill and other intangibles increased by $3 million (6%) 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 permanently 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 permanently impaired. See Acquisitions note to consolidated financial statements. The $3 million 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. During fiscal year 1996, the Company recorded restructuring charges totaling $242 million as a result of the merger with Conner Peripherals, Inc. ("Conner") which included employee related costs for severance of $37 million as a result of the reduction of approximately 1,370 personnel whose duties were made redundant, $21 million associated with change of control agreements for Conner executives and $3 million associated with accelerated vesting of stock for Conner executives; excess facilities costs including closure of duplicate and excess facilities primarily in California, Singapore, Malaysia, Scotland and Italy comprised of lease termination and holding costs of $29 million and write- off or write-down of owned and leased facilities of $16 million; write-off or write-down of manufacturing, assembly and test equipment and tooling of $41 million; intangibles primarily associated with the Company's tape drive products of $14 million; other assets comprised of inventory associated with discontinued products of $39 million, grant repayments related to closure of a distribution center in Scotland of $2 million, and other assets of $1 million; professional fees of financial advisors of $16 million and of attorneys and accountants of $9 million; contract cancellation costs and related legal fees in connection with existing purchase commitments of $12 million; and other costs of $2 million. Asset write-offs and write-downs for certain duplicated and excess assets totaled $99 million for tangible assets and $14 million for intangible assets. Asset impairment was identified when decisions were made as a result of 10 the merger to close certain facilities and discontinue certain products to eliminate duplicate product offerings in the newly merged company. These permanently impaired assets included manufacturing, assembly and test equipment and tooling unique to production of discontinued products, excess equipment as a result of consolidating facilities and leasehold improvements of leased facilities to be vacated. Discounted future cash flows were used to estimate fair value and all tangible assets have been disposed of or sold. As a result of employee terminations and write-offs and write-downs of equipment and facilities in connection with implementing the fiscal year 1996 restructuring plan, the Company estimates that salary expense was reduced by approximately $240 million per year and depreciation expense was reduced by approximately $20 million per year. These savings were partially offset by reduced revenue, resulting in a net savings of approximately $170 million per year. Implementation of the restructuring plan was substantially complete as of June 27, 1997. Certain lease termination and holding costs for vacant facilities continue to be incurred and charged against the restructuring reserve until the leases expire or the facilities are subleased. In 1997, the Company reversed $10 million of its restructuring reserves as a result of the completion of certain aspects of the restructuring plan at less than the originally estimated cost. This reversal included employee termination benefits of $5 million as a result of terminating fewer employees than originally anticipated, excess facilities costs of $4 million as a result of continuing to utilize certain facilities, and the settlement of certain outstanding lease obligations at less than the originally estimated cost of $1 million. Reclassifications between cost categories were made as a result of terminating fewer employees than originally planned and write-off of additional equipment that became excess or obsolete as a result of the merger with Conner. Partially offsetting the $10 million reversal was a $3 million charge for restructuring costs recorded by Seagate Software. The following table summarizes the Company's restructuring activity related to the 1996 restructuring charge for the three years ended July 3, 1998:
Severance and Excess Other Professional Contract In millions Benefits Facilities Equipment Intangibles Assets Fees Cancellations Other Total -------------------------------------------------------------------------------------------------------- 1996 restructuring charges $ 61 $ 45 $ 41 $ 14 $ 42 $ 25 $ 12 $ 2 $242 Cash charges (28) - - - - (21) (5) - (54) Non-cash charges - (10) (41) (14) (31) - - - (96) ----------------------------------------------------------------------------------------------------- Reserve Balances, June 26, 1996 33 35 - - 11 4 7 2 92 Cash Charges (18) (10) - - - (2) (3) (3) (36) Non-cash charges - (5) (13) - (5) - - - (23) Adjustments (5) (4) - - - - (1) - (10) Reclassifications (10) (5) 13 - (2) (2) - 6 - ----------------------------------------------------------------------------------------------------- Reserve balances, July 27, 1997 - 11 - - 4 - 3 5 23 Cash charges - (11) - - (1) - - (1) (13) ----------------------------------------------------------------------------------------------------- Reserve balances, July 3, 1998 $ - $ - $ - $ - $ 3 $ - $ 3 $ 4 $ 10 =====================================================================================================
Unusual items in 1997 consisted of a $153 million charge as a result of the judgment adverse to the Company in the Amstrad litigation and $13 million for compensation expense in connection with additional amounts paid with respect to the June 1996 acquisition of Holistic Systems Ltd. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -Results of Operations - 1998 s. 1997." Net other income decreased by $11 million compared with 1996, primarily due to an increase of $14 million in the charge for minority interest as a result of higher income in the Company's majority-owned subsidiary in Shenzhen, China, an increase of $8 million in amortization of premiums on foreign currency option contracts and an increase of $6 million in mark-to-market losses on foreign currency forward exchange contracts. These decreases in net other income were partially offset by a reduction of $21 million in 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 $115 million 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. The Company provided income taxes at the U.S. statutory rate of 35% 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. The net impact of these tax holidays was to increase net income by approximately $71 million ($0.28 per share, diluted) in 1997 and approximately $50 million ($0.21 per share, diluted) in 1996. 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. 11 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, guarantor or depository. 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, except for certain types of investments that may mature in more than three years but whose weighted average maturity is three years or less.
Fair Value Dollars in millions 1999 2000 2001 2002 2003 Thereafter Total July 3, 1998 -------------------------------------------------------------------------------- Assets Cash equivalents Fixed rate $ 574 $ - $ - $ - $ - $ - $ 574 $ 572 Average interest rate 5.37% - - - - - 5.37% Short-term investments Fixed rate 285 304 369 - - - 958 961 Average interest rate 5.81% 6.25% 6.05% - - - 6.04% Variable rate 200 - - - - - 200 200 Average interest rate 5.62% - - - - - 5.62% Total investment securities 1,059 304 369 - - - 1,732* 1,732 Average interest rate 5.54% 6.25% 6.05% - - - 5.77% Long-Term Debt Fixed rate - - - - - 700 700 693 Average interest rate - - - - - 7.33% 7.33%
*Includes $2 million of accreted interest to be received at maturity. Foreign Currency Risk---The Company transacts business in various foreign countries. Its primary foreign currency cash flows are in emerging market countries in Asia and in certain European countries. During 1998 and 1997, the Company employed a foreign currency hedging program utilizing foreign currency forward exchange contracts and purchased currency options to hedge local currency cash flows from payroll, inventory, other operating expenditures and fixed asset purchases in Singapore, Thailand, Malaysia, and Ireland. Under this program, increases or decreases in the Company's local currency operating expenses and other cash outflows, as measured in U.S. dollars, 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 uncertainty in the Southeast Asian 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. Under the Company's foreign currency hedging program, 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 foreign currency hedge contracts are marked-to-market 12 and unrealized gains and losses are included in current period net income. 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 was especially pronounced during the first and second quarters of fiscal 1998 as a result of the declines in value of the Thai Baht and Malaysian Ringgit, relative to the U.S. dollar. This mismatch resulted in a pre-tax charge of $76 million for the year ended July 3, 1998. The table below provides information as of June 27, 1997 and July 3, 1998 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. As of July 3, 1998, the Company had effectively closed out all of its foreign currency forward exchange contracts by purchasing offsetting contracts. The amounts listed below represent forward exchange contracts and offsets for which Seagate did not have a legal right of offset. Seagate would not have incurred any incremental accounting loss as of July 3, 1998 if any party had failed to perform. This was because the estimated fair value of the offsetting forward sales contracts was effectively zero.
Notional Average Estimated In millions, except average contract rate Amount Contract Rate Fair Value* ------------------------------------------ As of June 27, 1997 Purchased foreign currency forward exchange contracts: Malaysian ringgit $ 264 2.53 $ (1) Singapore dollar 284 1.39 (5) Thai baht 458 26.57 (5) ------ ---- $1,006 $(11) Purchased currency options: Malaysian ringgit $ 82 2.53 $ 1 Singapore dollar 244 1.39 1 ------ ---- $ 326 $ 2 As of July 3, 1998 Foreign currency forward exchange contracts: Malaysian ringgit: Forward purchase contracts $ 40 3.10 $(11) Forward sales contracts (29) 4.24 - ------ ---- $ 11 $(11) Singapore dollar: Forward purchase contracts $ 52 1.51 $ (7) Forward sales contract (45) 1.73 - ------ ---- $ 7 $ (7) Irish punt: Forward purchase contracts $ 9 1.43 $ 0 Forward sales contracts 9 1.46 0 ------ ---- $ - $ -
*Equivalent to the unrealized net gain (loss) on existing contracts. Other For 1998, the net gain resulting from the remeasurement of foreign financial statements into U.S. dollars was $17 million. Such net gains (losses) did not have a significant effect on the results of operations for 1997 or 1996. The effect of inflation on operating results for 1998, 1997 and 1996 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. 13 In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement is effective for fiscal years beginning after December 15, 1997, and will be adopted by the Company for its fiscal year 1999. Adoption of this pronouncement is not expected to have a material impact on the Company's financial statements. Also in June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information ("SFAS 131"). SFAS 131 replaces Statement of Financial Accounting Standards No. 14 and changes the way public companies report segment information. This statement is effective for fiscal years beginning after December 15, 1997 and will be adopted by the Company for its fiscal year 1999. Adoption of this pronouncement is not expected to have a material impact on the Company's financial statements. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that derivatives be recognized in the balance sheet at fair value and specifies the accounting for changes in fair value. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999, and will be adopted by the Company for its fiscal year 2000. The Company is in the process of assessing the impact of this pronouncement on its financial statements. In the second quarter of 1998, the Company implemented Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). All earnings per share amounts for all periods have been presented and, where necessary, restated to conform to the requirements of SFAS 128. The adoption of SFAS 128 did not have a material impact on the Company's earnings per share. 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. Liquidity and Capital Resources At July 3, 1998, the Company's cash, cash equivalents and short-term investments totaled $1.827 billion, a decrease of $456 million from the prior year-end balances. This decrease was primarily a result of expenditures of $709 million for property, equipment and leasehold improvements, the payment of $194 million in connection with the acquisition of Quinta, net of cash acquired, the net payment of $123 million in connection with the adverse judgement in the Amstrad PLC litigation and the repurchase of approximately 4 million shares of the Company's common stock for $105 million, partially offset by net cash provided by operating activities. 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 primarily consist of readily marketable debt securities with remaining maturities of more than 90 days at the time of purchase. As of July 3, 1998, the Company had committed lines of credit of $61 million which can be used for standby letters of credit or bankers' guarantees. At July 3, 1998, these lines of credit were fully utilized. The Company made investments in property and equipment in 1998 totaling $698 million. This amount comprised $248 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 Northern Ireland; $231 million for manufacturing facilities and equipment for the recording head operations in the United States, Malaysia, Northern Ireland, the Philippines and Thailand; $190 million for expansion of the Company's thin-film media operations in California, Singapore, Northern Ireland and Mexico; and $29 million for other purposes. The Company presently anticipates investments of approximately $700 million in property and equipment in 1999. The Company plans to finance these investments from existing cash balances and future cash flows from operations. 