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Annual Report 1994

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Sectors: Computer Hardware
Effective Date: October 03, 1994
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EXHIBIT 13.1


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ANNUAL REPORT 1994


CORPORATE PROFILE


Mylex Corporation designs and manufactures disk array controllers, system boards, network interface cards as well as supporting proprietary software and firmware for a wide range of personal computers, workstations and servers. Recognized by major OEMs, system integrators and value-added resellers as a world leader in RAID (Redundant Array of Independent Disks) technology. Mylex is the standard seller for RAID solutions and fully integrated PCI systems. Founded in 1983, Mylex is headquartered in Fremont, California. The company's stock is traded on the NASDAQ market under the symbol MYLX.


MYLEX HIGHLIGHTS FOR THE YEAR 1994


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Mylex opens sales office in UK MARCH 7


DEC selects the Mylex DAC960E controllers for their Storage Works family of modular storage products MARCH 10


Mylex begins shipping the DAC960P, a RAID disk array controller for the PCI bus MAY 23


Mylex begins shipping the DAC960S, a SCSI-to-SCSI disk array controller for non-PC platforms JUNE 20


Mylex becomes an authorized test copier for Novell's Certification Alliance Time to market cycles are dramatically reduced OCTOBER 28


Mylex introduces "system ready" SCSI to SCSI internal and external RAID controller products NOVEMBER 14


Mylex announces the industry's first dual connector disk array controller for the PCI bus, the DAC960PD DECEMBER 15


Mylex stock price closes at record high of $11.188, up 69% from the 1993 year-end close of $6.625 DECEMBER 30


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"PACE-SETTING MYLEX SURGED TO THE TOP OF THE


LIST ON THE STRENGTH OF A PRODUCT WITH AN EXOTIC


NAME (RAID) AND GROWING CUSTOMER BASE . . ."


VALLEY TIMES OCTOBER 3, 1994


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"DISK DRIVE ARRAYS GENERATED $3.4 BILLION


IN WORLDWIDE REVENUES IN 1993, AND THE TOTAL


IS FORECASTED TO REACH $13.0 BILLION IN 1997."


1994 DISK/TREND REPORT


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FISCAL 1994 PROVED TO BE AN IMPORTANT TURN-AROUND YEAR FOR MYLEX, HIGHLIGHTED BY RECORD REVENUES, NET INCOME AND EARNINGS PER SHARE. OUR RETURN TO GROWTH AND PROFITABILITY CAN BE ATTRIBUTED TO INCREASED WORLDWIDE ACCEPTANCE AND DEMAND FOR OUR INDUSTRY-LEADING RAID STORAGE PRODUCTS, WHICH ARE NOW REACHING A BROADER SEGMENT OF USERS AND APPLICATIONS THAN EVER BEFORE.


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During 1994 we shipped a record number of disk array controllers, testimony to Mylex's leadership position in today's expanding worldwide market. Sales orders grew at a brisk rate for both our OEM division and our newly formed Alternate Channel Sales division.


FINANCIAL PERFORMANCE: A BANNER YEAR


Mylex reported record revenues of $62.5 million in 1994, a 38% increase over 1993's $45.2 million. Net income for the year was $7.5 million, or $0.51 per share, a significant improvement compared to the previous year's net loss of $4.4 million, or ($0.35) per share. Mylex's cash, cash equivalents and short-term investment balance was $3.9 million at the close of 1994, compared to a balance of $3.3 million for 1993. The company's stock reached an all-time high of $11 3/16 per share on December 31, 1994 -- almost two-and-a-half times its mid-year selling price.


As a result of this outstanding financial performance, Mylex was able to negotiate a sizable increase in the company's line of credit, which rose from $2.5 million to $6 million.


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Improved financial and operational procedures enabled us to increase sales by 38%, double our assets and fund our growth without increasing the amount drawn down on our line of credit.


Mylex's RAID (Redundant Array of Independent Disks) disk array controller products accounted for 81% -- or $50 million -- of our net sales for 1994. This robust growth was across all industries, all company sizes and all geographic areas. Our remaining revenues were generated through the sale of system boards and other related hardware and software products. During the year, our OEM division added a significant number of world-class organizations to its customer list.


This growth was bolstered by developments in our Alternate Channel Sales division, which added major distributors to our global marketing network. In general, Mylex's marketing activities during 1994 focused on increasing the company's visibility with the financial and technical community through a combination of aggressive advertising, expanded press activities and significantly greater trade show appearances, and field presentations by senior management.


