10-Q 1 0001.txt FORM 10-Q FOR PERIOD ENDED OCTOBER 1, 2000 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q ____________________ [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 1, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ____________________ Commission File Number 0-12390 QUANTUM CORPORATION Incorporated Pursuant to the Laws of the State of Delaware ____________________ IRS Employer Identification Number 94-2665054 500 McCarthy Blvd., Milpitas, California 95035 (408) 894-4000 ____________________ 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 ___ ----- As of the close of business on October 29, 2000, Quantum Corporation had 148,935,551 shares of DLT & Storage Systems group common stock outstanding and 77,287,924 shares of Hard Disk Drive group common stock outstanding. QUANTUM CORPORATION INDEX
Page Number ------ PART I - FINANCIAL INFORMATION Quantum Corporation - Condensed Consolidated Financial Statements Condensed Consolidated Statements of Operations 3 Condensed Consolidated Balance Sheets 5 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Quantitative and Qualitative Disclosures About Market Risk 22 Quantum Corporation DLT & Storage Systems Group - Condensed Combined Financial Statements Condensed Combined Statements of Operations 23 Condensed Combined Balance Sheets 24 Condensed Combined Statements of Cash Flows 25 Notes to Condensed Combined Financial Statements 26 Management's Discussion and Analysis of Financial Condition and Results of Operations 31 Quantitative and Qualitative Disclosures About Market Risk 41 Quantum Corporation Hard Disk Drive Group - Condensed Combined Financial Statements Condensed Combined Statements of Operations 42 Condensed Combined Balance Sheets 43 Condensed Combined Statements of Cash Flows 44 Notes to Condensed Combined Financial Statements 45 Management's Discussion and Analysis of Financial Condition and Results of Operations 51 Quantitative and Qualitative Disclosure About Market Risk 62 PART II - OTHER INFORMATION 63 SIGNATURE 65
PART I - FINANCIAL INFORMATION Item 1. Financial Statements QUANTUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ---------- ---------- ---------- ---------- Revenue $1,181,011 $1,125,124 $2,406,064 $2,208,359 Cost of revenue - on net sales 955,958 932,719 1,900,536 1,836,035 Cost of revenue - special charge (benefit) (15,825) 57,068 (15,825) 57,068 ---------- ---------- ---------- ---------- Gross profit 240,878 135,337 521,353 315,256 Operating expenses: Research and development 91,811 92,453 185,890 182,886 Sales and marketing 61,214 55,459 127,700 108,680 General and administrative 35,402 30,570 70,043 59,714 Purchased in-process research and development - 37,000 - 37,000 Special charge (benefit) (90) 2,338 (90) 2,338 ---------- ---------- ---------- ---------- 188,337 217,820 383,543 390,618 Income (loss) from operations 52,541 (82,483) 137,810 (75,362) Other income (expense): Interest income and other, net 10,837 7,110 25,214 19,557 Interest expense (6,937) (7,218) (13,688) (14,426) ---------- ---------- ---------- ---------- 3,900 (108) 11,526 5,131 Income (loss) before income taxes 56,441 (82,591) 149,336 (70,231) Income tax provision (benefit) 20,827 (19,938) 53,302 (15,859) ---------- ---------- ---------- ---------- Net income (loss) $ 35,614 $ (62,653) $ 96,034 $ (54,372) ========== ========== ========== ========== Quantum common stock (1) : Net loss $ (25,474) $ (17,193) ========== ========== Net loss per share: Basic $ (0.15) $ (0.10) Diluted $ (0.15) $ (0.10) Weighted average common shares: Basic 164,916 165,788 Diluted 164,916 165,788 DLT & Storage Systems group (1) : Net income $ 44,285 $ 12,497 $ 88,235 $ 12,497 ========== ========== ========== ========== Net income per share: Basic $ 0.30 $ 0.08 $ 0.60 $ 0.08 Diluted $ 0.29 $ 0.07 $ 0.57 $ 0.07 Weighted average common shares: Basic 146,230 165,377 148,274 165,377 Diluted 154,797 173,080 154,714 173,080 Hard Disk Drive group (1):
3 Net income (loss) $ (8,671) $ (49,650) $ 7,799 $ (49,650) ========== ========== ========== ========== Net income (loss) per share: Basic $ (0.11) $ (0.60) $ 0.10 $ (0.60) Diluted $ (0.11) $ (0.60) $ 0.09 $ (0.60) Weighted average common shares: Basic 77,336 82,883 79,390 82,883 Diluted 77,336 82,883 85,533 82,883
(1) As discussed in Note 2 of the Notes to Condensed Consolidated Financial Statements, a recapitalization occurred on August 3, 1999. As a result, earnings per share for Quantum Corporation common stock reflect earnings through the recapitalization date, while earnings for DLT & Storage Systems group common stock and Hard Disk Drive group common stock reflect results subsequent to that date. See accompanying notes to condensed consolidated financial statements. 4 QUANTUM CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
October 1, March 31, 2000 2000 ---------- ---------- (unaudited) Assets ------ Current assets: Cash and cash equivalents $ 795,504 $ 918,262 Marketable securities 16,814 32,080 Accounts receivable, net of allowance for doubtful accounts of $22,638 and $23,110 619,038 609,225 Inventories 243,754 223,825 Deferred taxes 138,676 133,382 Other current assets 114,631 96,780 ---------- ---------- Total current assets 1,928,417 2,013,554 Property and equipment, net of accumulated depreciation of $322,158 and $299,671 232,409 236,685 Intangible assets, net 239,006 250,203 Other assets 57,696 33,510 ---------- ---------- $2,457,528 $2,533,952 ========== ========== Liabilities and Stockholders' Equity ------------------------------------ Current liabilities: Accounts payable $ 436,048 $ 470,210 Accrued warranty 96,987 99,560 Accrued compensation 75,400 90,452 Income taxes payable 73,525 44,284 Accrued special charges 24,538 43,363 Current portion of long-term debt 1,175 1,033 Other accrued liabilities 175,058 105,345 ---------- ---------- Total current liabilities 882,731 854,247 Deferred taxes 71,517 55,336 Long-term debt 37,237 37,838 Convertible subordinated debt 287,500 287,500 Stockholders' equity: Common stock 723,697 737,020 Treasury stock (94,554) - Retained earnings 542,581 545,050 Accumulated other comprehensive income 6,819 16,961 ---------- ---------- Total stockholders' equity 1,178,543 1,299,031 ---------- ---------- $2,457,528 $2,533,952 ========== ==========
See accompanying notes to condensed consolidated financial statements. 5 QUANTUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Six Months Ended October 1, September 26, 2000 1999 --------- --------- Cash flows from operating activities: Net income (loss) $ 96,034 $ (54,372) Adjustments to reconcile net income (loss) to net cash provided by operations: Special charge - 58,385 Purchased in-process research and development - 37,000 Depreciation 44,707 48,496 Amortization 16,609 13,872 Deferred income taxes (1,231) 405 Compensation related to stock plans 10,432 1,640 Changes in assets and liabilities: Accounts receivable (9,813) 54,663 Inventories (19,929) (520) Accounts payable (34,162) (31,120) Income taxes payable 29,241 (7,407) Accrued warranty (2,573) 15,668 Other assets and liabilities (48,692) (36,972) --------- --------- Net cash provided by operating activities 80,623 99,738 --------- --------- Cash flows from investing activities: Investment in equity securities (23,353) - Purchases of marketable securities - (33,406) Maturities of marketable securities 2,032 33,314 Acquisition of intangible assets - (2,500) Investment in property and equipment (34,789) (49,909) --------- --------- Net cash used in investing activities (56,110) (52,501) --------- --------- Cash flows from financing activities: Proceeds from long-term credit facilities - 10,000 Principal payments on long-term credit facilities (459) (18,501) Purchases of treasury stock (240,848) (145,652) Proceeds from factoring 70,000 - Proceeds from issuance of common stock, net 24,036 23,558 --------- --------- Net cash used in financing activities (147,271) (130,595) --------- --------- Decrease in cash and cash equivalents (122,758) (83,358) Cash and cash equivalents at beginning of period 918,262 772,368 --------- --------- Cash and cash equivalents at end of period $ 795,504 $ 689,010 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 13,485 $ 12,981 Income taxes $ 2,361 $ 18,341 Tangible and intangible assets acquired for shares of DSSG and HDDG common stock, net of cash acquired and liabilities assumed - $ 104,698
See accompanying notes to condensed consolidated financial statements. 6 QUANTUM CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements include the accounts of Quantum Corporation ("Quantum" or the "Company") and its majority owned subsidiaries. All material intercompany balances and transactions have been eliminated. The interim financial statements reflect all adjustments, consisting only of normal recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. The condensed consolidated balance sheet as of March 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying financial statements should be read in conjunction with the audited financial statements of Quantum Corporation for the fiscal year ended March 31, 2000 included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission. 2. Recapitalization On July 23, 1999, the Company's stockholders approved a tracking stock proposal. As a result, Quantum's Certificate of Incorporation was amended and restated, effective as of the close of business on August 3, 1999, designating two new classes of Quantum Corporation common stock, DLT & Storage Systems group ("DSSG") common stock, $.01 par value per share and Hard Disk Drive group ("HDDG") common stock, $.01 par value per share. On August 3, 1999, each authorized share of Quantum common stock, $.01 par value per share, was exchanged for one share of DSSG stock and one-half share of HDDG stock. These two securities are intended to track separately the performance of the DLT & Storage Systems group and the Hard Disk Drive group. 3. Securitized Assets HDDG has an asset securitization program with Capital Factors Inc., under which we sell them our eligible accounts receivable, on a with recourse basis. At October 1, 2000, $70 million of our accounts receivable were securitized under the program. Given the with recourse nature of the arrangement, the securitized accounts receivable are included within the accounts receivable balance, with the corresponding credit being included in other liabilities. 4. Inventories Inventories consisted of the following: (In thousands) October 1, March 31, 2000 2000 ---------- --------- Materials and purchased parts $ 56,774 $ 49,206 Work in process 37,227 42,323 Finished goods 149,753 132,296 -------- -------- $243,754 $223,825 ======== ======== 7 5. Net Income (Loss) Per Share Net income (loss) per share was calculated on a consolidated basis until DSSG stock and HDDG stock were created as a result of the recapitalization on August 3, 1999. Subsequent to this date, net income (loss) per share was computed individually for DSSG and HDDG. The following tables set forth the computation of basic and diluted net income (loss) per share:
(In thousands, except per share data) Period from June 28, Period from 1999 to Three Months Ended August 4, 1999 to August 3, October 1, 2000 September 26, 1999 1999 ----------------------- ----------------------- ------------- Quantum DSSG HDDG DSSG HDDG Corporation -------- -------- -------- -------- ------------- Numerator: Numerator for basic and diluted net income (loss) per share - income (loss) available to common stockholders $ 44,285 $(8,671) $ 12,497 $(49,650) $(25,474) ======== ======= ======== ======== ======== Denominator: Denominator for basic net income (loss) per share - weighted average shares 146,230 77,336 165,377 82,883 164,916 Effect of dilutive securities: Outstanding options 8,567 - 7,703 - - -------- ------- -------- -------- -------- Denominator for diluted net income (loss) per share - adjusted weighted average shares 154,797 77,336 173,080 82,883 164,916 ======== ======= ======== ======== ======== Basic net income (loss) per share $ 0.30 $( 0.11) $ 0.08 $ (0.60) $ (0.15) ======== ======= ======== ======== ======== Diluted net income (loss) per share $ 0.29 $( 0.11) $ 0.07 $ (0.60) $ (0.15) ======== ======= ======== ======== ========
8 (In thousands, except per share data)
Six Months Ended Period from October 1, 2000 April 1, 1999 to August 3, 1999 ----------------------------------- ----------------- DSSG HDDG Quantum Corporation --------------- --------------- ----------------- Numerator: Numerator for basic and diluted net income (loss) per share - income (loss) available to common stockholders $ 88,235 $ 7,799 $(17,193) ======== ======= ======== Denominator: Denominator for basic net income (loss) per share - weighted average shares 148,274 79,390 165,788 Effect of dilutive securities: Outstanding options 6,440 6,143 - -------- ------- -------- Denominator for diluted net income (loss) per share - adjusted weighted average shares 154,714 85,533 165,788 ======== ======= ======== Basic net income (loss) per share $ 0.60 $ 0.10 $ (0.10) ======== ======= ======== Diluted net income (loss) per share $ 0.57 $ 0.09 $ (0.10) ======== ======= ========
The computation of diluted net income per share for DSSG for the three and six months ended October 1, 2000 and for the period August 4, 1999 through September 26, 1999, excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 6,206,152 shares of DSSG common stock, or 21.587 shares per $1,000 note, because the effect would have been antidilutive. The computation of diluted net income (loss) per share for HDDG for the three and six months ended October 1, 2000 and for the period August 4, 1999 through September 26, 1999, excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 3,103,076 shares of HDDG common stock, or 10.793 shares per $1,000 note, because the effect would have been antidilutive. The computation of diluted net loss per share for Quantum for the period June 28, 1999 through August 3, 1999 and the period April 1, 1999 through August 3, 1999, excluded the effect of the 7% convertible subordinated notes issued in July 1997, which were convertible into 6,206,152 shares of 9 Quantum common stock, or 21.587 shares per $1,000 note, because the effect would have been antidilutive. Options to purchase 18,723,101 and 15,234,101 shares of HDDG common stock were outstanding at October 1, 2000 and September 26, 1999, respectively. However, the corresponding weighted average outstanding options were not included in the computation of diluted net loss per share for HDDG for the three months ended October 1, 2000, and the period August 4, 1999 through September 26, 1999, because the effect would have been antidilutive. Options to purchase 26,411,958 shares of Quantum common stock were outstanding at August 3, 1999. However, the corresponding weighted average outstanding options were not included in the computation of diluted net loss per share for Quantum for the period June 28, 1999 through August 3, 1999 and for the period April 1, 1999 through August 3, 1999, because the effect would have been antidilutive. Options to purchase 13,845,438 shares of DSSG common stock were outstanding for the three and six months ended October 1, 2000, but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. Options to purchase 7,360,119 shares of HDDG common stock were outstanding for the six months ended October 1, 2000, but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 6. Common Stock Repurchase During fiscal year 2000, the Board of Directors authorized the Company to repurchase up to $700 million of the Company's common stock in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock. An additional $100 million was authorized for repurchase of HDDG common stock. Under these authorizations, as of October 1, 2000, the Company had repurchased a total of 3.9 million shares of Quantum common stock, 29.2 million shares of DSSG common stock and 13.5 million shares of HDDG common stock for a combined total of $566 million. During the first six months of fiscal year 2001, the Company repurchased 13.5 million shares of DSSG common stock and 10 million shares of HDDG common stock for a combined total of $241 million. 7. Credit Line In April 2000, the Company entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At the Company's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At October 1, 2000, there were no outstanding balances drawn on these lines. 10 8. Litigation On August 7, 1998, the Company was named as one of several defendants in a patent infringement lawsuit filed in the U.S. District Court for the Northern District of Illinois, Eastern Division. The plaintiff, Papst Licensing GmbH, owns at least 24 U.S. patents, which it asserts that the Company has infringed. The Company has studied many of these patents before and, of the patents it has studied, believes that defenses of patent invalidity and non-infringement can be asserted. However, the Company has not completed a full study of all the patents asserted by Papst and there can be no assurance that the Company has not infringed these or other patents owned by Papst. In October, 1999 the case was transferred to a federal district court in New Orleans, Louisiana, where it has been joined with suits brought against Papst by Hewlett-Packard Company, Maxtor Corporation and Minebea Company, Ltd. for the purposes of coordinated discovery under multi-district litigation rules. Hewlett-Packard settled its dispute with Papst in April, 2000 and has withdrawn from the litigation. To date, discovery has not begun to any significant extent. Quantum does not believe that the transfer will affect the final disposition of this matter in a significant way. The final results of this litigation, as with any litigation, are uncertain. In addition, the costs of engaging in litigation with Papst will be substantial. The Company is also subject to other legal proceedings and claims that arise in the ordinary course of its business. For example, in fiscal year 2000, Discovision Associates brought patents they hold to the Company's attention. While management currently believes the amount of ultimate liability, if any, with respect to these actions will not materially affect the financial position, results of operations, or liquidity of the Company, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur, the impact could be material to the Company. 9. Special Charges Hard Disk Drive Group During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with streamlining HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to streamlining the global logistics model and changes in customer service strategy, $7.8 million in severance and benefits for terminated employees, and approximately $12 million in other costs associated with the plan. The facilities costs noted above include lease payments on facilities to be vacated in and around Milpitas, California and Singapore, the write-off of related leasehold improvements, and other maintenance expenses associated with the vacated facilities. HDDG expects that the affected facilities will be vacated by the end of the third quarter of fiscal year 2001. Subsequent to the end of the second quarter of fiscal year 2000, HDDG revised its estimate of costs required to implement the restructuring plan. HDDG estimated that severance and benefits, inventory and other costs, which included the disposition of additional capital assets, would be more than previously estimated as a result of the planned changes in customer service strategy. 11 HDDG also estimated that costs associated with vacating leased facilities would be less than previously estimated as a result of disposing of a major facility earlier than previously expected. Accordingly, HDDG reallocated amounts between these categories during the second half of fiscal year 2000. In the second quarter of fiscal year 2001, HDDG reversed $15.9 million as a special charge benefit on the income statement. This reversal was primarily due to negotiated lease cancellations and reduced severance and benefits due to attrition and redeployment of certain employees. Higher than previously experienced turnover has enabled the redeployment and continued utilization of certain employees who were included in workforce reduction plans. In addition, fixed assets that were intended to be written-off are now being utilized elsewhere in the organization as a result of technology and product roadmap plans. In connection with the charge, HDDG currently expects a workforce reduction of approximately 513 employees, down from the original expectation of 600 employees. In addition, approximately 100 open and budgeted positions have been eliminated. The reduction in force primarily affects employees at HDDG's drive configuration centers and warehouses in Milpitas, California and Dundalk, Ireland and employees within the desktop drive business. As of October 1, 2000, 481 employees have been terminated. The remaining employees will be terminated by the end of the third quarter of fiscal year 2001. As of October 1, 2000, HDDG had incurred $9 million in cash expenditures associated with employee severance and benefits, facilities and other costs. HDDG expects to incur additional cash expenditures associated with the plan of approximately $6 million. The following table summarizes activity related to the special charge at October 1, 2000.