14 During the year ended July 3, 1998 the Company acquired approximately 4 million shares of its common stock for approximately $105 million. The repurchase of these shares was primarily in connection with a stock repurchase program announced in June 1997 in which up to $600 million of the Company's common stock was authorized to be acquired in the open market. During the year ended June 27, 1997, 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 April and June 1997, Seagate invested an aggregate of $20 million to acquire approximately ten percent (10%) of Quinta's stock. In August 1997, the Company completed the acquisition of Quinta. Pursuant to the purchase agreement with Quinta, the shareholders of Quinta, other than Seagate, received cash payments aggregating $230 million upon the closing of the acquisition and were eligible to receive additional cash payments aggregating $95 million upon the achievement of certain product development and early production milestones. Of the $95 million, $19 million was paid or accrued in fiscal 1998. In July 1998, the Company and Quinta amended the purchase agreement to eliminate the product development and early production milestones and provide that the former shareholders of Quinta will be eligible to receive the remaining $76 million and the $14 million that had been accrued but unpaid in fiscal 1998. 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. 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, remains strong. Delays in the development, introduction and ramping of production of new products has in the past and may in the future significantly adversely impact operating results. 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. Many of these new drive products require increased storage capacity and more advanced technology. 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. There is also significant demand in the personal computer market for computer systems costing less than $1000. The Company is positioning itself to participate in this market, however, there can be no assurance that the Company will be able to produce disc drives for this market at a cost low enough to yield gross margins comparable to those of its current overall product mix. 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 or interruptions in the production of 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 "Disclosures about 15 Market Risk -Foreign Currency Risk"), increased competition and general economic and industry fluctuations. For example, revenue decreased to $6.819 billion in fiscal 1998 from $8.940 billion in fiscal 1997 as a result of increased competition resulting in significant price decreases and continuing weakness in demand for the Company's disc drive products. 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 note to the 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 manufacturers such as Fujitsu Limited, Hyundai Electronics America (Maxtor Corporation), International Business Machines Corporation, NEC Corporation, Samsung Electronics Co. Ltd. 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 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, such as the Company is now experiencing, 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. In addition, a strategy of vertical integration has in the past and could continue to delay the Company's ability to introduce products containing market-leading technology. 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. In addition, because the Company's products are priced in U.S. dollars, the currency instability in the Asian financial markets may have the effect of making the Company's products more expensive to computer manufacturers and other users than those of other disc drive manufacturers whose products may be priced in one of the affected Asian currencies, and, therefore, those customers may reduce future purchases of the Company's disc drive products. The Company anticipates that the recent turmoil in Asian financial markets and the recent deterioration of the underlying economic conditions in certain Asian countries may have an impact on its sales to customers located in or whose end-user customers are located in those countries due to the impact of currency fluctuations on the relative price of the Company's products and restrictions on government spending imposed by the International Monetary Fund (the "IMF") on those countries receiving the IMF's assistance. In addition, customers in those countries may face reduced access to working capital to fund purchases of disc drive components or software, such as the Company's products, due to higher interest rates, reduced bank lending due to contractions in the money supply or the deterioration in the customer's or its bank's financial condition or the inability to access other financing. The Company has incorporated its software acquisitions into a single entity called Seagate Software and is offering employees of Seagate Software and selected employees of the Company an opportunity to acquire an equity interest in Seagate Software. The Company intends to continue its expansion into software and other complementary data technology businesses through internal growth as well as acquisitions. 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 expects that it will continue to incur charges as it acquires businesses, including charges for the write-off of 16 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 incurred a charge to operations in the first quarter of fiscal 1998 of approximately $216 million for the write-off of in-process research and development, $214 million of which was in connection with the acquisition of Quinta. 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 Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. The Company considers a product to be in "Year 2000 compliance" if the product's performance and functionality are unaffected by processing of dates prior to, during and after the year 2000, but only if all products (for example hardware, software and firmware) used with the product properly exchange accurate date data with it. The Company has a program to assess the capability of its products to determine whether or not they are in Year 2000 compliance. Although the Company believes its disc and tape drive products and certain of its software products are in Year 2000 compliance, the Company has determined that certain of its software products produced by Seagate Software, which are not material to Seagate Technology, are not and will not be Year 2000 compliant, and is taking measures to inform its customers of that fact. To assist customers in evaluating their Year 2000 issues, Seagate Software has developed a list which indicates those products that are Year 2000 compliant as stand-alone products. The list is located on Seagate Software's World Wide Web page and is periodically updated when assessment of the Year 2000 compliance of additional products is completed. The incremental costs incurred to date related to these programs are immaterial. However, the assessment of whether a complete system will operate correctly depends on the BIOS capability and software design and integration, and for many end-users this will include BIOS and software and components provided by companies other than Seagate or Seagate Software. The Company does not believe it is legally responsible for costs incurred by customers related to ensuring such customers' or end-users' Year 2000 capability. Nevertheless, the Company is incurring various costs to provide customer support and customer satisfaction services regarding Year 2000 issues and anticipates that these expenditures will continue in fiscal 1999 and thereafter. In addition, the Company has contacted its major customers to determine whether their products into which the Company's products have been and will be integrated are Year 2000 compliant. The Company has received assurances of Year 2000 compliance from a number of those customers and the customers under existing contracts with the Company are under no contractual obligation to provide such information to the Company. The Company is taking steps with respect to new customer agreements to ensure that the customers' products and internal systems are Year 2000 compliant. As used herein, Year 2000 capable means, with respect to its disc drive and tape products, that when used properly and in conformity with the product information provided by the Company, the Company's product will accurately store, display, process, provide and/or receive data from, into and between the twentieth and twenty-first centuries, including leap year calculations, provided that all other technology used in combination with the Seagate disc drive or tape product properly exchanges date data with the Seagate product. Even if the Company's products are Year 2000 compliant, the Company may be named as a defendant in litigation against the vendors of all of the component products of systems if some component of the systems are unable to properly manage data related to the Year 2000.. The Company's agreements with customers typically contain provisions designed to limit the Company's liability for such claims. It is possible, however, that these measures will not provide protection from liability claims, as a result of existing or future federal, state or local laws or ordinances or unfavorable judicial decisions. Any such claims, with or without merit, could result in a material adverse affect on the Company's business, financial condition and results of operations, including increased warranty costs, customer satisfaction issues and potential lawsuits. The Company has initiated a comprehensive program to address Year 2000 readiness in its internal systems and with its customers and suppliers. The Company's program has been designed to address its most critical internal systems first and to gather information regarding the Year 2000 compliance of products supplied to it and into which the Company's products are integrated. Seagate Technology conducted a Year 2000 inventory of information 17 technology systems in the first quarter of 1997. Risk assessment was substantially complete by the end of the second quarter of 1997, and remediation activities continue to be on schedule. Approximately 1400 items were identified, and as of January 1999, 118 items remain unresolved, with most scheduled for completion by July 1999. An initial inventory of non-information technology systems was completed in the third quarter of 1997. A second inventory in the second and third quarters of 1998 included all manufacturing operations with special emphasis on embedded technology and facilities. Approximately 7000 items were identified (non-information technology and embedded combined) of which approximately two-thirds are Year 2000 compliant. As of January 1999, risk assessment is 95% complete and we believe that we will resolve all non-compliant items by July 1999. The Company is using the following phased approach to Year 2000 readiness: Inventory, Assessment, Disposition, Test and Audit. Anticipated dates of completion of each phase are as follows:
1. Inventory Complete 2. Assessment March 1, 1999 3. Disposition July 1, 1999 4. Test July 1, 1999 5. Audit August 1, 1999
These activities are intended to encompass all major categories of systems in use by the Company, including manufacturing, engineering, sales, finance and human resources. The costs incurred to date related to these programs have not been material. The Company currently expects that the total cost of its Year 2000 readiness programs, excluding redeployed resources, will not exceed $10 million over the next fiscal year. The total cost estimate does not include potential costs related to any customer or other claims or the costs of internal software or hardware replaced in the normal course of business. The total cost and time to completion estimates are based on the current assessment of the Company's Year 2000 readiness needs and are subject to change as the projects proceed. The Company is installing and testing new computer software for its financial, accounting, inventory control, order processing and other management information systems. In the course of these upgrades, the Company is identifying Year 2000 dependencies in such systems and is implementing changes to such systems to make them Year 2000 compliant. 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. The cost of bringing the Company's systems into Year 2000 compliance is not expected to have a material effect on the Company's financial condition or results of operations. The Company's material third party relationships include relationships with suppliers, customers and financial institutions. The Company has identified 600 suppliers which are critical to our operations and we have surveyed each to provide details of their Year 2000 efforts including internal systems, operations and supply chain as well as a schedule for their projects. As of January 1999, 97% of such suppliers have responded affirmatively and been approved. Efforts continue to validate the remaining suppliers, but plans will be developed for any that fail validation, including identifying alternate sources or purchasing additional inventory from sole source suppliers. The Company has also initiated formal communications with its significant suppliers and financial institutions to determine the extent to which the Company is vulnerable to those third parties' failure to remedy their own Year 2000 issue. To date the Company has contacted its significant suppliers and financial institutions and has received assurances of Year 2000 compliance from a number of those contacted. Most of the suppliers under existing contracts with the Company are under no contractual obligation to provide such information to the Company. The Company is taking steps with respect to new supplier agreements to ensure that the suppliers' products and internal systems are Year 2000 compliant. The Company's largest customers were also surveyed regarding their Year 2000 efforts. The Company does not currently anticipate any material impact due to a Year 2000 related failure of a major customer. All of the Company's financial institutions have been surveyed. All of the Company's primary banking activities can be accommodated by the Company's two major multi-national banking partners with the exception of payroll in certain Asian countries which must be handled in local currency. The Company is following Year 2000 progress in these areas 18 closely and will develop specific contingency plans for meeting payroll if the Company cannot obtain assurance that these local banks are fully prepared. Because the Company's core and mission-critical systems