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GOING GLOBAL: INTERNATIONAL GROWTH


Demand for Mylex products was strong in the international marketplace during 1994, particularly throughout Europe. To serve our growing customer base in western Europe, we established a sales office in the United Kingdom early in the year. And we began to take advantage of a number of opportunities in eastern Europe, which continues to undergo an economic and technological awakening. Over the last year, many countries that had previously settled for archaic tools and architectures demonstrated a newfound appetite for the latest technological developments. As a result, Mylex has entered into robust business partnerships with key customers in Poland, Turkey, Czechoslovakia and the Ukraine. To build on this foundation, we intend to expand our international efforts by a significant increase in our focus on Latin America and the Far East in 1995.


PRODUCTS NEWS: EXPANSION ON ALL FRONTS


Mylex's core business and superior technical expertise continue to focus on the production of high-performance RAID solutions for PC-based networks and workstations. According to


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the most recent DISK/TREND Report, in fact, we've shipped more disk array controllers than all of our worldwide competitors combined. With the introduction of a MicroChannel controller, a dual-connector PCI controller and an external SCSI controller, Mylex now offers a RAID solution for virtually every microcomputer-based platform in the industry today.


Mylex's ability to quickly design and market new products is illustrated by our presence in the Peripheral Component Interconnect (PCI) local bus arena. Thanks to its higher system performance, wider data path and increased expandability, the PCI bus is rapidly replacing the EISA bus found in older personal computer architectures. Mylex anticipated demand for PCI bus products by applying the technology to our three principal product lines. As a result, we were the first board manufacturer to offer PCI-compatible solutions in three different areas: RAID disk array controllers, network interface cards and mother-boards. All of these innovative products have been received enthusiastically.


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In all, four new products swung into full production in 1994: the DAC960S SCSI-to-SCSI RAID controller; the ASIC-based DAC960E and DAC960P, RAID controllers for the EISA and PCI buses, respectively, and the MPE-PNTM, a Pentium-based motherboard. The DAC960E and DAC960P rely on proprietary custom application-specific integrated circuits (ASICs) designed and developed by Mylex.


During 1994 we refined our system board product line, which now includes a trio of environmentally responsible, Energy Star-compliant "green" boards. As a result, Mylex now enjoys a comfortable mix between our familiar system board technology and our newer, high performance RAID controller products.


OPERATIONS: IMPROVEMENTS AT EVERY TURN


During 1994 Mylex instituted a number of operational changes to improve overall business productivity. We enhanced the tools our employees rely upon to do their jobs better and meet the diverse needs of our customers. We upgraded our information systems capabilities to allow for increased transaction activity and accommodate additional system users.


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And we rebuilt the infrastructure of our finance department to increase our business/transaction analysis capabilities and put controls in place to deal responsibly with the challenges of rapid growth.


On the manufacturing front, Mylex restructured operations to prepare for ISO 9001 certification in 1995. This internationally recognized set of guidelines for ensuring product quality has become an important differentiator for supplying the increasing number of OEMs, VARs and system integrators who now use ISO quality standards as a crucial part of their vendor selection criteria.


In addition, Mylex entered into new purchasing agreements with some of the world's largest component suppliers during 1994, enabling us to achieve significant cost reductions, increased material availability and greater access to future technology developments. We implemented material scheduling and inventory control systems to ensure a flexible and responsive product pipeline. And through out-sourcing to local ISO 9000 sub-contractors, we reduced production cycles while maintaining a high level of quality for our customers.


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We utilized our in-house manufacturing capabilities primarily to produce our many new products which we introduced during the year.


As a result of all of these operational improvements, Mylex was able to maintain very strong quality "report cards" with our major OEM customers. Our performance consistently met and exceeded industry standards for quality, product delivery, technology, reliability and business relationships.


ENGINEERING: NEW HORIZONS


Mylex's intellectual property resides in the proprietary ASICs firmware and software that we develop. To augment and enhance our design capabilities, we focused on hiring engineers with strong backgrounds in state-of-the-art ASIC development using high-level methodologies such as behavioral design and synthesis. Over the course of the past year, in fact, Mylex increased hardware and software engineering headcount by 30%, with a similar increase planned for 1995.


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Mylex has also become an authorized test center for Novell through the Novell Certification Alliance (NCA), a self-testing and certification program. The NCA program enables us to perform Novell Labs in-house certification test suites on our Novell-approved products, dramatically shortening time to market cycles. In addition, the NCA provides an avenue for marketing and advertising Novell-approved Mylex products. Once testing is completed and verified, Novell Labs issues certification and test bulletins which are released through a variety of Novell's extensive distribution channels.