(In thousands) Severance And Facilities Other Benefits Costs Inventory Costs Total -------- ----- --------- ----- ----- Special charge provision $ 7,833 $26,359 $ 13,214 $12,000 $ 59,406 Cash Payments (5,963) (1,559) - (1,883) (9,405) Non-cash charges - (7,296) (15,588) (5,502) (28,386) Adjustments 1,166 (7,852) 2,374 4,312 - Special charge benefit (2,284) (7,787) - (5,798) (15,869) ------- ------- -------- ------- -------- Balance at October 1, 2000 $ 752 $ 1,865 $ - $ 3,129 $ 5,746 ======= ======= ======== ======= ========
DLT & Storage Systems Group During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTtape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated 12 employees, $3.2 million for fixed asset write-offs, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. The facilities costs noted above include lease payments for vacant space in a facility in Colorado Springs, Colorado, the write-off of related leasehold improvements and manufacturing equipment, as well as the write-off of certain leasehold improvements at Quantum's facility in Penang, Malaysia, as this space was converted to DSSG manufacturing. DSSG expects that the Colorado facility will be vacated by the end of fiscal year 2001. The write-off of investments reflects DSSG's decision to end its research on certain optical based storage solutions. As a result, DSSG has written-off an equity investment and technology licenses related to optical technology. DSSG currently expects a workforce reduction of approximately 900 employees. The reduction in force primarily affects employees at DSSG's manufacturing operations in Colorado Springs, Colorado, as well as administrative employees within the DLTtape Division. As of October 1, 2000, 294 employees have been terminated. DSSG anticipates that the remaining employees will be terminated by the end of the fourth quarter of fiscal year 2001. As of October 1, 2000, DSSG had incurred cash expenditures of $4 million associated with employee severance and benefits, facilities and other costs. DSSG expects to incur additional cash expenditures associated with the plan of approximately $14 million, which will be funded out of operations. The following table summarizes activity related to the special charge at October 1, 2000:
(In thousands) Severance And Facilities Fixed Other Benefits Costs Investments Assets Costs Total Special charge provision $ 7,646 $13,500 $ 13,908 $ 3,163 $ 1,866 $ 40,083 Cash payments (2,997) (85) -- -- (1,138) (4,220) Non-cash charges -- -- (13,908) (3,163) -- (17,071) ------- ------- -------- ------- ------- -------- Balance at October 1, 2000 $ 4,649 $13,415 $ -- $ -- $ 728 $ 18,792 ======= ======= ======== ======= ======= ========
10. Comprehensive Income Accumulated other comprehensive income on the condensed consolidated balance sheets consists of unrealized gains on available for sale investments and foreign currency translation adjustments. Total comprehensive income for the three months and six months ended October 1, 2000 and September 26, 1999, is presented in the following table:
(In thousands) Three Months Ended Six Months Ended ------------------------------ ------------------------------ October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ------------ --------------- ------------ --------------- Net income (loss) $ 35,614 $(62,653) $ 96,034 $(54,372) Other comprehensive income - Change in unrealized gain on investments (8,135) - (7,940) -
13 Foreign currency translation adjustments (1,972) 1,693 (2,202) 773 -------- -------- -------- -------- Comprehensive income $ 25,507 $(60,960) $ 85,892 $(53,599) ======== ======== ======== ========
11. Business Segment Information Quantum Corporation's reportable segments are its two business groups, the Hard Disk Drive group and the DLT & Storage Systems group, as further described in their separate financial statements. HDDG consists of desktop and high-end hard disk drives. DSSG consists of DLTtape(TM) drives and media, autoloaders and libraries, network attached storage solutions and solid state storage systems. The Company markets its products to computer manufacturers and through a broad range of distributors, resellers and systems integrators. The Company evaluates segment performance based on net profit or loss not including non-recurring gains or losses. Segment assets include those items that can be specifically identified with or reasonably allocated to a particular segment. Results for the Company's reportable segments for the three months and six months ended October 1, 2000 and September 26, 1999 are presented in the following table:
(In millions) Three Months Ended ----------------------------------------------- October 1, 2000 September 26, 1999 ------------------- ---------------------- HDDG DSSG Total HDDG DSSG Total ---- ---- ----- ---- ---- ----- Revenue from external customers $819 $362 $1,181 $768 $357 $1,125 Intersegment revenues 4 - 4 - - - Segment profit (loss) (8) 44 36 (84) 21 (63)
(In millions) Six Months Ended ----------------------------------------------- October 1, 2000 September 26, 1999 ------------------- ---------------------- HDDG DSSG Total HDDG DSSG Total ---- ---- ----- ---- ---- ----- Revenue from external customers $1,678 $728 $2,406 $1,521 $688 $2,208 Intersegment revenues 9 - 9 - - - Segment profit (loss) 8 88 96 (127) 73 (54)
12. Subsequent Events On October 3, 2000, the Company entered into a definitive agreement with Maxtor Corporation to combine Maxtor and HDDG in an all-stock transaction. The merger agreement envisages that HDDG's stockholders will receive 1.52 shares of Maxtor common stock for every share of HDDG common stock they own. The transaction, which was unanimously approved by the Boards of Directors of both companies, is expected to be completed in early calendar 2001. The transaction is expected to be tax-free to Quantum stockholders. This transaction is subject to stockholders and regulatory 14 approval. If the combination is completed, a. Quantum's DLT & Storage Systems Group will operate as a legally separate, stand-alone company that will be known as Quantum Corporation; b. DSSG stockholders will receive on a one-for-one basis, shares of the then- independent company comprising all of the operations and assets of the Quantum DLT & Storage Systems Group; and c. DSSG intends to issue restricted stock to Quantum employees that become employees of the combined HDDG/Maxtor company, in exchange for the loss of unvested DSSG stock options held by such employees. As a result, Quantum is expected to incur substantial compensation charges if the combination is completed. These expectations are forward-looking statements and actual results may differ. On October 24, 2000 the Company announced plans to make its server appliances subsidiary an independent, publicly-traded company called Snap Appliances, Inc. On October 30, 2000 Snap Appliances filed a registration statement with the Securities and Exchange Commission for the initial public offering ("IPO") of its common stock. Immediately following the IPO, Quantum will own at least 80% of Snap Appliances' outstanding common stock. Quantum intends to distribute these shares to Quantum DSSG stockholders subject to receiving a favorable IRS ruling and Board of Directors approval. After the IPO the remaining DSSG business will be comprised of two business groups, Enterprise Solutions and DLTtape. On November 8, 2000, Quantum DSSG announced plans to expand its product design and new product introduction resources for the Company's DLTtape Group in Colorado. Under the plan, the Company will move more than 100 engineering, marketing and administrative positions relating to the DLTtape business to Colorado from its Shrewsbury, MA facility. In addition, the Company will create an Advanced Technology Development Lab in Shrewsbury that will focus on advancing future tape drive innovations. There will be costs associated with this plan. DSSG is currently not able to quantify these costs. 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Quantum Corporation This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements usually are phrased in the future tense or contain the words "estimate," "anticipate," "expect," or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties. These uncertainties could cause actual results to differ materially from those expected for the reasons set forth under Trends and Uncertainties relating to the DLT & Storage Systems group and Trends and Uncertainties relating to the Hard Disk Drive group. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Business Description Quantum operates its business through two separate business groups: the DLT & Storage Systems group ("DSSG") and the Hard Disk Drive group ("HDDG") as described in their respective sections of this report. On October 3, 2000, the Company entered into a definitive agreement with Maxtor Corporation to combine Maxtor and HDDG in an all-stock transaction. The merger agreement envisages that HDDG's stockholders will receive 1.52 shares of Maxtor common stock for every share of HDDG common stock they own. The transaction, which was unanimously approved by the Boards of Directors of both companies, is expected to be completed in early calendar 2001. The transaction is expected to be tax-free to Quantum stockholders. This transaction is subject to stockholders and regulatory approval. These expectations are forward-looking statements and actual results may differ. On October 24, 2000 the Company announced plans to make its server appliances subsidiary an independent, publicly-traded company called Snap Appliances, Inc. On October 30, 2000 Snap Appliances filed a registration statement with the Securities and Exchange Commission for the initial public offering ("IPO") of its common stock. Immediately following the IPO, Quantum will own at least 80% of Snap Appliances' outstanding common stock. Quantum intends to distribute these shares to Quantum DSSG stockholders subject to receiving a favorable IRS ruling and Board of Directors approval. After the IPO the remaining DSSG business will be comprised of two business groups, Enterprise Solutions and DLTtape. On November 8, 2000, the Company's DSSG announced plans to expand its product design and new product introduction resources for the Company's DLTtape Group in Colorado. Under the 16 plan, the Company will move more than 100 engineering, marketing and