are either complete or in the final stages of completion, the Company does not consider failure of these systems to be within a reasonable Year 2000 worst case scenario. The Company believes it is primarily at risk due to failures within external infrastructures such as utilities and transportation systems. The Company is currently examining these risk areas to develop responses and action plans. These include a potential business shutdown at all locations on December 30, 1999, and where feasible, power down on December 31, 1999 with controlled startup prior to business resumption on January 3, 2000. While the Company currently expects that the Year 2000 issue will not pose significant operational problems, delays in the implementation of new information systems, or a failure to fully identify all Year 2000 dependencies in the Company's systems and in the systems of its suppliers, customers and financial institutions could have material adverse consequences, including delays in the delivery or sale of products. Therefore, the Company is developing contingency plans for continuing operations in the event such problems arise. The Company's stock price, like that of other technology companies, is subject to significant volatility. The announcement of new products, services or technological innovations or major restructurings by the Company or its competitors, quarterly variations in the Company's results of operations, changes in revenue or earnings estimates by the investment community and speculation in the press or investment community are among the factors affecting the Company's stock price. In addition, the stock price may be affected by general market conditions and domestic and international macroeconomic factors unrelated to the Company's performance. Because of the foregoing reasons, recent trends should not be considered reliable indicators of future stock prices or financial results. The Company is in the process of addressing the issues raised by the introduction of the Single European Currency ("Euro") as of January 1, 1999 and during the transition period through January 1, 2002. The Company expects that its internal systems that will be affected by the initial introduction of the Euro will be Euro capable by January 1, 1999, and does not expect the costs of system modifications to be material. The Company does not presently expect that introduction and use of the Euro will materially affect the Company's foreign exchange and hedging activities, or the Company's use of derivative instruments, or will result in any material increase in costs to the Company. While the Company will continue to evaluate the impact of the Euro introduction over time, based on currently available information, management does not believe that the introduction of the Euro currency will have a material adverse impact on the Company's financial condition or overall trends in results of operations. 19 CONSOLIDATED BALANCE SHEETS SEAGATE TECHNOLOGY
July 3, June 27, In millions, except share data 1998 1997 Assets ------------------- Cash and cash equivalents $ 666 $1,047 Short-term investments 1,161 1,236 Accounts receivable, net 799 1,041 Inventories 508 808 Deferred income taxes 243 254 Other current assets 238 166 ------ ------ Total Current Assets 3,615 4,552 ------ ------ Property, equipment and leasehold improvements, net 1,669 1,787 Goodwill and other intangibles, net 169 199 Other assets 192 185 ------ ------ Total Assets $5,645 $6,723 ====== ====== Liabilities Accounts payable $ 577 $ 863 Accrued employee compensation 175 200 Accrued expenses 405 505 Accrued warranty 197 198 Accrued income taxes 20 69 Current portion of long-term debt 1 1 ------ ------ Total Current Liabilities 1,375 1,836 ------ ------ Deferred income taxes 435 479 Accrued warranty 161 191 Other liabilities 33 39 Long-term debt, less current portion 704 702 ------ ------ Total Liabilities 2,708 3,247 ------ ------ 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 1998 and 1997 3 3 Additional paid-in capital 1,929 1,903 Retained earnings 1,299 1,947 Deferred compensation (55) (57) Treasury common stock at cost; 7,132,867 shares in 1998 and 7,341,645 shares in 1997 (238) (319) Foreign currency translation adjustment (1) (1) ------ ------ Total Stockholders' Equity 2,937 3,476 ------ ------ Total Liabilities and Stockholders' Equity $5,645 $6,723 ====== ======
See notes to consolidated financial statements. 20 CONSOLIDATED STATEMENTS OF OPERATIONS SEAGATE TECHNOLOGY
For the years ended July 3, June 27, June 28, In millions, except per share data 1998 1997 1996 ------------------------------- Revenue $6,819 $8,940 $8,588 Cost of sales 5,830 6,918 7,007 Product development 585 459 420 Marketing and administrative 502 493 486 Amortization of goodwill and other intangibles 40 50 47 In-process research and development 223 3 99 Restructuring 347 (7) 242 Unusual items (22) 166 - ------ ------ ------ Total Operating Expenses 7,505 8,082 8,301 ------ ------ ------ Income (Loss) from Operations (686) 858 287 Interest income 98 92 94 Interest expense (51) (35) (56) Other, net (65) (24) 6 ------ ------ ------ Other Income (Expense), net (18) 33 44 Income (loss) before income taxes (704) 891 331 Benefit (provision) for income taxes 174 (233) (118) ------ ------ ------ Net Income (Loss) $ (530) $ 658 $ 213 ====== ====== ====== Net income (loss) per share: Basic $(2.17) $ 2.82 $ 1.07 Diluted (2.17) 2.62 .97 Number of shares used in per share computations: Basic 243.6 233.6 199.7 Diluted 243.6 257.9 236.1
See notes to consolidated financial statements. 21 CONSOLIDATED STATEMENTS OF CASH FLOWS SEAGATE TECHNOLOGY
For the years ended July 3, June 27, June 28, In millions, except per share data 1998 1997 1996 ------------------------------- Operating Activities Net income (loss) $ (530) $ 658 $ 213 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 664 607 417 Deferred income tax (33) 96 (85) In-process research and development 223 3 99 Non-cash portion of restructuring charge 203 - - Amstrad litigation charge - 153 - Other, net 41 79 92 Changes in operating assets and liabilities: Accounts receivable 242 30 (58) Inventories 213 (84) (259) Accounts payable (278) 169 (16) Accrued expenses, employee compensation and warranty (262) (63) 85 Accrued income taxes (37) 72 (16) Other assets and liabilities 54 160 158 ------- ------- ------- Net cash provided by operating activities 500 1,880 630 Investing Activities Acquisition of property, equipment and leasehold improvements, net (709) (941) (965) Purchases of short-term investments (4,810) (4,473) (3,025) Maturities and sales of short-term investments 4,889 3,907 3,131 Acquisitions of businesses, net of cash acquired (204) - (111) Equity investments (27) (44) (11) Other, net 13 19 38 ------- ------- ------- Net cash used in investing activities (848) (1,532) (943) Financing Activities Issuance of long-term debt - 699 - Repayment of long-term debt (1) (8) (16) Sale of common stock 67 84 97 Purchase of treasury stock (105) (582) (124) ------- ------- ------- Net cash provided by (used in) financing activities (39) 193 (43) Effect of exchange rate changes on Cash and cash equivalents 6 2 1 ------- ------- ------- Increase (decrease) in cash and cash equivalents (381) 543 (355) Elimination of Conner's net cash activity for the duplicated six months ended December 31, 1995 - - (32) Cash and cash equivalents at the beginning of the year 1,047 504 891 ------- ------- ------- Cash and cash equivalents at the end of the year $ 666 $ 1,047 $ 504 ======= ======= =======
See notes to consolidated financial statements. 22 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY SEAGATE TECHNOLOGY
For the years ended Foreign July 3, 1998, June 27, Additional Treasury Currency 1997, and June 28, 1996 Common Stock Paid-In Retained Deferred Common Translation Shares Amount Capital Earnings Compensation Stock Adjustment Total In millions - ---------------------------------------------------------------------------------------------------------------------------------- Balance at June 30, 1995 194 $2 $ 686 $1,274 $ (3) $ (22) $ (1) $1,936 Purchase of treasury stock at cost (124) (124) Sale of stock 7 77 (20) 40 97 Acquisition of Arcada minority interest 2 85 85 Issuance of restricted stock, net of cancellations 2 59 (59) - Amortization of deferred compensation 4 4 Income tax benefit from stock options exercised 47 47 Conversion of debentures to common stock 9 200 (39) 106 267 Unrealized loss on marketable securities (1) (1) Net income 213 213 Elimination of Conner activity for the duplicated six months ended December 31, 1995 (1) (21) (37) (58) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at June 28, 1996 213 2 1,133 1,390 (58) - (1) 2,466 Purchase of treasury stock at cost (582) (582) Sale of stock 4 42 (71) 113 84 Issuance of restricted stock, net of cancellations 7 (7) (7) 7 - Amortization of deferred compensation 8 8 Income tax benefit from stock options exercised 52 52 Conversion of debentures to common stock 35 1 669 (24) 143 789 Unrealized gain on marketable securities 1 1 Net income 658 658 - ---------------------------------------------------------------------------------------------------------------------------------- Balance at June 27, 1997 252 3 1,903 1,947 (57) (319) (1) 3,476 Purchase of treasury stock at cost (105) (105) Sale of stock (99) 166 67
23 Issuance of restricted stock, net of cancellations 6 (20) (6) 20 - Amortization of deferred compensation 8 8 Income tax benefit from stock options exercised 12 12 Unrealized gain on marketable securities 1 1 Other stock-based compensation 8 8 Net loss (530) (530) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at July 3, 1998 252 $ 3 $ 1,929 $ 1,299 $ (55) $ (238) $ (1) $ 2,937 ====================================================================================================================================
See notes to consolidated financial statements. 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Summary of Significant Accounting Policies Nature of Operations---Seagate Technology, Inc. (the "Company" or "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 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. The actual results with regard to restructuring charges could have a material unfavorable impact on the Company if the actual expenditures to implement the restructuring plan are greater than what the Company estimated when establishing the restructuring 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 1998 ended on July 3, 1998, fiscal 1997 ended on June 27, 1997 and fiscal 1996 ended on June 28, 1996. Fiscal year 1998 comprised 53 weeks and fiscal years 1997 and 1996 each comprised 52 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. 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---Seagate transacts business in various foreign countries. Its primary currency cash flows are in emerging market countries in Asia and in certain European countries. During 1998 and 1997, Seagate employed 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. These local currency cash flows were designated as either firm commitments or as anticipated transactions depending upon the contractual or legal nature of local currency commitments in Singapore, Thailand, and Malaysia. Anticipated transactions were hedged with purchased currency options and with foreign currency forward exchange contracts; firm commitments were hedged with foreign currency forward exchange contracts. The Company may enter 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 25 carrying amounts when the hedged transaction occurs. All other foreign currency forward exchange 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 forward exchange contracts which qualify as hedges of firm commitments are recognized in income 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 occurred in the first and second quarters of fiscal 1998 with respect to the Thai baht, Malaysian ringgit and Singapore dollar. 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 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, gains 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. The Company's software revenues are primarily derived from the sale of product licenses, software maintenance, technical support, training and consulting. During the first quarter of fiscal 1999, the Company began recognizing license revenues in accordance with the American Institute of Certified Public Accountant's Statement of Position 97-2, "Software Revenue Recognition." Revenues from software license agreements are primarily recognized at the time of product delivery, provided that fees are fixed or determinable, evidence of an arrangement exists, collectibility is probable and the Company has vendor-specific objective evidence of fair value. Revenues from resellers, including VARs, OEMs and distributors, are primarily recognized at the time of product delivery to the reseller. The Company's policy is to defer such revenues if resale contingencies exist. Some of the factors that are considered to determine the existence of such contingencies include payment terms, collectibility and past history with the customer. Product returns are reserved for in accordance with SFAS 48. Such returns are estimated based on historical return rates. The Company considers other factors such as fixed and determinable fees, resale contingencies, arms length contract terms and the ability to reasonably estimate returns to ensure compliance with SFAS 48. Additionally, reserves are provided for product return authorizations received by the Company prior to fiscal cutoff dates. Service revenues from customer maintenance fees for ongoing customer support and product updates are recognized ratably over the maintenance term, which is typically 12 months. Service revenues from training and consulting are recognized when such services are performed. 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 $68 million, $41 million and $34 million in 1998, 1997 and 1996, respectively. Stock-Based Compensation---The Company accounts for employee stock-based compensation under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APBO 25") and related interpretations. Pro forma net income and net income per share are disclosures required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and are included in the Stock-Based Benefit Plans - Pro Forma Information note to the consolidated financial statements. 