OUR PEOPLE


Above all, Mylex is a people-oriented company. Our new corporate culture demands that we take great pains to ensure that our employees are empowered to solve problems and contribute to the Company's success. Customer satisfaction is a main focus at Mylex, and we believe that all employees -- regardless of their position or function -- have a profound effect on customer satisfaction. For that reason, in 1994 we instituted the Total Customer Satisfaction Award, presented monthly to a Mylex employee who demonstrates superior per-


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formance in a specific area and exemplary customer service in carrying out his or her duties. We plan to continue to focus in 1995 on improving programs for our employees and providing them with the tools they need to increase productivity at all levels and maintain our high revenue-to-employee ratio.


Just as we encourage our employees to achieve excellence, so we also encourage them to plan for their futures. Management took major steps forward in 1994 to upgrade our employee benefits package. These steps included introducing a tax-deferred 401(k) saving plan, along with a new medical/dental/vision plan that provides our people with greater flexibility in choosing benefit options that meet their specific family needs, while reducing their costs for these coverages.


OUR FUTURE


Mylex entered 1994 with a brand new management team and a full agenda to promote change. We're happy to report success in these endeavors; our strong sales growth of 38% over 1993 resulted in a return to solid profitability. We intend to maintain our leadership


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position in the growing market for storage management products through continued investment in research and development activities.


Much of Mylex's future will center on the continued development of leading-edge technology in the Intelligent I/O arena, where our RAID products hold a dominant position. We believe the partnerships we've forged with industry leaders, along with our aggressive product development efforts, will yield new opportunities and expanded horizons for the application of our technology base. We look forward to those opportunities and horizons, and the challenges they will bring.


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Selected Financial Data -- PAGE 13


Management's Discussion and Analysis -- PAGE 14


Consolidated Balance Sheets -- PAGE 19


Consolidated Statement of Operations -- PAGE 20


Consolidated Statement of Equity -- PAGE 21


Consolidated Statement of Cash Flows -- PAGE 22


Notes to Financial Statements -- PAGE 23


Independent Auditor's Report -- PAGE 28


Corporate Information -- INSIDE BACK COVER


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SELECTED FIVE YEAR CONSOLIDATED FINANCIAL DATA


(IN THOUSANDS EXCEPT SHARE DATA) ------------------------------------------------------------------------------ YEAR ENDED DECEMBER 31, 1994 1993 1992 1991 1990 Net Sales $62,513 45,234 48,769 54,268 47,867 Cost of Sales 40,322 36,456 42,112 47,634 35,417 Gross Profit 22,191 8,778 6,657 6,634 12,450 Operating Expenses and Other Income/Expense 12,130 13,268 11,118 9,931 6,758 Income (loss) Before Income Tax 10,061 (4,490) (4,461) (3,297) 5,692 Income Tax (Expense) Benefit (2,552) 46 1,461 1,092 (2,308) Net Income (loss) 7,509 (4,444) (3,000) (2,205) 3,384
------- ------- ------- ------- ------- Income (loss) Per Share:


Primary $ .53 $ (.35) $ (.25) $ (.19) $ .31
------- ------- ------- ------- -------- Fully Diluted $ .51 $ (.35) $ (.25) $ (.19) $ .28
======= ======= ======= ======= ======== Average Common Shares Outstanding: Primary 14,208 12,740 12,103 11,337 11,076 Fully Diluted 15,247 12,740 12,103 11,337 12,299


CONSOLIDATED BALANCE SHEET DATA Total Assets $27,358 $14,640 $23,694 $22,433 $25,929 Working Capital $16,562 $ 3,461 $ 6,286 $ 8,405 $11,107 Long-term Obligations $ 493 $ 910 $ 1,293 $ 1,651 $ 1,382 Stockholders' Equity $17,760 $ 4,664 $ 7,963 $10,060 $11,420


SUMMARY QUARTERLY DATA -----------------------------------------------------------------------------------
DEC 31 SEP.30 JUNE 30 MAR. 31 DEC. 31 SEP. 30 JUNE 30 MAR. 31 QUARTER ENDED 1994 1994 1994 1994 1993 1993 1993 1993