administrative positions relating to the DLTtape business to Colorado from its Shrewsbury, MA facility. In addition, the Company will create an Advanced Technology Development Lab in Shrewsbury that will focus on advancing future tape drive innovations. There will be costs associated with this plan. DSSG is currently not able to quantify these costs. Results of Operations Revenue. Revenue in the three and six months ended October 1, 2000 was $1.181 billion and $2.406 billion, respectively, compared to $1.125 billion and $2.208 billion, respectively, for the corresponding periods in fiscal year 2000. Revenue in the three and six months ended October 1, 2000 reflected increased revenue from sales of DLTtape libraries and Snap servers, increased DLTtape media royalties, and increased revenue from sales of high-end hard disk drives. The increase in revenue in the six month period also reflected increased revenue from sales of desktop hard disk drives. The increased revenue from Snap server network attached storage appliances reflected the acquisition of Meridian Data, Inc. ("Meridian") in September 1999. Th increased sales of DLTtape libraries reflect an increase in unit sales of DLTtape libraries. The increase in DLTtape media royalties reflected an increase in total market media unit sales and a shift to licensee sales from direct sales. The increase in total market media unit sales reflected an increase in the installed base of DLTtape drives. DSSG earns a royalty fee from sales of DLTtape media cartridges by licensed media manufacturers. The increase in revenue from high-end hard disk drives reflected increased shipments as a result of strong demand, particularly from computer equipment manufacturers, as HDDG transitioned to new high performance products, as well as a mix shift toward higher capacity products which carry higher average unit prices. The increase in revenue from desktop hard disk drives in the six month period reflected an increase in shipments, partially offset by lower average unit prices. Shipments of desktop hard disk drives reached a record high in the second quarter of fiscal year 2001. However, revenue in the three month period declined reflecting lower average unit prices as a result of competitive pricing pressures. Sales to our top five customers in the three and six months ended October 1, 2000 represented 49% and 48% of revenue, respectively, compared to 48% and 47%, respectively, for the corresponding periods in fiscal year 2000. These amounts reflected a retroactive combination of the sales to Ingram Micro and Electronic Resources Limited as a result of their merger in July 1999. Sales to Compaq Computer Corporation were 15% and 12% of revenue in the three and six months ended October 1, 2000, respectively, compared to 12% of revenue in the corresponding periods in fiscal year 2000. Sales to Dell Computer Corporation were 12% and 10% of revenue in the three and six months ended October 1, 2000, compared to less than 10% of revenue for the corresponding periods in fiscal year 2000. Sales to Hewlett-Packard Company were 11% and less than 10% of revenue in the three and six months ended October 1, 2000, respectively, compared to 12% and 13% of revenue in the corresponding periods of fiscal year 2000. 17 Sales to computer equipment manufacturers and distribution channel customers were 64% and 28% of revenue, respectively, in the three months ended October 1, 2000, compared to 59% and 35% of revenue, respectively, in the three months ended September 26, 1999. For the six months ended October 1, 2000, computer equipment manufacturer and distribution channel sales were 64% and 29% of revenue, respectively, compared to 59% and 35% of revenue, respectively, for the corresponding periods in fiscal year 2000. The remaining revenue in the three and six months ended September 26, 1999 represented media royalty revenue and sales to value added resellers and in the three and six months ended October 1, 2000 represented media royalty revenue, sales to value added resellers and direct sales. Gross Margin Rate. The gross margin rate in the three months ended October 1, 2000 increased to 20.4% from 12.0% in the three months ended September 26, 1999. The gross margin for the first six months of fiscal year 2001 was 21.7%, compared to 14.3% in the corresponding period in fiscal year 2000. The gross margin rate in the three and six month periods of fiscal year 2001 reflected the impact of a $15.8 million special charge benefit. The benefit was primarily due to negotiated lease cancellations and reduced severance and benefits due to attrition and redeployment of certain employees. The gross margin rate excluding the impact of the benefit was 19.1% and 21.0% in the three and six month periods ended October 1, 2000, respectively. The gross margin rate in the three and six month periods for fiscal year 2000 reflected the impact of a $57.1 million special charge related to HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of rapidly growing low-cost PC market. The gross margin rate excluding the impact of the charge was 17.1% and 16.9% in the three and six month periods ended September 26, 1999. Excluding the impact of the special benefit and charge, the increase in the gross margin rate reflected increased revenue from DLTtape libraries and Snap Servers and DLTtape media royalties, which have significantly higher margins than Quantum's hard disk drive products. The increase also reflected higher margins earned on desktop and high-end hard disk drives. Gross margins earned on sales of DLTtape drives and DLTtape media cartridges declined, reflecting lower average unit prices. Research and Development Expenses. Research and development expenses in the three and six months ended October 1, 2000, were $92 million, or 7.8% of revenue, and $186 million, or 7.7% of revenue, respectively, compared to $92 million, or 8.2% of revenue, and $183 million, or 8.3% of revenue, respectively, for the corresponding periods of fiscal year 2000. The increase in research and development expenses reflecting the inclusion of Snap Appliances' expenses, which were not included in the periods prior year periods as the acquisition occurred on September 10, 1999, were offset by the expense reductions in the hard disk drive business associated with the special charge taken in the second quarter of fiscal year 2000. Sales and Marketing Expenses. Sales and marketing expenses in the three and six months ended October 1, 2000, were $61 million, or 5.2% of revenue, and $128 million, or 5.3% of revenue, respectively, compared to $55 million, or 4.9% of revenue, and $109 million, or 4.9% of revenue, respectively, for the corresponding periods of fiscal year 2000. The increase in sales and marketing expenses reflected the inclusion of Snap Appliances expenses and an increase in costs associated with the DLTtape libraries. Spending in Snap Appliances increased as DSSG continued to build 18 both category awareness for network attached storage (NAS) appliances and brand awareness for the Snap! Server(TM) line. The increase in DSSG spending was partially offset by decreased HDDG sales and marketing expenses. General and Administrative Expenses. General and administrative expenses in the three and six months ended October 1, 2000, were $35 million, or 3.0% of revenue, and $70 million, or 2.9% of revenue, respectively, compared to $31 million, or 2.7% of revenue, and $60 million, or 2.7% of revenue, respectively, for the corresponding periods of fiscal year 2000. The increase in general and administrative expenses reflected the inclusion of Snap Appliances expenses, which were not comparatively included in the prior year periods as the acquisition occurred on September 10, 1999, increased expenses associated with DLTtape libraries and an increase in human resource spending within HDDG in support of change management, process reengineering and retention. Purchased In-process Research and Development Expense. DSSG expensed purchased in-process research and development of $37 million, as a result of the Meridian acquisition in the second quarter ended September 26, 1999. Special Charge - HDDG. During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and our operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with streamlining HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to streamlining the global logistics model and changes in customer service strategy, $7.8 million in severance and benefits for terminated employees and approximately $12 million in other costs associated with the plan. HDDG is proceeding according to plan and expects to realize more than $100 million in cost savings per year, beginning in fiscal year 2001. The majority of the savings are expected in cost of revenue as a result of a more efficient distribution system and reduced customer service costs, with the remaining savings in research and development, as a result of the consolidation of product development programs. As compared to fiscal year 2000, HDDG expects operating expenses to be relatively flat in fiscal year 2001, with increased investments in disk drive and other storage products, primarily reflected in research and development, offsetting the operating cost savings resulting from the special charge. These expectations are forward-looking statements and actual results may differ. In the second quarter of fiscal year 2001, HDDG reversed $15.9 million as a special charge benefit on the income statement. This reversal was primarily due to negotiated lease cancellations and reduced severance and benefits due to attrition and redeployment of certain employees. In addition, fixed assets that were intended to be written-off are now being utilized elsewhere in the organization as a result of technology and product roadmap plan. Special Charge - DSSG. During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and 19 reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTtape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed asset write-offs, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. DSSG is proceeding according to plan and expects to realize annual cost savings from the plan of approximately $40 million beginning upon full implementation of the plan at the end of fiscal year 2001. Approximately $30 million of the savings are expected in cost of revenue as a result of reduced manufacturing costs with the remaining