26 Impact of Recently Issued Accounting Standards---In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 is effective for fiscal years beginning after December 15, 1997 and will be adopted by the Company for its fiscal 1999. Adoption of this pronouncement is not expected to have a material impact on the Company's financial statements. Also in June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 replaces Statement of Financial Accounting Standards No. 14 and changes the way public companies report segment information. SFAS 131 is effective for fiscal years beginning after December 15, 1997 and will be adopted by the Company for its fiscal 1999 which commenced July 4, 1998. Adoption of this pronouncement is not expected to have a material impact on the Company's financial statements. In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). This statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that derivatives be recognized in the balance sheet at fair value and specifies the accounting for changes in fair value. SFAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999 and will be adopted by the Company for its fiscal year 2000. The Company is in the process of assessing the impact of this pronouncement on its financial statements. Net Income Per Share---In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). SFAS 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options and convertible securities. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented, and where necessary, restated to conform to the SFAS 128 requirements. The adoption of SFAS 128 did not have a material impact on the Company's earnings per share. For the periods in which the Company had net income, basic net income per share was based on the weighted average number of shares of common stock outstanding during the period. For the same periods diluted net income per share further included the effect of stock options outstanding during the period and assumed the conversion of the Company's convertible subordinated debentures for the period of time such debentures were outstanding. For the period in which the Company had a net loss, the net loss per share was computed using only the weighted average number of shares of common stock outstanding during the period. 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. The Company has classified its entire investment portfolio as available-for-sale. Available-for-sale securities are classified as cash equivalents or short-term investments and 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 and accretion are 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 and distributors. 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 the fair value of available-for-sale securities at July 3, 1998 and June 27, 1997: 27
In millions July 3, 1998 June 27, 1997 ---------------------------- Money market mutual funds $ 71 $ 182 U.S. government and agency obligations 398 364 Repurchase agreements 81 150 Auction rate preferred stock 167 227 Municipal bonds 102 78 Corporate securities 612 731 Other 301 417 ------ ------ $1,732 $2,149 ====== ====== Included in short-term investments $1,161 $1,236 Included in cash and cash equivalents 571 913 ------ ------ $1,732 $2,149 ====== ======
The fair value of all available-for-sale securities approximates amortized cost. Gross realized and unrealized gains and losses on the sale of available-for-sale securities were not material for each of the three years in the period ended July 3, 1998. The fair value of the Company's investment in debt securities, by contractual maturity, is as follows:
. In millions July 3, 1998 June 27, 1997 ----------------------------- Due in less than 1 year $ 771 $1,529 Due in 1 to 3 years 723 211 ------ ------------- $1,494 $1,740 ====== =============
Fair Value Disclosures--- The carrying value of cash and cash equivalents approximates fair value. The fair values of short-term investments, notes, 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 millions July 3, 1998 June 27, 1997 -------------------------------------------------------- Carrying Estimated Carrying Estimated amount fair value amount fair value --------------------------------------------------------- Cash and cash equivalents $ 666 $ 666 $1,047 $1,047 Short-term investments 1,161 1,161 1,236 1,236 7.125% senior notes, due 2004 (200) (199) (200) (200) 7.37% senior notes, due 2007 (200) (198) (200) (201) 7.45% senior debentures, due 2037 (200) (198) (200) (202) 7.875% senior debentures, due 2017 (100) (98) (100) (100) Italian Lira debentures, 14.65% to 15.25% (1) (1) (1) (1) Foreign currency forward exchange and option contracts (18) (18) (2) (10) Foreign currency forward sale contracts 0 0 N/A N/A
Derivative Financial Instruments---The Company may enter 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. Based on uncertainty in the Southeast Asian foreign currency markets, beginning in the second quarter of 1998 the Company has temporarily suspended its hedging program. At July 3, 1998, the Company had effectively closed out all of its foreign currency forward exchange contracts by 28 purchasing offsetting contracts and the remaining foreign currency market risk from derivative financial instruments is not material. Accounts Receivable Accounts receivable are summarized below:
In millions 1998 1997 ---------------- Accounts receivable $ 853 $1,101 Less allowance for noncollection (54) (60) ----- ------ $ 799 $1,041 ===== ====== Inventories Inventories are summarized below: In millions 1998 1997 --------------- Components $ 172 $ 359 Work-in-process 87 134 Finished goods 249 315 ----- ------ $ 508 $ 808 ===== ======
Property, Equipment and Leasehold Improvements Property, equipment and leasehold improvements consisted of the following:
In millions Estimated Useful Life 1998 1997 ---------------------------------------------- Land $ 33 $ 15 Equipment 1-1/2 - 4 years 2,187 1,919 Building and leasehold improvements Life of lease - 30 years 854 763 Construction in progress 168 362 ------- ------- 3,242 3,059 Less accumulated depreciation and amortization (1,573) (1,272) ------- ------- $ 1,669 $ 1,787 ======= =======
Equipment and leasehold improvements include assets under capitalized leases. Amortization of leasehold improvements is included in depreciation expense. Depreciation expense was $549 million, $451 million and $330 million in 1998, 1997 and 1996, respectively. 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 permanently 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, first by reducing goodwill, and second by reducing long- term assets and other intangibles (generally based on an estimate of discounted future net cash flows). Goodwill and other intangibles 29 are being amortized on a straight-line basis over periods ranging from two to fifteen years. Accumulated amortization was $201 million and $161 million as of July 3, 1998 and June 27, 1997, respectively. Other intangible assets consist of trademarks, assembled workforces, distribution networks, developed technology, customer bases, and covenants not to compete related to acquisitions accounted for by the purchase method. Amortization of purchased intangibles, other than acquired developed technology, is provided on the straight-line basis over the respective useful lives of the assets ranging from 36 to 60 months for trademarks, 24 to 48 months for assembled workforces and distribution networks, 12 to 36 months for customer bases and 18 to 24 months for covenants not to compete. In-process research and development without alternative future use is expensed when acquired. Developed Technology. The Company applies Statement of Financial Accounting Standards No. 86 ("SFAS 86", "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," to software technologies developed internally, acquired in business acquisitions, and purchased. Internal development costs are included in research and development and are expensed as incurred. SFAS 86 requires the capitalization of certain internal development costs once technological feasibility is established, which based on the Company's development process generally occurs upon the completion of a working model. As the time period between the completion of a working model and the general availability of software has been short, capitalization of internal development costs has not been material to date. Capitalized costs are amortized based on the greater of the straight-line basis over the estimated product life (generally 30 to 48 months) or the ratio of current revenues to the total of current and anticipated future revenues. Purchased developed technology is amortized based on the greater of the straight-line basis over the estimated useful life (30 to 48 months) or the ratio of current revenues to the total of current and anticipated future revenues. The recoverability of the carrying value of purchased developed technology is reviewed periodically. The carrying value of developed technology is compared to the estimated future gross revenues from that product reduced by the estimated future costs of completing and disposing of that product, including the costs of performing maintenance and customer support (net undiscounted cash flows) and to the extent that the carrying value exceeds the undiscounted cash flows the difference is written off. Long-Term Debt and Lines of Credit Long-term debt consisted of the following:
In millions 1998 1997 ------------ 7.125% senior notes, due 2004 $ 200 $ 200 7.37% senior notes, due 2007 200 200 7.45% senior debentures, due 2037 200 200 7.875% senior debentures, due 2017 100 100 Italian lira debentures, 14.65% to 15.25% notes and loans due through 1999 1 1 Capitalized lease obligations with interest at 14% to 19.25% collateralized by certain manufacturing equipment and buildings 4 2 ----- ----- 705 703 Less current portion 1 1 ----- ----- $ 704 $ 702 ===== =====
At July 3, 1998, future minimum principal payments on long-term debt and capitalized lease obligations were as follows:
In millions 1999 $ 1 2000 1 2001 - 2002 1
30 2003 1 After 2003 701 ---- $705 ====
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 $1.054 billion principal amount of the debentures was converted to approximately 50.8 million shares of the Company's common stock and approximately $2 million principal amount of the debentures were redeemed. None of the 5% debentures were redeemed. 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 February 1997 in an offering registered under the Securities Act of 1933, as amended. As of July 3, 1998, the Company had committed lines of credit of $61 million which can be used for standby letters of credit or bankers' guarantees. These lines of credit were fully utilized at July 3, 1998. Net Income Per Share The following table sets forth the computation of basic and diluted net income (loss) per share.
For the years ended July 3, June 27, June 28, In millions, except per share data 1998 1997 1996 ------------------------------ Basic Net Income (Loss) Per Share Computation - -------------------------------------------------------- Numerator: Net income (loss) $ (530) $ 658 $ 213 Denominator: Weighted average number of common shares outstanding during the period 243.6 233.6 199.7 ------ ------ ------ Basic net income (loss) per share $(2.17) $ 2.82 $ 1.07 ====== ====== ====== Diluted Net Income (Loss) Per Share Computation - -------------------------------------------------------- Numerator: Net income (loss) $ (530) $ 658 $ 213 Add convertible subordinated debentures interest, net of income tax effect - 17 16 Total $ (530) $ 675 $ 229 Denominator:
31 Weighted average number of common shares outstanding during the period 243.6 233.6 199.7 Incremental common shares attributable to exercise of outstanding options (assuming proceeds would be used to purchase treasury stock) - 7.4 7.2 Incremental common shares attributable to conversion of convertible subordinated debentures - 16.9 29.2 Total 243.6 257.9 236.1 ------ ------ ------ Diluted net income (loss) per share $(2.17) $ 2.62 $ 0.97 ====== ====== ======
Incremental common shares attributable to exercise of outstanding options (assuming proceeds would be used to purchase treasury stock) of 4,080,000 for the year ended July 3, 1998, were not included in the diluted net income per share computation because the effect would be antidilutive due to the net loss incurred during that period. 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 1998, 1997 and 1996 were $3 million, $115 million and $73 million, respectively. Tax-Deferred Savings Plan The Company has a tax-deferred savings plan, the Seagate Technology, Inc. Savings and Investment Plan ("the 40l(k) plan"), for the benefit of qualified employees. The 40l(k) plan is designed to provide employees with an accumulation of funds at retirement. Qualified employees may elect to make contributions to the 401(k) plan on a monthly basis. The Company may make annual contributions to the 401(k) plan at the discretion of the Board of Directors. No material contributions were made by the Company for each of the three years in the period ended July 3, 1998. 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 July 3, 1998:
Options Outstanding ----------------------------- Shares in millions Number Weighted Average of Shares Exercise Price ---------- ---------------- Balance June 30, 1995 21.4 $11.45 Granted 11.1 22.30 Exercised (6.2) 8.71 Canceled (3.3) 14.27 Elimination of Conner activity for the duplicated six months ended December 31, 1995 .7 14.13 ----- Balance June 28, 1996 23.7 16.91 Granted 6.0 36.31 Exercised (5.2) 12.15 Canceled (2.5) 20.42 ----- Balance June 27, 1997 22.0 22.92
32 Granted 18.3 27.10 Exercised (2.4) 13.34 Canceled (11.9) 32.62 ----- Balance July 3, 1998 26.0 $22.30 =====
In fiscal 1998, the Company offered to all optionees below the level of Senior Vice President, who held options with an exercise price higher than the prevailing fair market value of the Company's common stock the right to exchange their options for new options exercisable at such fair market value. In connection with this transaction, 8.4 million options were exchanged. The number of options shown as granted and canceled in the above table reflects this exchange of options. Such options had a weighted average exercise price before repricing of $34.20 and the new options were granted at a weighted average price of $24.45. Options available for grant were 13.6 million at July 3, 1998; 5.1 million at June 27, 1997; and 9.0 million at June 28, 1996. On October 30, 1997, the stockholders 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 million. At July 3, 1998, options to purchase 10.0 million shares of common stock were exercisable. The following table summarizes information about options outstanding at July 3, 1998.