Net Sales $18,619 16,119 14,132 13,642 12,098 11,764 8,504 12,868 Gross Profit 7,458 5,741 5,004 3,988 3,284 2,510 928 2,057 Income/(loss) From Operations 4,025 2,966 2,030 1,603 867 (4,174) (894) 177 Net Income/(loss) 2,851 2,136 1,433 1,089 732 (4,312) (929) 65 Net Income/(loss) Per Share: Primary .19 .14 .10 .07 .05 (.34) (.07) .00 Fully Diluted .19 .14 .10 .07 .05 (.34) (.07) .00 Weighted Average Shares: Primary 14,937 14,820 13,984 14,652 14,636 12,768 12,767 13,708 Fully Diluted 15,540 15,718 14,548 15,249 14,636 12,768 12,767 13,739


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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS


RESULTS OF OPERATIONS: 1994 VS 1993


YEAR ENDED DECEMBER 31, 1994, COMPARED TO YEAR ENDED DECEMBER 31, 1993


In 1994 the Company returned to profitability and improved its financial condition. Profitability increased as a result of higher revenues, improved gross margins and decreased operating expenses. The Company's financial condition improved as a result of positive cash flow from operations, from the conversion of subordinated debentures to common stock and from employees purchasing the Company's common stock through the Company's 1993 Stock Option Plan.


SALES AND PROFITS


Net sales increased by 38% to $62.5 million in 1994 from $45.2 million in 1993. Sales of the Company's disk array controller products increased by 151% in 1994 over 1993 levels, reflecting the Company's numerous design wins in late 1993 and 1994. The net sales growth in 1994 was attributable to overall market growth and strong demand for the Company's disk array controller products. Sales from disk array products represented 81% of total sales in 1994 compared to 44% in 1993.


The Company is committed to and dependent upon continued development of new products as well as enhancement of existing products. The Company believes its future profitability is dependent to a large extent upon the successful introduction of its new PCI and SCSI to SCSI disk array product families as well as continued market acceptance of its current disk array products. However, there can be no assurance that new products will be successfully developed or, if developed that such new products or the Company's current products will achieve and sustain market acceptance.


The Company depends heavily upon its suppliers to provide high quality materials on a timely basis, at a reasonable price, and with suitable credit terms. Although many of the components for the Company's products are available from numerous sources at competitive prices, some of the most critically-needed components are sole-sourced. As a result, there can be no assurance that sufficient quantities of these or other critical components will be available for the Company's production needs. In the event that these essential components cannot be obtained, the Company may be unable to meet demand for its products, adversely affecting results from operations.


The Company's largest customer during 1994 was IBM Corporation ("IBM") which accounted for 22% of the Company's sales. The Company's next two largest customers, Digital Equipment Corporation and Hewlett-Packard Company, accounted for an additional 17% and 14% respectively of total sales. Many of the Company's customers manufacture and sell products in the networked PC market, which is subject to rapid technological change and intense price competition. These factors affecting the networked PC market in general, or any of the Company's customers in particular, could have a material adverse effect on the Company's future results of operations. While there are OEM agreements in pace that define the terms of the sales and support services with some of the company's largest customers, these agreements do not include specific quantity commitments. The Company sells products to its customers on a purchase order basis. As a result, historical sales cannot be relied upon as an accurate indicator of future sales.


Gross profit was $22.2 million or 35.5% of sales in 1994, compared to $8.8 million or 19.4% of sales in 1993. The increase in gross profits in fiscal 1994 was due to higher margin disk array controller products representing greater sales volumes and an increased percentage of the product mix. Gross profits of the Company's disk array controller boards increased during 1994 due to the replacement of several costly components on the controller boards with less costly ASIC chips designed by the


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Company which resulted in decreased material costs. Maintenance of current gross margins or improvements of gross margins are dependent upon continued manufacturing cost reductions and the successful development and market acceptance of the Company's new disk array controller products. There can be no assurance that the Company will be able to develop and introduce such products in a timely manner, or that such products will gain or sustain market acceptance. The Company anticipates increased competition in the market for its disk array products during 1995. The impact of such competition on the Company's sales and gross profits is uncertain. The Company anticipates that additional competition could result in a decline in the selling prices for these products which would impact both gross margins and operating results.


RESEARCH AND DEVELOPMENT


Expenditures for research and development increased by 35% to $3.3 million in 1994 as compared to $2.5 million in 1993. Research and development expenses decreased slightly as a percent of sales to 5.3% from 5.5% in 1993 due to the significant growth of net sales. The growth in research and development expenses was primarily due to increased technology development efforts related to intelligent input/output management projects. The Company expects to increase its investment in research and development activities during 1995 to achieve market acceptance of new products and to continue its strategy of maintaining technology leadership in the RAID market.