amount in operating expenses, primarily research and development, as a result of ending research on certain optical-based storage solutions. As compared to fiscal year 2000, DSSG expects operating expenses to increase because of increased investments in storage systems products and marketing in fiscal year 2001 and as a result of including the Snap Appliances' operations for a full year following the acquisition of Meridian in September 1999. These expectations are forward-looking statements and actual results may differ. Interest and Other Income/Expense. Net interest and other income for the three and six months ended October 1, 2000 were $3.9 million and $11.5 million, respectively, compared to $0.1 million expense and $5 million income, respectively, for the corresponding periods of fiscal year 2000. The increase reflected increased interest income as a result of a higher average cash balance and an increase in gain on currency translation. Income Taxes. The Company's effective tax rate for the three months and six months ended October 1, 2000 was 37% and 36%, respectively, as compared to an effective benefit rate of 44% and 48% on losses before purchased in-process research and development and special charges for the corresponding periods in the prior year. The difference in tax rates is primarily attributable to pre- tax profits this year compared to pre-tax losses in the prior year. Liquidity and Capital Resources. Cash, cash equivalents and marketable securities were $812 million at October 1, 2000 compared to $950 million at March 31, 2000. The Company used cash in the six months ended October 1, 2000 to purchase $241 million of treasury stock, as discussed below. Other uses of cash included $34 million for investments in property and equipment. The Company generated approximately $81 million of cash from operations, primarily related to net income and non-cash expenses, partially offset by changes in other assets and liabilities and a decrease in accounts payable and an increase in inventories. Other sources of cash were $94 million in proceeds from accounts receivable factoring and the issuance of common stock. HDDG has an asset securitization program with Capital Factors Inc, under which we sell our eligible accounts receivable on a with recourse basis. At October 1, 2000, $70 million of our accounts receivable were securitized under the program. Given the with recourse nature of the 20 arrangement, the securitized accounts receivable are included within the accounts receivable balance, with the corresponding credit being included in other liabilities. During fiscal year 2000, the Board of Directors authorized the Company to repurchase up to $700 million of the Company's common stock in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock. An additional $100 million was authorized for repurchase of HDDG common stock. Under these authorizations, as of October 1, 2000, the Company had repurchased a total of 3.9 million shares of Quantum common stock, 29.2 million shares of DSSG common stock and 13.5 million shares of HDDG common stock for a combined total of $566 million. During the first six months of fiscal year 2001, the Company repurchased 13.5 million shares of DSSG common stock and 10 million shares of HDDG common stock for a combined total of $241 million. In April 2000, the Company entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At the Company's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At October 1, 2000, there were no outstanding balances drawn on these lines. The Company expects to spend approximately $98 million in fiscal year 2001 for capital equipment and leasehold improvements. These capital expenditures will support the disk drive, tape drive and storage solutions businesses, research and development, and general corporate operations. The Company believes that its existing capital resources, including the credit facilities and any cash generated from operations, will be sufficient to meet all currently planned expenditures and sustain operations for the next 12 months. However, this belief assumes that operating results and cash flow from operations will meet our expectations. These expectations are forward-looking statements and actual results may be affected by the factors discussed in "Trends and Uncertainties Relating to the DLT & Storage Systems Group and Hard Disk Drive Group" in this report. In the future, the Company may seek to raise cash through the issuance of debt or equity securities. There can be no assurance that such financing would be available on terms favorable to the Company, if at all. Euro Impact The Company believes that the adoption of a single currency, the Euro, by eleven European countries has not and will not materially affect our business, information systems or consolidated financial position, operating results or cash flows. 21 Item 3. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Company's Annual Report on Form 10-K for the year ended March 31, 2000. The Company is exposed to equity price risk on its investment in TiVo, Inc. common stock. The Company does not attempt to reduce or eliminate its market exposure on this security. The Company entered into a strategic alliance with TiVo in fiscal year 1999 to supply hard disk drives utilizing Quantum's QuickView technology for integration into TiVo's Personal Video Recorder. At October 1, 2000, the fair market value of the Company's investment was approximately $17 million. As TiVo is a relatively new company and has introduced a new product in the consumer electronics market, the Company does not believe it is possible to reasonably estimate any future price movement of TiVo common stock. In addition, Quantum's operating results are expected to be affected by charges to be incurred in connection with the merger of HDDG and Maxtor and the November 8, 2000 DLTtape business plan. See "Trends and Uncertainties Relating to the DLT & Storage System Group and Hard Disk Drive Group." 22 Item 1. Financial Statements QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP CONDENSED COMBINED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended October 1, September 26, October 1, September 26, 2000 1999 2000 1999 -------- -------- -------- -------- Product revenue $311,887 $312,074 $625,110 $603,381 Royalty revenue 49,864 45,024 102,825 84,461 -------- -------- -------- -------- Total revenue 361,751 357,098 727,935 687,842 Cost of revenue 203,913 186,892 410,262 365,986 -------- -------- -------- -------- Gross profit 157,838 170,206 317,673 321,856 Operating expenses: Research and development 31,901 30,480 67,730 58,205 Sales and marketing 37,043 26,599 75,813 51,989 General and administrative 19,046 15,238 37,411 29,637 Purchased in-process research and development - 37,000 - 37,000 -------- -------- -------- -------- 87,990 109,317 180,954 176,831 Income from operations 69,848 60,889 136,719 145,025 Other income (expense): Interest income and other, net 3,839 3,687 10,161 10,170 Interest expense (4,494) (4,812) (9,013) (9,656) -------- -------- -------- -------- (655) (1,125) 1,148 514 Income before income taxes 69,193 59,764 137,867 145,539 Income tax provision 24,908 38,704 49,632 73,014 -------- -------- -------- -------- Net income $ 44,285 $ 21,060 $ 88,235 $ 72,525 ======== ======== ======== ======== Net income per share (1): Basic $0.30 $0.13 $0.60 $0.44 Diluted $0.29 $0.12 $0.57 $0.42 Weighted average common shares (1): Basic 146,230 165,377 148,274 166,019 Diluted 154,797 173,080 154,714 173,029 Net income for the period from August 4, 1999 to September 26, 1999 $ 12,497 $ 12,497 ======== ======== Net income per share: Basic $0.08 $0.08 Diluted $0.07 $0.07 Weighted average common shares: Basic 165,377 165,377 Diluted 173,080 173,080
(1) Basic and diluted net income per share and weighted average common shares for the three and six months ended September 26, 1999 are pro forma and assume the recapitalization occurred at the beginning of fiscal year 2000. See accompanying notes to condensed combined financial statements. 23 QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP CONDENSED COMBINED BALANCE SHEETS (In thousands)
October 1, March 31, 2000 2000 ---------- ---------- (unaudited) Assets ------ Current assets: Cash and cash equivalents $ 320,437 $ 336,720 Marketable securities - 2,032 Accounts receivable, net of allowance for doubtful accounts of $3,906 and $3,492 238,606 214,107 Inventories 103,485 101,478 Deferred taxes 54,668 54,669 Other current assets 57,162 38,424 ---------- ---------- Total current assets 774,358 747,430 Property and equipment, net of accumulated depreciation of $100,696 and $80,997 84,763 78,137 Intangible assets, net 238,732 248,288 Other assets 21,596 12,149 ---------- ---------- $1,119,449 $1,086,004 ========== ========== Liabilities and Group Equity ---------------------------- Current liabilities: Accounts payable $ 128,262 $ 94,596 Accrued warranty 55,862 52,593 Accrued compensation 35,920 36,379 Income taxes payable 48,303 - Accrued special charge 18,792 20,954 Current portion of long-term debt 783 689 Due to the Hard Disk Drive group - 30,100 Other accrued liabilities 27,682 27,749 ---------- ---------- Total current liabilities 315,604 263,060 Deferred taxes 30,992 13,578 Long-term debt 24,825 25,225 Convertible subordinated debt 191,667 191,667 Group equity 556,361 592,474 ---------- ---------- $1,119,449 $1,086,004 ========== ==========