Outstanding Options Exercisable Options ------------------------------------------ ------------------------- Weighted Average Shares in millions Number Contractual Life Weighted Average Number Weighted Average Range of exercise prices of Shares (in years) Exercise Price of Shares Exercise Price ------------------------------------------- -------------------------- $.00 - $11.06 3.2 4.93 $ 7.98 3.1 $ 8.05 11.12 - 21.56 4.3 6.60 15.50 2.5 14.27 21.62 - 28.25 15.5 8.60 24.52 3.4 24.32 28.50 - 51.75 3.0 8.09 35.86 1.0 33.83 ------------------------------------------- -------------------------- $.00 - $51.75 26.0 7.76 $22.30 10.0 $17.70
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. The Company has the right to repurchase the restricted stock from an executive upon his or her voluntarily or involuntary termination of employment with the Company for any reason at the same price paid by the executive. If an executive voluntarily resigns at or above age 65, the Company may release from the repurchase option, or if his or her employment terminates as a result of death, disability, termination by the Company other than for cause or constructive termination within the two-year period following a change of control, the Company will release from the repurchase option a pro rata number of shares based on the number of months that have passed since the grant date divided by the number of months in the vesting period. 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 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. In 1998, 453,500 shares were granted and 253,867 shares were repurchased under the terms of the plan. At July 3, 1998, 115,367 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 $8 million, $8 million and $4 million in 1998, 1997 and 1996, respectively. Stock Purchase Plan---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 generally 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, 1,348,000; 1,054,000 and 1,129,000 shares of common stock were issued in 1998, 1997 and 1996, respectively. 33 Common stock reserved for future issuance under the Company's Employee Stock Purchase Plan aggregated 1,426,000 shares at July 3, 1998. In July 1998, the Board of Directors approved an amendment to the Employee Stock Purchase Plan to increase the number of shares of common stock reserved for issuance thereunder by 6 million, subject to stockholder approval at the 1998 Annual Meeting of Stockholders. Pro Forma Information ---The Company has elected to follow APBO 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee 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, 1995 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:
1998 1997 1996 ------------------ Stock Option Plan Shares Expected life (in years) 3.2 3.5 3.5 Risk-free interest rate 5.5% 6.2% 5.6% Volatility .45 .45 .45 Employee Stock Purchase Plan Shares Expected life (in years) .6 .5 .5 Risk-free interest rate 5.5% 5.4% 5.4% Volatility .63 .46 .46
The weighted average fair value of stock options granted under the Company's Stock Option Plans was $10.05, $14.57 and $9.45 per share in 1998, 1997 and 1996, respectively. The weighted average fair value of shares granted under the Company's Employee Stock Purchase Plan was $12.03, $8.89 and $6.00 per share in 1998, 1997 and 1996, respectively. The weighted average purchase price of shares granted under the Company's Employee Stock Purchase Plan was $26.99, $27.95 and $23.46 per share in 1998, 1997 and 1996, 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:
In millions 1998 1997 1996 ---------------------- Except per share data Pro forma net income (loss) $ (600) $ 610 $ 195 Pro forma basic net income (loss) per share (2.46) 2.64 0.98 Pro forma diluted net income (loss) per share (2.46) 2.45 0.90
The effects on pro forma disclosures of applying SFAS 123 are not likely to be representative of the effects on pro forma disclosures of future years. 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. 34 Income Taxes The provision for (benefit from) income taxes consisted of the following:
In millions 1998 1997 1996 ------------------------ Current Tax Expense (Benefit) Federal $ (157) $ 122 $ 168 State - 6 28 Foreign 16 9 7 ------ ----- ----- (141) 137 203 ------ ----- ----- Deferred Tax Expense (Benefit) Federal (19) 65 (76) State (20) 14 (9) Foreign 6 17 - ------ ----- ----- (33) 96 (85) ------ ----- ----- Provision for (Benefit from) Income Taxes $ (174) $ 233 $ 118 ====== ===== =====
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 $12 million, $52 million, and $47 million for 1998, 1997 and 1996, respectively. Income (loss) before income taxes consisted of the following:
In millions 1998 1997 1996 ----------------------- Federal $(778) $ 41 $ (77) Foreign 74 850 408 ----- ----- ----- (704) 891 331 ===== ===== =====
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 millions July 3, June 27, 1998 1997 -------- --------- Deferred Tax Assets Accrued warranty $ 151 $ 166 Inventory valuation accounts 38 33 Receivable reserves 29 29 Accrued compensation and benefits 27 36 Depreciation 37 23 Restructuring reserves 25 12 Other reserves and accruals 40 47 Acquisition related items 36 29 Net operating loss and tax credit carry-forwards 87 31 Other assets 9 9 ----- ----- Total Deferred Tax Assets 479 415 Valuation allowance (82) (57) ----- ----- Net Deferred Tax Assets 397 358 ----- -----
35
Deferred Tax Liabilities Unremitted income of foreign subsidiaries (549) (561) Acquisition related items (19) (20) Other liabilities (21) (2) ----- ----- Total Deferred Tax Liabilities (589) (583) ----- ----- Net Deferred Tax Liabilities $(192) $(225) ===== ===== As Reported on the Balance Sheet Deferred Income Tax Assets $ 243 $ 254 Deferred Income Tax Liabilities (435) (479) ----- ----- Net Deferred Tax Liability $(192) $(225) ===== =====
The valuation allowance has been provided for deferred tax assets related to certain foreign net operating loss carry-forwards, foreign tax credit carry- forwards and future tax benefits associated with the acquisition of certain software companies. The valuation allowance increased by $25 million, $20 million and $15 million in 1998, 1997 and 1996, respectively. The Company, as of July 3, 1998, has domestic, foreign and state net operating loss carry-forwards of approximately $36 million, $47 million and $500 million, respectively, expiring in 1999 through 2013 if not used to offset future taxable income. The Company, as of July 3, 1998, also has tax credit carry-forwards of approximately $36 million expiring in 2000 through 2013 if not used to offset future tax liabilities. The differences between the provision for (benefit from) income taxes at the U.S. statutory rate and the effective rate are summarized as follows:
In millions 1998 1997 1996 ----------------------- Provision (benefit) at U.S. statutory rate $(246) $312 $116 State income tax provision (benefit), net of federal income tax benefit (15) 19 10 Benefit from net earnings of foreign subsidiaries considered to be permanently invested in non-U.S. operations - (97) (59) Write-off of in-process research and development 75 - 30 Restructuring - - 18 Valuation reserve 25 19 15 Other individually immaterial items (13) (20) (12) ----- ---- ---- Provision for (benefit from) income taxes $(174) $233 $118 ===== ==== ====
A substantial portion of the Company's Far East manufacturing operations at plant locations in Singapore, Thailand, China and Malaysia operate free of tax under various tax holidays. The tax holiday in Singapore expires in June 2005. The tax holidays in Chockchai, Wellgrow and Korat, Thailand expire in June 2001, February 2004 and September 2004, respectively. The tax holidays in Shenzen and Wuxi, China expire in December 1998 and December 2000, respectively. The tax holidays in Penang and Perai, Malaysia expire in June 1999 and December 1999, respectively. Certain tax holidays may be extended if specific conditions are met. The tax holidays had no impact on the net loss in 1998. The net impact of these tax holidays was to increase net income by approximately $71 million ($0.28 per share, diluted) in 1997 and approximately $50 million ($0.21 per share, diluted) in 1996. Cumulative undistributed earnings of the Company's Far East subsidiaries for which no income taxes have been provided aggregated approximately $1.439 billion at July 3, 1998. These earnings are considered to be permanently invested in non-U.S. operations. Additional federal and state taxes of approximately $518 million would have to be provided if these earnings were repatriated to the U.S. 36 The Company received a statutory notice of deficiency dated June 27, 1997 from the Internal Revenue Service relative to taxable years 1991 through 1993 assessing potential deficiencies approximating $39 million plus interest and approximately $6 million of penalties. The proposed adjustments to taxable income relate primarily to re-allocations of income and expenses between the Company and its Far East subsidiaries, the timing for deduction of accrued domestic expenses and reserves and the allowable amount of domestic tax credits. No assets have been levied as a result of the statutory notice of deficiency. The Company petitioned the United States Tax Court on September 24, 1997 for a re-determination of the deficiencies. The Company believes that the outcome of this matter will not have a material adverse effect on its financial position or results of operations. The Company received a statutory notice of deficiency dated June 12, 1998 from the Internal Revenue Service relative to Conner's taxable years 1991 and 1992 assessing potential deficiencies approximating $11 million plus interest. The proposed adjustments to taxable income relate primarily to re-allocations of income and expenses between the Company and its Far East subsidiaries and the timing for deduction of accrued domestic expenses and reserves. No assets have been levied as a result of the statutory notice of deficiency. The Company believes it has meritorious defenses to the Internal Revenue Service adjustments but has not yet determined the forum in which it will contest the proposed deficiencies. 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. Certain of the Company's foreign and state tax returns for various fiscal years are under examination by taxing authorities. 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. Combined and separate results of the Company and Conner for the periods prior to the acquisition were as follows:
For the year ended June 28, In millions 1996 --------- Revenue: Prior to December 30, 1995: Seagate $3,016 Conner 1,464 Combined results after December 29, 1995 4,108 ------ $8,588 ====== Net Income: Prior to December 30, 1995: Seagate $ 232 Conner 37 Combined results after December 29, 1995 (56) ------ $ 213 ======
The combined net loss after December 29, 1995 (see table above) of $56 million includes a $168 million restructuring charge, net of related tax effect, as a result of the merger with Conner and an $89 million 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. 37 Acquisitions The Company has a history of acquisitions and during the three most recent fiscal years significant acquisitions included Quinta Corporation and Eastman Storage Software Management Group in fiscal 1998, and Arcada Holdings, Inc., Holistic Systems, Calypso Software Systems, Inc., and OnDemand Software, Inc. in fiscal 1996. No significant acquisitions occurred in fiscal 1997. The following details information specific to these acquisitions including purchase price allocation, significant assumptions used in valuing the purchase price and the appraisal method utilized. Valuation Methodology In accordance with the provisions of APB Opinion 16, all identifiable assets, including identifiable intangible assets, were assigned a portion of the cost of the acquired enterprise (purchase price) on the basis of their respective fair values. This included the portion of the purchase price properly attributed to incomplete research and development projects that should be expensed according to the requirements of Interpretation 4 of SFAS No. 2. Valuation of acquired intangible assets. Intangible assets were identified through (i) analysis of the acquisition agreement, (ii) consideration of the Company's intentions for future use of the acquired assets, and (iii) analysis of data available concerning Quinta's, Arcada's, and Eastman's (collectively referred to as the "Targets") products, technologies, markets, historical financial performance, estimates of future performance and the assumptions underlying those estimates. The economic and competitive environment in which the Company and the Targets operate was also considered in the valuation analysis. To determine the value of in-process research and development, the Companyconsidered, among other factors, the state of development of each project, the time and cost needed to complete each project, expected income, associated risks which included the inherent difficulties and uncertainties in completing each project and thereby achieving technological feasibility and risks related to the viability of and potential changes to future target markets. This analysis resulted in amounts assigned to in-process research and development for projects that had not yet reached technological feasibility and which did not have alternative future uses. The Income Approach, which includes analysis of markets, cash flows, and risks associated with achieving such cash flows, was the primary technique utilized in valuing each in-process research and development project. The underlying in-process projects acquired were the most significant and uncertain assumptions utilized in the valuation analysis of in-process research and development projects. To determine the value of developed technologies, the expected future cash of existing product technologies were evaluated, taking into account risks related to the characteristics and applications of each product, existing and future markets and assessments of the life cycle stage of each product. Based on this analysis, the existing technologies that had reached technological feasibility were capitalized. To determine the value of the distribution networks and customer bases, Seagate Technology, considered, among other factors, the size of the current and potential future customer bases, the quality of existing relationships with customers, the historical costs to develop customer relationships, the expected income and associated risks. Associated risks included the inherent difficulties and uncertainties in transitioning the business relationships from the acquired entity to Seagate and risks related to the viability of and potential changes to future target markets. To determine the value of trademarks, the Company considered, among other factors, the assumption that in lieu of ownership of a trademark, Seagate would be willing to pay a royalty in order to exploit the related benefits of such trademark. To determine the value of assembled workforces, the Company considered, among other factors, the costs to replace existing employees including search costs, interview costs and training costs. Goodwill is determined based on the residual difference between the amount paid and the values assigned to identified tangible and intangible assets. If the values assigned to identified tangible and intangible assets exceed the amounts paid, including the effect of deferred taxes, the values assigned to long-term assets were reduced proportionately. The underlying in-process projects acquired within each acquisition was the most significant and uncertain assumption utilized in the valuation analysis. Such uncertainties could give rise to unforeseen budget over runs and/or 38 revenue shortfalls in the event that the Company is unable