SELLING AND MARKETING


Sales and marketing expenses were $3.6 million or 5.7% of net sales in 1994, compared to $3.0 million or 6.5% of net sales in 1993. The 21% increase in sales and marketing expenses was primarily due to the addition of employees to manage the increased volume and to higher commission, advertising and travel related expenses. The Company expects that sales and marketing expenses will increase during 1995 as the infrastructure is expanded to support growing market opportunities through domestic and international distribution channels.


GENERAL AND ADMINISTRATIVE


General and administrative expenses increased to $4.6 million or 7.4% of net sales in 1994 from $2.7 million or 5.9% of net sales in 1993. The increase in general and administrative expenses of 73% during 1994 was due to the addition of personnel to support the growth in the Company's business and significantly increased legal expenses over those incurred in 1993. The Company anticipates that general administrative expenses will increase during 1995. These expenses may vary as a percentage of net sales in future periods.


PROVISION FOR UNCOLLECTIBLE ACCOUNTS RECEIVABLE


The provision for uncollectible accounts receivable decreased by $4.7 million in 1994. The Company did not incur any bad debt expense during the year as accounts written off during 1994 had been fully reserved as of December 31, 1993. The Company wrote off $4.8 million of uncollectible accounts receivable during 1994, $4.6 million of which was related to products shipped to Northgate Computer Systems, Inc. The receivable from Northgate was fully reserved during 1993 due to the deterioration of Northgate's financial condition. The receivable from Northgate was written off during 1994 as a resale of Northgate's filing for bankruptcy and after an analysis of the assets remaining to satisfy both secured and unsecured creditors. The Company has obtained a security interest in Northgate's inventories during 1993 and expects to receive approximately $113 thousand in net proceeds from the sale of such inventories.


IMPACT OF INFLATION


The impact of inflation on the Company's business was not material during the year ended December 31, 1994.


INTEREST EXPENSES AND OTHER


Interest expense increased by approximately 8% due to increasing interest rates in the second half of 1994. Other income/expense reflects the net of other expenses such as business licenses fees and were in line with the prior year's expenses.


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INCOME TAXES


The Company's combined federal, and state effective income tax provision rate of 25% is less than the federal statutory rate of 34% primarily due to a change in the beginning of the year valuation allowance for which no benefit had been recognized.


Net income increased by $11.9 million to $7.5 million or 12% of net sales in 1994 from a net loss of $4.4 million in 1993, as a result of increased sales, improved margins and significantly reduced bad debt expenses.


RESULTS OF OPERATIONS: 1993 VS 1992


YEAR ENDED DECEMBER 31, 1993, COMPARED TO YEAR ENDED DECEMBER 31, 1992


SALES AND PROFITS


The Company's net sales for the year ended December 31, 1993, decreased by $3.6 million to $45.2 million compared to $48.8 million for the year ended December 31, 1992. Sales declined primarily due to aggressive price competition leading to a reduction in both the selling prices and unit volumes of the Company's system boards. The number of system boards shipped by the Company during 1993 totaled approximately 50,000 as compared to approximately 80,000 shipped during 1992. Sales of the Company's disk array products increased significantly during 1993 due to growing industry acceptance of the Company's disk array technology and product family.


The Company's largest customer during 1993 was IBM Corporation ("IBM") which accounted for $8.3 million or 18% of the Company's sales during that year. During the quarter ended December 31, 1993 sales to IBM accounted for 38% of net sales.


Gross profit for fiscal 1993 increased by $2.1 million to $8.8 million from $6.7 million for fiscal 1992. Gross profit for 1993 was 19.4% of net sales compared to 13.7% for 1992. The increase in gross profit in fiscal 1993 was due to the increased sales of higher margin disk array controllers products which more than offset the declining margins of the Company's system boards. Sales of disk array products accounted for 44.4% of sales during the year ended December 31, 1993, and 71.5% of sales during the fourth quarter of 1993.


The Company recorded a loss before taxes for the year ended December 31, 1993, of $4.5 million or 9.9% of net sales, compared to a pre-tax loss of 4.5 million or 9.1% of net sales for the year ended December 31, 1992. The net loss after income tax benefits for fiscal 1993 was $4.4 million, an increase from the net loss after income tax benefits for fiscal 1992 of $3.0 million. The increased net loss was partially due to a r
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