See accompanying notes to condensed combined financial statements. 24 QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP CONDENSED COMBINED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Six Months Ended October 1, September 26, 2000 1999 ---------- ---------- Cash flows from operating activities: Net income $ 88,235 $ 72,525 Adjustments to reconcile net income to net cash provided by operations: Purchased in-process research and development - 37,000 Depreciation 19,244 15,377 Amortization 14,513 11,916 Deferred income taxes 2 (107) Compensation related to stock plans 7,165 1,096 Changes in assets and liabilities: Accounts receivable (24,499) 29,623 Inventories (2,007) 3,062 Accounts payable 33,666 17,904 Income taxes payable 48,303 - Accrued warranty 3,269 10,105 Other assets and liabilities (41,750) (21,371) --------- --------- Net cash provided by operating activities 146,141 177,130 --------- --------- Cash flows from investing activities: Investment in equity securities (9,343) - Maturities of marketable securities 2,032 - Purchases of marketable securities - (39) Acquisition of intangible assets - (2,500) Investment in property and equipment (23,527) (19,784) --------- --------- Net cash used in investing activities (30,838) (22,323) --------- --------- Cash flows from financing activities: Proceeds from long-term credit facilities - 6,667 Principal payments on long-term credit facilities (306) (12,334) Inter-group payment for common stock issued - (2,835) Purchases of treasury stock (146,251) (144,094) Proceeds from issuance of common stock, net 14,971 17,764 --------- --------- Net cash used in financing activities (131,586) (134,832) --------- --------- Increase (decrease) in cash and cash equivalents (16,283) 19,975 Cash and cash equivalents at beginning of period 336,720 272,643 --------- --------- Cash and cash equivalents at end of period $ 320,437 $ 292,618 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 8,946 $ 8,620 Income taxes $ 8,222 $ 3,866 Tangible and intangible assets acquired for shares of DSSG and HDDG common stock, net of cash acquired and liabilities assumed $ - $ 101,863
See accompanying notes to condensed combined financial statements. 25 QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The accompanying unaudited condensed combined financial statements of the DLT & Storage Systems group ("DSSG"), together with the condensed combined financial statements of the Hard Disk Drive group ("HDDG"), include all of the accounts in the condensed consolidated financial statements of Quantum. The separate group condensed combined financial statements give effect to the accounting policies applicable with the implementation of the tracking stock proposal. The separate DSSG and HDDG financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (i) the historical balance sheets, results of operations, and cash flows of businesses that comprise each of the groups, with all significant intragroup transactions and balances eliminated, (ii) in the case of DSSG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with DSSG, including allocated portions of Quantum's debt and selling, general and administrative costs, and (iii) in the case of HDDG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with HDDG, including allocated portions of Quantum's debt and selling, general and administrative costs. Intergroup transactions and balances are not eliminated in the separate financial statements of DSSG or HDDG. The condensed combined financial statements of the DLT & Storage Systems Group provide DSSG stockholders with financial information about the DLT & Storage Systems group operations. Holders of DSSG stock and HDDG stock are Quantum stockholders and are subject to all of the risks of an investment in Quantum and all of Quantum's businesses, assets and liabilities. Quantum retains ownership and control of all of the assets and operations of each group. Financial effects arising from one group that affect Quantum's consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the other group's stock. Any net losses of DSSG or HDDG, and dividends or distributions on, or repurchases of HDDG stock, or repurchases of preferred stock at a price per share greater than par value, will reduce the funds of Quantum legally available for payment of dividends on DSSG stock. As a result, DSSG's condensed combined financial statements should be read in conjunction with Quantum's condensed consolidated financial statements and HDDG's condensed combined financial statements. The condensed combined balance sheet as of March 31, 2000 has been derived from the audited financial statements of Quantum Corporation included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim financial statements reflect all adjustments, consisting only of normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. Certain prior period amounts have been reclassified to conform to the current period's presentation. 26 2. Inventories Inventories consisted of the following: (In thousands)
October 1, March 31, 2000 2000 ---------- -------- Materials and purchased parts $ 52,766 $ 41,819 Work in process 33,005 37,024 Finished goods 17,714 22,635 -------- -------- $103,485 $101,478 ======== ========
3. Net Income Per Share As a result of the recapitalization, net income per share for DSSG has been calculated based on the group's net income subsequent to August 3, 1999. It was not calculated on a group basis for periods prior to the recapitalization because DSSG stock was not part of Quantum's capital structure at that time. The following table sets forth the computation of basic and diluted net income per share for DSSG:
(In thousands, except per share data) Three Months Period from Six Months Ended August 4, 1999 Ended October 1, to September 26, October 1, 2000 1999 2000 ------------ ---------------- ------------ Numerator: Numerator for diluted net income per share - income available to common stockholders $ 44,285 $ 12,497 $ 88,235 ============ ================ ============ Denominator: Denominator for basic net income per share - weighted average shares 146,230 165,377 148,274 Effect of dilutive securities: Outstanding options 8,567 7,703 6,440 ------------ ---------------- ------------ Denominator for diluted net income per share - adjusted weighted average shares 154,797 173,080 154,714 ============ ================ ============ Basic net income per share $ 0.30 $ 0.08 $ 0.60 ============ ================ ============ Diluted net income per share $ 0.29 $ 0.07 $ 0.57 ============ ================ ============
The computation of diluted net income per share for DSSG for the three and six months ended October 1, 2000 and for the period August 4, 1999 through September 26, 1999, excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 6,206,152 shares of DSSG common stock, or 21.587 shares per $1,000 note, because the effect would have been antidilutive. 27 Options to purchase 13,845,438 shares of DSSG common stock were outstanding for the three and six months ended October 1, 2000, but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 4. Common Stock Repurchase During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of Quantum's common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock. An additional $100 million was authorized for repurchase of HDDG common stock. Under these authorizations, as of October 1, 2000, Quantum had repurchased a total of 3.9 million shares of Quantum common stock, 29.2 million shares of DSSG common stock and 13.5 million shares of HDDG common stock for a combined total of $566 million. During the first six months of fiscal year 2001, Quantum repurchased 13.5 million shares of DSSG common stock and 10 million shares of HDDG common stock for a combined total of $241 million. 5. Credit Line In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At October 1, 2000, there were no outstanding balances drawn on these lines. 6. Special Charge During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTtape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed asset write-offs, primarily related to the transfer of manufacturing to Penang, Malaysia, and $1.9 million in other costs associated with the plan. The facilities costs noted above include lease payments for vacant space in a facility in Colorado Springs, Colorado, the write-off of related leasehold improvements and manufacturing equipment, as well as the write-off of certain leasehold improvements at Quantum's facility in Penang, 28 Malaysia, as this space was converted to DSSG manufacturing. DSSG expects that the Colorado facility will be vacated by the end of fiscal year 2001. The write-off of investments reflects DSSG's decision to end its research on certain optical based storage solutions. As a result, DSSG has written-off an equity investment and technology licenses related to optical technology. DSSG currently expects a workforce reduction of approximately 900 employees. The reduction in force primarily affects employees at DSSG's manufacturing operations in Colorado Springs, Colorado, as well as administrative employees within the DLTtape Division. As of October 1, 2000, 294 employees have been terminated. DSSG anticipates that the remaining employees will be terminated by the end of the fourth quarter of fiscal year 2001. As of October 1, 2000, DSSG had incurred cash expenditures of $4 million associated with employee severance and benefits, facilities and other costs. DSSG expects to incur additional cash expenditures associated with the plan of approximately $14 million, which will be funded out of operations. The following table summarizes activity related to the special charge at October 1, 2000:
(In thousands) Severance And Facilities Fixed Other Benefits Costs Investments Assets Costs Total Special charge provision $ 7,646 $13,500 $ 13,908 $ 3,163 $ 1,866 $ 40,083 Cash payments (2,997) (85) -- -- (1,138) (4,220) Non-cash charges -- -- (13,908) (3,163) -- (17,071) ------- ------- -------- ------- ------- -------- Balance at October 1, 2000 $ 4,649 $13,415 $ -- $ -- $ 728 $ 18,792 ======= ======= ======== ======= ======= ========
7. Comprehensive Income Accumulated other comprehensive income included in group equity on the condensed combined balance sheets of the DLT & Storage System group consists of foreign currency translation adjustments. Total comprehensive income for the three months and six months ended October 1, 2000 and September 26, 1999 is presented in the following table:
(In thousands) Three Months Ended Six Months Ended --------------------------- -------------------------- October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ------------ --------- ------------ --------- Net income $ 44,285 $ 21,034 $ 88,235 $ 72,499 Other comprehensive income - Foreign currency translation adjustments (233) - (233) - -------- -------- -------- -------- Comprehensive income $ 44,052 $ 21,034 $ 88,002 $ 72,499 ======== ======== ======== ========