to successfully complete a certain research and development project.Seagate management recognizes that the Company is primarily responsible for estimating the fair value of the purchased research and development in all acquisitions accounted for under the purchase method. The following details specific information about significant acquisitions including related assumptions used in the purchase price allocation. Acquisition of Quinta Corporation: - ---------------------------------- In April and June 1997, the Company invested an aggregate of $20 million to acquire approximately ten percent (10%) of the outstanding stock of Quinta Corporation ("Quinta"), a developer of ultra-high capacity disc drive technologies, including a new optically-assisted Winchester (OAW) technology. In August 1997, the Company completed the acquisition of Quinta. Pursuant to the purchase agreement with Quinta, the shareholders of Quinta, other than Seagate, received cash payments aggregating $230 million upon the closing of the acquisition and were eligible to receive additional cash payments aggregating $95 million upon the achievement of certain product development and early production milestones. Of the $95 million, $19 million was charged to operations in fiscal 1998. Of the $19 million charged to operations, $5 million was paid in fiscal 1998. In July 1998, the Company and Quinta amended the purchase agreement to eliminate the product development and early production milestones and provide that the former shareholders of Quinta will be eligible to receive the remaining $76 million and the $14 million that had been accrued but unpaid in fiscal 1998. In the first quarter of fiscal 1999, the Company expects to take a charge to operations for the remaining $76 million. Quinta's research and development project revolves around an Optically Assisted Winchester ("OAW") technology. OAW refers to Quinta's newly designed recording technology that, upon completion, would be implemented into Winchester hard disk drives. OAW combines traditional magnetic recording technology with Winchester hard disc drives and optical recording capabilities; optical recording technology enables greater data storage capacity. By integrating advanced optical features along with a highly fine and sophisticated tracking and delivery system within the head design, OAW would multiply the real density of disc drives. Through August 8, 1997, the acquisition date, Quinta had demonstrated significant achievements in developing its technology. However, further technological milestones were required before technological feasibility could be achieved. Quinta's development process consists of the following development milestones: (i) route light (optical fiber), (ii) flying head use, (iii) recording media, (iv) mirror creation and demonstration (two stage servo), (v) complete assembly, (vi) form factor containment, (vii) design verification test, (viii) customer qualification, and (ix) delivery. Assumptions used in estimating the fair value of intangible assets: Revenue - ------- Future revenue estimates were generated for the following product that the OAW technology would be utilized: (i) fixed drives, (ii) removable drive, (iii) fixed/removable drives, and (iv) cartridges. There were no revenues expected through fiscal 1998 since the underlying technology was anticipated not to be technologically feasible until fiscal 1999. Revenues were estimated to be approximately $26.6 million in fiscal 1999 and to increase to approximately $212 million for fiscal year 2000 when the in-process project was expected to be complete and shipping. Revenue growth was expected to decline to a sustainable 20% growth by fiscal 2005. The estimated revenue growth is consistent with the introduction of new technology. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the disc drive market, (iv) the aggregate size of the disc drive market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. Quinta's development cycle, in total, is expected to take approximately 18 to 24 months. 39 Operating expenses - ------------------ Operating expenses used in the valuation analysis of Quinta included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of Seagate's overall business model, specific product results, including both historical and expected direct expense levels (as appropriate), and an assessment of general industry metrics was conducted. Due to Quinta's limited operating history, an analysis of Quinta's historical performance was not meaningful. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the in-process technologies ranged from approximately 65% to 80%. General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the in-process technologies ranged from 2.6% in fiscal 2000 to a sustainable 3.5% in fiscal 2001 and beyond. For fiscal 1999, however, when the OAW technology would become commercially available, G&A expense was estimated to be 6.4% due to the relatively low revenue expectation in the initial commercialization period. Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the in-process technologies ranged from 3.3% in fiscal 2000 to a sustainable 3.5% in fiscal 2001 and beyond. For fiscal 1999, however, when the OAW technology would become commercially available, S&M expense was estimated to be 8.7% due to the relatively low revenue expectation in the initial commercialization period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These activities include routine changes and additions. The maintenance R&D expense was estimated to be 0.5% of revenue for the in-process technologies throughout the estimation period. Effective tax rate - ------------------ The effective tax rate utilized in the analysis of the in-process technologies was 38%, which reflects the Company's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate - ------------- The discount rates selected for Quinta's in-process technology was 25%. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (WACC) of approximately 15% at the date of acquisition and (ii) the Weighted Average Return on Assets of approximately 25%. The discount rate utilized for the in-process technology was determined to be higher than Seagate's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than the Company's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. As a result of this acquisition, the Company incurred a one-time write-off of in-process research and development of approximately $214 million. Intangible assets arising from the acquisition of Quinta are being amortized on a straight- line basis over two years. This acquisition was accounted for as a purchase and, accordingly, the results of operations of Quinta have been included in the Company's consolidated financial statements from the date of acquisition. The following is a summary of the purchase price allocation (in millions): Tangible assets less liabilities assumed $ 34 In-process research and development 214 Assembled workforce 2 ---- $250 ====
Acquisition of Eastman Software Storage Management Group, Inc.: 40 In June 1998, the Company acquired Eastman Software Storage Management Group, Inc.("Eastman"), a subsidiary of Eastman Kodak Company, the developer of storage migration software technology for distributed networks, for $10 million. Eastman Software SMG's two primary products are OPEN/stor for Windows NT and AvailHSM for NetWare. By integrating Eastman's product line, Seagate will be able to convert their Storage Migrator product into a stand-alone HSM application for Windows NT environments. As of the date of acquisition, the Company abandoned the AvailHSM product and technology due to dated features and functionality; the valuation analysis did not include a fair value for the AvailHSM product. As for OPEN/stor at the date of acquisition, the Company planned to phase out the product over the following 12 to 15 months. The Company's purpose for the acquisition was for the next generation technologies that were underway at Eastman, referenced by project names Sakkara and Phoenix. These projects were complete re-writes of Eastman's prior generation technology that would allow the product to be sold stand-alone upon completion. In accordance with SFAS 86, paragraph 38 ("Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed"), "the cost of software purchased to be integrated with another product or process will be capitalized only if technological feasibility was established for the software component and if all research and development activities for the other components of the product or process were completed at the time of the purchase." Although Seagate purchased existing products from Eastman, the existing products did not operate on a stand-alone basis. Therefore, as mentioned above, all of the original underlying code and base technology for the next generation products were in the process of being completely re-written as date of valuation. Assumptions used in estimating the fair value of intangible assets: Revenue - ------- Future revenue estimates were generated for the following technologies: (i) OPEN/stor, (ii) Sakkara, and (iii) Phoenix. Aggregate revenue for existing Eastman products was estimated to be approximately $167,000 for the one month ending June 30, 1998. Revenues were estimated to increase to approximately $3.9 million and $7.1 million for fiscal years 1999 and 2000 when most of the in- process projects were expected to be complete and shipping. Thereafter, revenue was estimated to increase at rates ranging from 20% to 30% for fiscal years 2001 through 2006. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the storage management software market, (iv) the aggregate size of the storage management software market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. Operating expenses - ------------------ Operating expenses used in the valuation analysis of Eastman included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of both Seagate's and Eastman's overall business model, specific product results, including both historical and expected direct expense levels, and an assessment of general industry metrics was conducted. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be approximately 5% throughout the estimation period. General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be approximately 10% throughout the estimation period. Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be 27% throughout the estimation period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These activities include routine changes and 41 additions. The maintenance R&D expense was estimated to be 5% of revenue for the developed and in-process technologies throughout the estimation period. In addition, as of the date of acquisition, Seagate Software management anticipated the costs to complete the in-process technologies at approximately $1.8 million. Effective tax rate - ------------------ The effective tax rate utilized in the analysis of developed and in-process technologies was 38%, which reflects the Company's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate - ------------- The discount rates selected for Eastman's developed and in-process technologies were 15% and 20%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (WACC) of approximately 15% at the date of acquisition and (ii) the Weighted Average Return on Assets of approximately 18%. The discount rate utilized for the in-process technology was determined to be higher than the Company's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than the Company's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. The purchase price allocation was based upon the anticipated release date, as of the valuation date, of significant projects acquired, such as Sakkara and Phoenix. Such release dates were estimated from the second quarter of the Company's fiscal year 1999 through the fourth quarter of fiscal 1999. Material net cash inflows from such related projects were expected to commence immediately after their respective release dates. As a result of the acquisition, the Company incurred a one-time write-off of in-process research and development of $7 million. The following is a summary of the purchase price allocation (in millions): Current assets and other tangible assets $ .5 Liabilities assumed (.5) Assembled workforce .4 Developed technology .5 In-process research and development 6.8 Microsoft agreement 1.5 Goodwill .8 ---- $ 10 ====
Acquisition of Holistic Systems, Ltd.: During the year ended June 26, 1996, the Company acquired Holistic Systems Ltd. ("Holistic"), an information management software company. The purchase price of approximately $85.5 million was paid in cash. This acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired business have been included in the consolidated financial statements from the date of the acquisition. The purchase price allocation was based on the anticipated release date, as of the valuation date, of the in- process research and development project acquired (Holos version 6.0). The release date for Holos version 6.0 was estimated to be in the fourth quarter of fiscal 1997. The discount rates selected for Holistic's developed and in- process technologies were 15% and 17.5%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (WACC) of approximately 15% at the date of acquisition and (ii) the Weighted Average Return on Assets of approximately 17%. The discount rate utilized for the in-process technology was determined to be higher than the Company's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than the Company's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. Goodwill and other intangibles arising from the acquisition are being amortized over periods from one to seven years. As a result of the payments out of escrow in fiscal year 1997 to former stockholders of Holistic, the Company incurred one-time charges of compensation expense and in-process research and development of $13 million and $3 million, respectively. The compensation expense is included in unusual items on the consolidated statement of operations. 42 The following is a summary of the purchase price allocation (in millions): Current assets and other tangible assets $ 10 Liabilities assumed (5) Trademarks 5.9 Assembled workforce 1.9 Developed technology 16.4 Customer base 3.7 In-process research and development 35.9 Restricted cash held in escrow 18 Deferred tax liability (1.3) ----- $85.5 =====
Acquisition of Calypso Software Systems, Inc.: During the year ended June 26, 1996, the Company acquired Calypso Software Systems, Inc., a network management software company. The purchase price of approximately $13.9 million was paid in cash. This acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired business have been included in the consolidated financial statements from the date of acquisition. Goodwill and other intangibles arising from the acquisition are being amortized over periods from one to seven years. The following is a summary of the purchase price allocation (in millions): Current assets and other tangible assets $ 1.2 Liabilities assumed (.2) Assembled workforce .4 Developed technology 3.6 Customer base .5 In-process research and development 5.4 Goodwill 3.0 ----- $13.9 =====
Acquisition of OnDemand Software, Inc.: During the year ended June 26, 1996, the Company acquired OnDemand Software, Inc., a network management software company. The purchase price of approximately $13.4 million was paid in cash. This acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired business have been included in the consolidated financial statements from the date of acquisition. Goodwill and other intangibles arising from the acquisition are being amortized over periods from one to seven years. The following is a summary of the purchase price allocation (in millions ): Current assets and other tangible assets $ .8 Liabilities assumed (.2) Assembled workforce. .2 Developed technology 2.0 Covenant not to compete .1 In-process research and development 8.9 Goodwill 1.6 ----- $13.4 =====