8. Subsequent Events 29 On October 3, 2000, Quantum entered into a definitive agreement with Maxtor Corporation to combine Maxtor and HDDG in an all-stock transaction. The merger agreement envisages that HDDG's stockholders will receive 1.52 shares of Maxtor common stock for every share of HDDG common stock they own. The transaction, which was unanimously approved by the Boards of Directors of both companies, is expected to be completed in early 2001. The transaction is expected to be tax- free to Quantum stockholders, this transaction is subject to stockholders and regulatory approval. If the combination is completed, a. Quantum's DLT & Storage Systems Group will operate as a legally separate, stand-alone company that will be known as Quantum Corporation; b. DSSG stockholders will receive on a one-for-one basis, shares of the then- independent company comprising all of the operations and assets of the Quantum DLT & Storage Systems Group; and c. DSSG intends to issue restricted stock to Quantum employees that become employees of the combined HDDG/Maxtor company, in exchange for the loss of unvested DSSG stock options held by such employees. As a result, Quantum is expected to incur substantial compensation charges if the combination is completed. These expectations are forward-looking statements and actual results may differ. On October 24, 2000 Quantum announced plans to make its server appliances subsidiary an independent, publicly-traded company called Snap Appliances, Inc. On October 30, 2000 Snap Appliances filed a registration statement with the Securities and Exchange Commission for the initial public offering ("IPO") of its common stock. Immediately following the IPO, Quantum will own at least 80% of Snap Appliances' outstanding common stock. Quantum intends to distribute these shares to DSSG stockholders subject to receiving a favorable IRS ruling and Board of Directors approval. After the IPO the remaining DSSG business will be comprised of two business groups, Enterprise Solutions and DLTtape. On November 8, 2000, Quantum announced plans to expand its product design and new product introduction resources for it's DLTtape group in Colorado. Under the plan, Quantum will move more than 100 engineering, marketing and administrative positions relating to the DLTtape business to Colorado from its Shrewsbury, MA facility. In addition, Quantum will create an Advanced Technology Development Lab in Shrewsbury that will focus on advancing future tape drive innovations. There will be substantial costs associated with this plan. DSSG is currently not able to quantify these costs. 30 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - DLT & Storage Systems Group This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements usually are phrased in the future tense or contain the words "estimate," "anticipate," "expect," or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties. These uncertainties could cause actual results to differ materially from those expected for the reasons set forth under Trends and Uncertainties relating to the DLT & Storage Systems group. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Business Overview The DLT & Storage Systems group ("DSSG") designs, develops, manufactures, licenses and markets DLTtape(TM) drives, DLTtape media cartridges and storage solutions. DSSG's storage solutions consist of DLTtape libraries, network attached storage solutions, solid state storage systems and service. Digital Linear Tape, or DLTtape, is DSSG's half-inch tape technology that is the industry standard for mid-range UNIX and NT system backup and archive applications. DSSG recently introduced a new family of tape drive products based on Super DLTtape technology, targeted to serve workgroup, mid-range and enterprise business needs. Super DLTtape technology is an extension of the DLTtape technology product set. Super DLTtape continues to build on generations of DLTtape success while ensuring compatibility with previous DLTtape formats. DSSG's tape libraries are part of our Enterprise Solutions business and serve the entire tape library data storage market from desktop computers to enterprise class computers. DSSG offers a broad line of automated tape libraries which are used to manage, store and transfer data in enterprise networked computing environments. DSSG is a leading provider of network attached storage, or NAS, solutions for workgroups. DSSG's NAS appliances offer a combination of interoperability, reliability, ease of use and cost-effectiveness that we believe is better suited to the storage needs of workgroups than other storage alternatives. Our Snap Server appliances utilize our optimized hardware and proprietary operating system, the Snap OS, to enable our customers to add additional storage capacity to a network quickly, inexpensively and conveniently. The target end-users for Snap Server appliances are workgroups within small to large organizations and application service providers and Internet service providers. 31 DLTtape drives store data on DLTtape media cartridges. Historical use of DLTtape drives has shown that drives use many media cartridges per year. DSSG's DLTtape media cartridges are manufactured and sold by licensed third party manufacturers. DSSG receives a royalty fee on DLTtape media cartridges sold by its licensees which, while resulting in lower revenue than DLTtape media sold directly by DSSG, generates comparable income from operations. DSSG prefers to sell a substantial portion of DLTtape media cartridge through its license model because this minimizes DSSG's operational risks and expenses and provides an efficient distribution channel. Currently, approximately 85% of media sales occur through this license model. On October 24, 2000 Quantum announced plans to make its server appliances subsidiary an independent, publicly-traded company called Snap Appliances, Inc. On October 30, 2000 Snap Appliances filed a registration statement with the Securities and Exchange Commission for the initial public offering ("IPO") of its common stock. Immediately following the IPO, Quantum will own at least 80% of Snap Appliances' outstanding common stock. Quantum intends to distribute these shares to DSSG stockholders subject to receiving a favorable IRS ruling and Board of Directors approval. After the IPO the remaining DSSG business will be comprised of two business groups, Enterprise Solutions and DLTtape. On November 8, 2000, Quantum announced plans to expand its product design and new product introduction resources for its DLTtape Group in Colorado. Under the plan, Quantum will move more than 100 engineering, marketing and administrative positions relating to the DLTtape business to Colorado from its Shrewsbury, MA facility. In addition, Quantum will create an Advanced Technology Development Lab in Shrewsbury that will focus on advancing future tape drive innovations. There will be costs associated with this plan. DSSG is currently not able to quantify these costs. Products The DLT & Storage Systems group's products include: DLT: ---- . Super DLTtape (TM) drives. DSSG recently introduced a new family of tape drive products based on Super DLTtape technology, targeted to serve workgroup, mid-range and enterprise business needs. The mid-range market including workgroup and department servers, large corporate departments and mid-size automated libraries will see a drive with a native capacity of 110GB (220GB compressed) and a sustained transfer rate of 11MB per second (22MB compressed). In response to high performance enterprise needs, DSSG also offers a Super DLTtape drive with a sustained transfer rate of greater than 16MB per second (32MB compressed). Super DLTtape drives are expected to begin volume shipment in the second half of calendar year 2000. . DLTtape drives. DSSG currently offers three tape drive products--the DLT8000, the DLT7000 and the DLT4000. The DLT8000 provides a combination of 40GB of native capacity (80GB compressed) and a sustained data transfer rate of 6MB per second (12MB compressed). The DLT7000 provides a combination of 35GB of native capacity (70GB compressed) and a sustained data transfer rate of 5MB per second (10MB compressed). The DLT4000 provides a combination of 20GB of native capacity (40GB compressed) and a sustained data transfer rate of 1.5MB per second (3MB compressed). 32 . DLTtape media cartridges. The DLTtape family of half-inch tape media cartridges is designed and formulated specifically for use with DLTtape drives. The capacity of a DLTtape media cartridge is up to 40GB (80GB compressed). DSSG's half-inch tape cartridges take advantage of shorter wavelength recording schemes to ensure read compatibility with future generations of DLTtape drives. The tape itself features a special high- grade metal particle formula that reduces tape and head wear. The result is tape that delivers a proven one million passes with a negligible impact on soft error rates and a 30-year archival life. DSSG has qualified the one supplier of Super DLTtape media and is currently qualifying others; the tape will include enhanced features to support Super DLTtape products. Storage Solutions: ------------------ . Tape libraries. DSSG offers a broad line of automated DLTtape libraries that support a wide range of back-up and archival needs from workgroup servers to enterprise-class servers. DSSG's tape libraries range from its tape autoloaders which accommodate a single DLTtape drive and up to 280GB of storage capacity to the P6000 series library which features Prism Library Architecture(TM) and can be configured in multiple units to scale up to 22.8 terabytes of storage capacity. In addition, DSSG offers WebAdmin(TM), the industry's first Internet browser-based tape library management system, allowing system administrators to monitor widely distributed storage systems at remote locations with point-and-click ease. . Network attached storage solutions. DSSG's Snap! Server(TM) family of network attached storage appliances, include the Snap Server 1000, Snap Server 2000, and Snap Server 4100, including storage capacities ranging from 15GB to 240GB. Snap Servers connect directly to a network and can be easily and seamlessly integrated with other network devices. To install a Snap Server, a user simply connects the appliance to a network and a power source and then turns on the appliance. The entire installation process should take less than five minutes and does not require an information technology professional. The Snap OS includes a file system that can simultaneously function in a variety of operating environments, including Apple MacOS, Linux, Microsoft Windows, Novell Netware and UNIX. The Snap hardware includes motherboards with standard components, hard disk drives, memory and processors. The Snap Server 1000 features 15GB or 30 GB of storage capacity, one disk drive, and a 3.5 pound desktop or portable form factor. The Snap Server 2000 features 60 GB of storage capacity, two disk drives, desktop form factor, and RAID 0, 1. The Snap Server 4100 features 120 GB or 240 GB of storage capacity, four disk drives, 1U rack form factor, and RAID 0, 1, 5. . LANvault(TM) tape backup appliance. LANvault is a backup appliance with a DLTtape library, a central management console and a customer service Web portal. This product is intended to meet the requirements for remote site backup and is designed as a workgroup backup solution appliance preloaded with industry-standard backup software for ease of installation and use. . Solid state storage systems. DSSG offers two families of solid state storage systems--the Rushmore(TM) Ultra series and the Rushmore eSystem Accelerators. The Rushmore Ultra Solid State Disks are available in capacities ranging from 268MB to 3.2GB and have data access times of less than 50 microseconds, 100 to 200 times faster than magnetic hard disk drives. 