Acquisition of Minority Interest of Arcada Holdings, Inc.: 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 with a fair value of approximately $52 million and 1,817,000 options to purchase shares of Arcada common stock with a fair value of approximately $33 million (aggregate fair value of $85 million. The options were issued to employees of Arcada and Conner, Arcada's parent, in exchange for options of Arcada. The options have a term of 10 years and vest 1/16 per quarter over 4 years. The value of the options were based on the intrinsic value of the options, which approximates the 43 fair value. Arcada developed, marketed and supported data protection and storage management software products that operate across multiple desktop and client/server environments. As of the acquisition date, Arcada had spent a significant amount of research and development related to the re-development efforts to add features and utilities to the Desktop, NetWare and Windows NT products such as disc grooming, hierarchical storage management, upgraded graphical user interfaces, file and server replication, and server mirroring in order to continue to meet increasingly complex user needs. In accordance with SFAS 86, paragraph 38 ("Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed"), "the cost of software purchased to be integrated with another product or process will be capitalized only if technological feasibility was established for the software component and if all research and development activities for the other components of the product or process were completed at the time of the purchase." Although Seagate purchased existing products from Arcada, since the majority of the original underlying code and base technology for the NetWare and Windows NT product families was completed in the 1990 time frame, the technologies, as of the date of valuation, were desperately in need of, and therefore, as mentioned above, was undergoing significant re-development. Assumptions used in estimating the fair value of intangible assets: Revenue - ------- Future revenue estimates were generated for the following product families: (i) Desktop, (ii) NetWare, and (iii) Windows NT. Aggregate revenue for Arcada products was estimated to be approximately $94 million for the ten and one-half months ending December 31, 1996. Revenues were estimated to increase to approximately $161 million and $233 million for calendar years 1997 and 1998 when most of the in-process projects were expected to be complete and shipping. Thereafter, revenue was estimated to increase at rates ranging from 35% to 40% for calendar years 1999 through 2002. Revenue estimates were based on (i) aggregate revenue growth rates for the business as a whole, (ii) individual product revenues, (iii) growth rates for the storage management software market, (iv) the aggregate size of the storage management software market, (v) anticipated product development and introduction schedules, (vi) product sales cycles, and (vii) the estimated life of a product's underlying technology. The estimated product development cycle for the new products ranged from 12 to 18 months. Operating expenses - ------------------ Operating expenses used in the valuation analysis of Arcada included (i) cost of goods sold, (ii) general and administrative expense, (iii) selling and marketing expense, and (iv) research and development expense. In developing future expense estimates, an evaluation of both Seagate and Arcada's overall business model, specific product results, including both historical and expected direct expense levels, and an assessment of general industry metrics was conducted. Cost of goods sold. Cost of goods sold, expressed as a percentage of revenue, for the developed and in-process technologies ranged from approximately 5% to 30% (30% for Desktop, 10% for NetWare, and 5% for Windows NT). General and administrative ("G&A") expense. G&A expense, expressed as a percentage of revenue, for the developed and in-process technologies ranged from 12% in calendar 1996 to 8% in calendar 1998 and beyond. Selling and marketing ("S&M") expense. S&M expense, expressed as a percentage of revenue, for the developed and in-process technologies was estimated to be 30% throughout the estimation period. Research and development ("R&D") expense. R&D expense consists of the costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as "maintenance" R&D). Maintenance R&D includes all activities undertaken after a product is available for general release to customers to correct errors or keep the product updated with current information. These activities include routine changes and additions. The maintenance R&D expense was estimated to be 5% of revenue for the developed technologies and 3% of revenue for the in-process technologies throughout the estimation period. In addition, as of the date of acquisition, the Company anticipated the costs to complete the Desktop, NetWare, and Windows NT technologies at approximately $6.8 million, $4.5 million, and $7.5 million, respectively. Since the 44 acquisition date, all projects originally acquired from Arcada were commercially released prior to the end of the fourth quarter of fiscal 1997. Effective tax rate - ------------------ The effective tax rate utilized in the analysis of developed and in-process technologies was 38%, which reflects the Company's combined federal and state statutory income tax rates, exclusive of non-recurring charges at the time of the acquisition and estimated for future years. Discount rate - ------------- The discount rates selected for Arcada's developed and in-process technologies were 15% and 17.5%, respectively. In the selection of the appropriate discount rates, consideration was given to (i) the Weighted Average Cost of Capital (WACC) of approximately 13% to 15% at the date of acquisition and (ii) the Weighted Average Return on Assets of approximately 18%. The discount rate utilized for the in-process technology was determined to be higher than the Company's WACC due to the fact that the technology had not yet reached technological feasibility as of the date of valuation. In utilizing a discount rate greater than the Company's WACC, management has reflected the risk premium associated with achieving the forecasted cash flows associated with these projects. As a result of the acquisition, the Company incurred a one-time write-off of in- process research and development of $44 million. Goodwill and other intangibles arising from the acquisition are being amortized on a straight-line basis over periods ranging from two to seven years. The following is a summary of the purchase price allocation (in millions ): Assembled workforce $ 1.4 Distribution network .1 Corporate accounts .4 Strategic alliances 1.4 OEM agreements 3.2 Value added resellers 2.0 Trademarks 2.8 Developed technology 4.6 In-process research and development 44.0 Deferred tax liability (6.2) Goodwill 31.4 ----- $85.1 =====
Acquisition of Sytron Corporation. In July 1995, Arcada Software, Inc. a majority-owned subsidiary of Arcada, acquired the assets and liabilities of Sytron Corporation ("Sytron"), a company that develops, produces and markets software products for data storage management. The purchase price of approximately $5.0 million was paid in cash. Arcada accounted for the acquisition using the purchase method, and the results of operations of Sytron are only included in the Company's operations since the acquisition was completed. The following is a summary of the purchase price allocation (in millions): Current assets and other tangible assets $ .8 Liabilities assumed (.5) Developed technology 1.5 In-process research and development 2.8 Goodwill .4 ---- $5.0 ====
In 1998, the Company increased its investment in Dragon Systems, a maker of voice recognition software, by $18 million. Goodwill arising from the equity investment in Dragon Systems is being amortized on a straight-line basis over seven years. In 1996, the Company increased its investment in SanDisk Corporation, a flash memory manufacturer, by $10 million. Goodwill arising from the equity investment in SanDisk Corporation is being amortized on a straight- line basis over seven years. 45 Restructuring In the second and third quarters of fiscal 1998, the Company recorded restructuring charges aggregating $347 million. The Company had experienced reductions in revenue from the third quarter of fiscal year 1997 to the fourth quarter of fiscal year 1997 of 21%, from the fourth quarter of fiscal year 1997 to the first quarter of fiscal year 1998 of 4% and from the first quarter of fiscal year 1998 to the second quarter of fiscal year 1998 of an additional 12%. During the second quarter of fiscal 1998, forecasted production needs were much lower than the current capacity of the Company and the Company recognized that the recent oversupply in the marketplace was not a short-term anomaly. In this period, the Company also decided to discontinue production of several products, rendering test and manufacturing equipment unique to those products obsolete. Prior to this period, there was no indication of permanent impairment of these assets associated with the recent excess capacity of the Company or the products to be discontinued. These charges reflect steps the Company is taking to align worldwide operations with current market conditions by reducing existing capacity in all areas of the Company and improving the productivity of its operations and the efficiency of its development efforts by consolidating manufacturing and R&D operations. Actions include exiting production of mobile products; early discontinuation of several other products; closing and selling the Clonmel, Ireland drive manufacturing facility; closing and subleasing the San Jose and Moorpark, California design center facilities; aborting production expansion projects in Cork, Ireland; and divesting the Company of the new Philippines manufacturing facility, which was nearing completion. Included in the restructuring charge are the write-down and write-off of tangible assets comprised of manufacturing, assembly and test equipment and tooling formerly utilized in California, Singapore, Thailand, Ireland and facilities located in California, the Philippines and Thailand totaling $200 million and intangible assets totaling $2.5 million for of goodwill associated with permanently impaired media manufacturing equipment. The majority of the tangible assets have been disposed of or sold including the disposal of the Clonmel, Ireland facility in May 1998 and the sublease of one of the five buildings at the San Jose, California design center. The Company is marketing three additional buildings in the San Jose, California design center for sublease. The fifth building has a remaining lease term so short as to make a sublease impractical. Equipment formerly utilized at these facilities, in addition to equipment associated with restructuring actions in Singapore and Thailand, has been relocated to other sites or scrapped. Of the $137 million in write-offs and write-downs of equipment, $109 million was scrapped and $28 million is awaiting final disposition. In addition, $10 million of equipment was transferred at net book value for use in operations at other sites. Subsequent to the recording of the restructuring reserve, depreciation related to certain assets that continued in use, was included in operations. At the time these assets were identified as available for sale no further depreciation was recorded. The write-off of intangibles and other assets includes capital equipment deposits and goodwill associated with permanently impaired equipment. Costs associated with aborting production expansion projects in Cork, Ireland include primarily architect costs, lease termination costs associated with equipment leased by contractors, and lease termination costs for temporary housing used by contractor personnel. Certain facilities including design centers in California, as well as manufacturing facilities in Thailand continued in use after restructuring amounts were recorded. The Moorpark, California product design center remained in use for six months after the write-down of leasehold improvements and equipment totaling $9 million. This facility has been subleased for a portion of the remaining minimum lease term. Two Thailand manufacturing facilities continue to be utilized until a satisfactory agreement can be made with an external vendor to supply parts currently manufactured at these locations. At the time the decision to exit these facilities was made, the Company believed that it had identified a supplier for parts. It was subsequently determined that the supplier could not meet the Company's quality standards. In connection with this restructuring, the Company currently expects a workforce reduction of approximately 15,000 employees. Of the 15,000 employees, 8,144 are involuntary terminations of regular, full-time employees, 1,528 are contract laborers, primarily engaged through temporary employment agencies, and the remainder represent attrition. Approximately 14,100 of the 15,000 employees, including 7,959 of the 8,144 involuntary terminations of regular, full-time employees, had been terminated as of July 3, 1998. The Company anticipates that the implementation of the restructuring plan will be substantially complete by the end of December 1998. The fiscal year 1998 aggregated restructuring reserve included asset write-off or write-down of tangible assets totaling $200 million and intangible assets totaling $2 million. In the table below, the aggregated restructuring charges for tangible assets are comprised of $137 million included in "Equipment," $9 million included in "Intangibles and Other Assets" and $54 million included in "Excess Facilities." The remaining $24 million included in "Excess Facilities" is for lease termination and holding costs and the remaining $2 million of "Intangibles and Other Assets" is for the write-off of intangibles. The following table summarizes the Company's restructuring activities related to the 1998 restructuring charge for the year ended July 3, 1998: 46
Severance Intangibles and Excess & Other Contract In millions Benefits Facilities Equipment Assets Cancellations Other Total -------------------------------------------------------------------------------------- Q2 restructuring charge $ 6 $ 52 $ 112 $ 4 $ 12 $ 19 $ 205 Q3 restructuring charge 51 26 25 7 31 2 142 -------------------------------------------------------------------------------------- 1998 restructuring charges 57 78 137 11 43 21 347 -------------------------------------------------------------------------------------- Cash charges (48) (3) - - (38) (11) (100) Non-cash charges - (55) (137) (11) - - (203) -------------------------------------------------------------------------------------- Reserve balances, July 3, 1998 $ 9 $ 20 $ - $ - $ 5 $ 10 $ 44 ======================================================================================
During fiscal year 1996, the Company recorded restructuring charges totaling $242 million as a result of the merger with Conner, such charges were incurred for the reduction of approximately 1,370 personnel whose duties were made redundant; write-off or write-down of equipment, intangibles and other assets to fair value; closure of duplicate and excess facilities primarily in California, Singapore, Malaysia, Scotland and Italy; discontinuing products as a result of overlap of product offerings in the merged company; professional fees of financial advisors, attorneys and accountants; and contract cancellation exposure. There were no indicators of asset impairment in a prior period because impairment arose specifically from the restructuring actions taken as a result of the merger. All facilities whose holding costs prior to disposal that were charged to the restructuring reserve have been vacated and no income has been generated as a result of activities in these facilities. All equipment has been scrapped. The employment of 1,313 employees has been terminated and implementation of the restructuring plan was substantially complete as of June 27, 1997. Manufacturing equipment totaling $4 million used to manufacture products that were to be discontinued as a result of the restructuring plan was included in the restructuring charge but remained in use for three to six months until the assets were scrapped due to their proprietary nature. Certain design center facility leasehold improvements totaling $6 million for buildings to be vacated were also included in the restructuring charge. These facilities were in use after the restructuring charge was recorded for approximately three months at which time the buildings were vacated and the leasehold improvements were abandoned. During this period of time, no income was generated from these activities and no depreciation expense was recorded. Certain lease termination and holding costs for vacant facilities continue to be incurred and charged against the restructuring reserve until the leases expire or the facilities are subleased. In 1997, the Company reversed $10 million of its restructuring reserves as a result of the completion of certain aspects of the restructuring plan at less than the originally estimated cost. This reversal included employee termination benefits of $5 million as a result of terminating fewer employees than originally anticipated, excess facilities costs of $4 million as a result of continuing to utilize certain facilities, and the settlement of certain outstanding lease obligations at less than the originally estimated cost of $1 million. Reclassifications between cost categories were made as a result of terminating fewer employees than originally planned and write-off of additional equipment that became excess or obsolete as a result of the merger with Conner. Asset write-off and write-down of certain duplicated and excess assets totaled $99 million for tangible assets and $14 million for intangible assets. In the table below, the restructuring charges for tangible assets are comprised of $41 million included in "Equipment," $42 million included in "Other Assets" and $16 million included in "Excess Facilities." The remaining $29 million included in "Excess Facilities" is for lease termination and holding costs. The following table summarizes the Company's restructuring activity related to the 1996 restructuring charge for the three years ended July 3, 1998:
Severance and Excess Other Professional Contract In millions Benefits Facilities Equipment Intangibles Assets Fees Cancellations Other Total ---------------------------------------------------------------------------------------------------------------- 1996 restructuring charges $ 61 $ 45 $ 41 $ 14 $ 42 $ 25 $12 $ 2 $242 Cash charges (28) - - - - (21) (5) - (54) Non-cash charges - (10) (41) (14) (31) - - - (96) ----------------------------------------------------------------------------------------------------------------
47 Reserve balances, June 26, 1996 33 35 - - 11 4 7 2 92 Cash charges (18) (10) - - - (2) (3) (3) (36) Non-cash charges - (5) (13) - (5) - - - (23) Adjustments (5) (4) - - - - (1) - (10) Reclassifications (10) (5) 13 - (2) (2) - 6 - ---------------------------------------------------------------------------------------------------------------- Reserve balances, July 27, 1997 - 11 - - 4 - 3 5 23 Cash charges - (11) - - (1) - - (1) (13) ---------------------------------------------------------------------------------------------------------------- Reserve balances, July 3, 1998 $ - $ - $ - $ - $ 3 $ - $ 3 $ 4 $ 10 ================================================================================================================
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 July 3, 1998 Adjustments United Far and In millions States East Eliminations Consolidated --------------------------------------------- Sales to unaffiliated customers $3,643 $3,176 $ - $6,819 Transfers between geographic areas 1,425 6,302 (7,727) - Total revenue $5,068 $9,478 $(7,727) $6,819 Income (loss) from operations $ (721) $ 35 $ - $ (686) Other income (expense), net (57) 39 - (18) Income (loss) before income taxes $ (778) $ 74 $ - $ (704) Identifiable assets $2,337 $3,308 $ - $5,645 Year Ended June 27, 1997 Adjustments United Far and In millions States East Eliminations Consolidated --------------------------------------------- Sales to unaffiliated customers $5,216 $ 3,724 $ - $8,940
48 Transfers between geographic areas 1,398 6,463 (7,861) - Total revenue $6,614 $10,187 $(7,861) $8,940 Income from operations $ 44 $ 814 $ - $ 858 Other income (expense), net (3) 36 - 33 Income before income taxes $ 41 $ 850 $ - $ 891 Identifiable assets $3,050 $ 3,673 $ - $6,723
Year Ended June 28, 1996 Adjustments United Far and In millions States East Eliminations Consolidated -------------------------------------------- Sales to unaffiliated customers $5,888 $2,700 $ - $8,588 Transfers between geographic areas 1,272 6,248 (7,520) - Total revenue $7,160 $8,948 $(7,520) $8,588 Income (loss) from operations $ (77) $ 364 $ - $ 287 Other income (expense), net - 44 - 44 Income (loss) before income taxes $ (77) $ 408 $ - $ 331 Identifiable assets $2,311 $2,929 $ - $5,240
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 revenue 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 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 1998 and 1997, Compaq Computer Corporation accounted for more than 10% of consolidated revenue for a total of $873 million and $995 million, respectively. No customer accounted for 10% or more of consolidated revenue in 1996. Net foreign currency transaction losses included in the determination of net income (loss) were $252 million, $2 million and $8 million for 1998, 1997, and 1996, respectively. The Company transacts business in various foreign countries. Its primary foreign currency cash flows are in emerging market countries in Asia and in certain European countries. During 1998 and 1997, the Company employed 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. During fiscal 49 1998 the Singapore dollar, Thai baht, and Malaysian ringgit declined in value relative to the U.S. dollar. The transaction loss of $252 million for fiscal 1998 primarily included losses incurred on closing out these foreign currency forward exchange contracts. Litigation 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. On October 24, 1997 the Court entered a Final Judgment against Rodime and in favor of Seagate. Rodime has appealed the final judgment. The appeal before the Court of Appeals for the Federal Circuit will be heard in September 1998. The Company intends to vigorously defend itself in the appeal brought by Rodime. 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 denied the motion on July 1, 1997. On April 27, 1998, the Court entered an order establishing a construction of the claims in Mr. White's patents which is broader than the construction which the Company advocated, and on June 25, 1998, the Court denied reconsideration of the April 27 order. The Court has set a February 1999 trial date. 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 involved in the suit. The Company intends to vigorously defend itself against any and all charges of infringement of these patents. See Subsequent Events (Unaudited) Note. 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 fifth 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. ("Conner") 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 asserted claims of the patents are invalid. The Company also believes that subsequent to the merger with Conner, 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. 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. Other Matters---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 50 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 July 3, 1998:
In millions Operating Leases 1999 $ 58 2000 44 2001 27 2002 30 2003 19 After 2003 133 ---- $311 ====
Total rent expense for all land, facility and equipment operating leases was approximately $58 million, $51 million and $45 million for 1998, 1997 and 1996, respectively. Capital Expenditures---The Company's commitments for construction of manufacturing facilities and equipment approximated $173 million at July 3, 1998. Supplemental Cash Flow Information
In millions 1998 1997 1996 ----------------------- Cash Transactions: Cash paid for interest $ 52 $ 26 $ 64 Cash paid for income taxes, net of refunds (1) 59 208 Non-Cash Transactions: Conversion of debentures $ - $ 788 $ 266
Subsequent Events (Unaudited) On March 8, 1999, the Company announced that it expects to take a one-time charge in the third quarter of fiscal 1999 related to the restructuring of certain worldwide operations. This will include the closure of the Company's microelectronics manufacturing facility in Livingston, Scotland, consolidation of global customer service facilities, and additional actions necessary to further increase the productivity and efficiency of worldwide operations. The Company expects the charge to be in the range of $50 - 60 million. On February 12, 1999 the Company entered into a settlement agreement with Mr. James M. White with respect to a patent infringement action against the Company. On February 22, 1999, the court dismissed the action with prejudice. The settlement of this matter did not have a material adverse effect on the Company's financial conditions or results of operations. See Litigation note. The Company, its majority owned subsidiary, Seagate Software, Inc., ("SSI") and SSI's Network and Storage Management Group Inc. ("NSMG") subsidiary announced on October 5, 1998 that they had entered into an agreement and Plan of Reorganization ("the Plan") as of such date with VERITAS Holding Corporation ("New VERITAS") and VERITAS Software Corporation ("VERITAS"). VERITAS provides end to end storage management software solutions. 51 The Plan provides for the contribution by the Company, SSI and certain of their respective subsidiaries to New VERITAS of (a) the outstanding stock of NSMG and certain other subsidiaries of SSI, and (b) those assets used primarily in the Network Storage Management Business of SSI ("the NSMG Business"), in consideration for the issuance of shares of common stock of New VERITAS to SSI and the offer by New VERITAS to grant options to purchase common stock of New VERITAS to certain of SSI's employees who become employees of New VERITAS or its subsidiaries. As part of the plan, New VERITAS will also assume certain liabilities of the NSMG business. The Plan is structured to qualify as a tax free exchange. The merger will be accounted for as a non monetary transaction using the fair value of the assets exchanged. Upon consummation of the merger, New VERITAS shall issue shares of common stock to SSI equal to approximately 40% of the fully diluted common stock equivalent equity interest in New VERITAS (assuming conversion of all convertible securities, including the VERITAS convertible debentures and exercise of all assumed options and warrants) less that number of shares of New VERITAS common stock issuable upon exercise of New VERITAS options issued to the SSI employees who surrender their outstanding options to purchase shares of SSI's common stock. Upon consummation of the merger, the former security holders of VERITAS will be issued New VERITAS securities representing approximately 60% of the fully diluted common stock equivalent equity interest in New VERITAS. The merger is subject to a number of conditions, including but not limited to the effectiveness of a Registration Statement on Form S-4 filed by New VERITAS with the Securities and Exchange Commission, approval of the stockholders of New VERITAS and SSI, the expiration or termination of the waiting period (and any extension thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1996, as amended, and other customary closing conditions. SSI anticipates recording a substantial gain and certain expenses in connection with the merger. The gain will be recorded in fiscal 1999. The expenses will include a one-time write-off of in-process research and development during fiscal 1999 as well as amortization of goodwill and intangibles over four years following the merger. The magnitude of the gain and expenses will depend on several factors, including the average stock price of VERITAS around the date of the merger, the number of shares of stock exchanged and the value of VERITAS' business. SSI will account for its investment in VERITAS using the equity method. The merger is expected to be consummated in the fourth quarter of fiscal 1999. Historically, NSMG has had higher gross margins as a percent of sales than the Company. Therefore, if the exchange with VERITAS is consummated, it could result in lower gross margins for the Company. The Company's gross margins for the six months ended January 1, 1999 and the year ended July 3, 1998 were 22.3% and 14.5% respectively. Without NSMG, such gross margins would have been 20.0% and 12.6%, respectively. However, under the equity method of accounting, the Company will record its equity interest in the net income or loss of VERITAS each quarter. This equity income or loss will be classified as non-operating income (loss) on the Company's income statement. 52 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 July 3, 1998 and June 27, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended July 3, 1998. 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 conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Seagate Technology, Inc. at July 3, 1998 and June 27, 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 3, 1998, in conformity with generally accepted accounting principles. Ernst & Young LLP San Jose, California July 14, 1998, except for the twelth paragraph of the Acquisitions note, as to which the date is July 31, 1998 and the first and second paragraphs of the Patent Litigation note, as to which the date is August 17, 1998. EX-23.1 3 CONSENT OF ERNST & YOUNG, INDEPENDENT AUDITORS EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 1O-K/A) of Seagate Technology, Inc. of our report dated July 14, 1998, except for the twelfth paragraph of the Acquisitions note, as to which the date is July 31, 1998, and the first and second paragraphs of the Patent Litigation note, as to which the date is August 17, 1998, included in the 1998 Annual Report to Stockholders of Seagate Technology, Inc. Our audits also included the financial statement schedule of Seagate Technology, Inc. listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express in opinion based an our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-43911, 33-50973, 33-39916, 33-56215, 33-34793, 33-64339, 333-00697, 333-01059, 333-40005, 333-70105), pertaining to the 1991 Incentive Stock Option Plan, the Employee Stock Purchase Plan, the Executive Stock Option Plan of Seagate Technology, Inc., the 1992 Conner Peripherals, Inc. Restricted Stock Plan and the Arcada Holdings, Inc. Stock Option Plan, and in the related prospectus, of our report dated July 14, 1998, except for the twelfth paragraph of the Acquisitions note, as to which the date is July 31, 1998, and the first and second paragraphs of the Patent Litigation note, as to which the date is August 17, 1998, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K/A) of Seagate Technology, Inc. /s/ Ernst & Young LLP --------------------- San Jose, California April 16,1999 -----END PRIVACY-ENHANCED MESSAGE-----