33 The Rushmore eSystem Accelerator is a comprehensive set of hardware, tools, services and consulting bundled into one package. With capacities ranging from 536MB to 3.2GB, the Rushmore eSystem Accelerator delivers data access times of less than 25 microseconds, more than 18,000 accesses to information per second for time-critical applications. Results of Operations Revenue. Revenue for DSSG in the three and six months ended October 1, 2000 was $362 million and $728 million, respectively, compared to $357 million and $688 million, respectively, for the corresponding periods in fiscal year 2000. The increase in revenue reflected increased sales of DLTtape libraries and Snap Servers, and increased DLTtape media royalties. Sales of tape libraries reached a record high in the second quarter of fiscal year 2001. Sales of Snap Server network attached storage appliances also reached a record high without comparable sales in the prior year period as DSSG's sales of Snap Servers followed the acquisition of Meridian in September 1999. The increase in units of DLTtape media cartridges sold reflects sales of cartridges for use in both new DLTtape drives and to meet the ongoing new media needs of the installed base of DLTtape drives that remain in use. The increase in DLTtape media royalties reflected an increase in the sales of DLTtape media cartridges by licensed media manufacturers for which DSSG earns a royalty fee. Revenue from sales of DLTtape drives declined. The decrease in DLTtape drive revenue reflected an increase in shipments, offset by a decline in average unit prices due to competitive pricing. The table below summarizes the components of DSSG's revenue in the three months and six months ended October 1, 2000 and September 26, 1999, respectively:
(in millions) Three Months Ended Six Months Ended --------------------------- -------------------------- October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ------------ --------- ------------ --------- DLT drives $199 $219 $411 $438 DLT media 34 36 62 64 DLT royalty 50 45 103 84 Storage systems 109 82 209 149 Intra-group elimination* (30) (25) (57) (47) ---- ---- ---- ---- Revenue $362 $357 $728 $688 ==== ==== ==== ====
*Represents intra-group sales of DLTtape drives for incorporation into DSSG's tape libraries. Sales to the top five customers in the three and six months ended October 1, 2000 represented 46% and 47% of revenue, respectively, compared to 47% and 48% of revenue, respectively, for the corresponding periods in fiscal year 2000. Sales to Compaq were 17% and 18% of revenue, in the three and six months ended October 1, 2000, respectively, compared to 18% and 20% of revenue, respectively, in the corresponding periods in fiscal year 2000. Sales to Hewlett-Packard were 13% 34 and 12% of revenue in the three and six months ended October 1, 2000, respectively, compared to 16% and 15% of revenue, respectively, in the corresponding periods in fiscal year 2000. Sales to computer equipment manufacturers and distribution channel customers were 59% and 17% of revenue, respectively, in the three months ended October 1, 2000, compared to 62% and 18% of revenue, respectively, in the three months ended September 26, 1999. For the six months ended October 1, 2000, computer manufacturer and distribution channel sales were 61% and 16% of revenue, respectively, compared to 65% and 15% of revenue, respectively, in the corresponding period of fiscal year 2000. The remaining revenue in the three and six months ended October 1, 2000 represented media royalty revenue, sales to value-added resellers and direct sales and in the three and six months ended September 26, 1999, represented media royalty revenue and sales to value-added resellers. Gross Margin Rate. The gross margin rate in the three months ended October 1, 2000, was 43.6%, compared to 47.7% in the three months ended September 26, 1999. The gross margin rate for the first six months of fiscal year 2001 was 43.6% compared to 46.8% for the corresponding period in fiscal year 2000. The decrease reflected lower DLTtape drive margins as a result of price declines, partially offset by an increase in the proportion of overall revenue represented by DLTtape media royalty revenue. Research and Development Expenses. Research and development expenses in the three and six months ended October 1, 2000, were $32 million, or 8.8% of revenue, and $68 million, or 9.3% of revenue, respectively, compared to $30 million, or 8.5% of revenue, and $58 million, or 8.5% of revenue, respectively, in the corresponding periods of fiscal year 2000. The increase in research and development expenses reflected the inclusion of Snap Appliances expenses, which were not comparatively included in the prior year periods as the acquisition occurred on September 10, 1999. Sales and Marketing Expenses. Sales and marketing expenses in the three and six months ended October 1, 2000, were $37 million, or 10.2% of revenue, and $76 million, or 10.4% of revenue, respectively, compared to $27 million, or 7.5% of revenue, and $52 million, or 7.6% of revenue, respectively, in the corresponding periods of fiscal year 2000. The increase in sales and marketing expenses reflected the inclusion of Snap Appliances expenses and an increase in sales and marketing costs associated with the expansion of ATL's infrastructure. Spending increased as DSSG continued to build both category awareness for NAS applications and brand awareness for the Snap! Server line. General and Administrative Expenses. General and administrative expenses in the three and six months ended October 1, 2000, were $19 million, or 5.3% of revenue, and $37 million, or 5.1% of revenue, respectively, compared to $15 million, or 4.3% of revenue, and $30 million, or 4.3% of revenue, respectively, in the corresponding periods of fiscal year 2000. The increase in general and administrative expenses reflected the inclusion of Snap Appliances expenses, which were not comparatively included in the prior year periods as the acquisition occurred on September 10, 1999, and increased expenses associate with DLTtape libraries. Purchased In-process Research and Development Expense. DSSG expensed purchased in-process research and development of $37 million, as a result of the Meridian acquisition in the second quarter ended September 26, 1999. 35 Special Charge. During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTtape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed asset write-offs, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. DSSG is proceeding according to plan and expects to realize annual cost savings from the plan of approximately $40 million beginning upon full implementation of the plan at the end of fiscal year 2001. Approximately $30 million of the savings are expected in cost of revenue as a result of reduced manufacturing costs with the remaining amount in operating expenses, primarily research and development, as a result of ending research on certain optical-based storage solutions. As compared to fiscal year 2000, DSSG expects operating expenses to increase because of increased investments in storage systems products and marketing in fiscal year 2001 and as a result of including the Snap Appliances' operations for a full year following the acquisition of Meridian in September 1999. These expectations are forward-looking statements and actual results may differ. Interest and Other Income/Expense. Net interest and other income/expense for the three and six months ended October 1, 2000 was $0.7 million expense and $1.1 million income, respectively, compared to $1.1 million expense and $0.5 million income, respectively, for the corresponding periods of fiscal year 2000. The lower net expense for the three month period, and the higher net income for the six month period reflected increased interest income as a result of higher average cash balances. Income Taxes. DSSG's effective tax rate for the three and six months ended October 1, 2000 and September 26, 1999 was 36% and 40%, respectively. The decrease in the fiscal year 2001 effective tax rate reflects an increased percentage of foreign earnings taxed at less than the U.S. rate. Liquidity and Capital Resources DSSG cash, cash equivalents and marketable securities were $320 million at October 1, 2000 compared to $339 million at March 31, 2000. DSSG used cash in the six months ended October 1, 2000 to purchase $146 million of treasury stock, as discussed below. Other uses of cash included approximately $24 million for investments in property and equipment. DSSG generated cash from operations of $146 million, primarily reflecting net income, increases in income taxes payable and accounts payable, partially offset by increases in other assets and accounts receivable. Other sources of cash included $15 million from the issuance of common stock. During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of Quantum's common stocks in open market or private transactions. Of the total 36 repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock. An additional $100 million was authorized for repurchase of HDDG common stock. Under these authorizations, as of October 1, 2000, Quantum had repurchased a total of 3.9 million shares of Quantum common stock, 29.2 million shares of DSSG common stock and 13.5 million shares of HDDG common stock for a combined total of $566 million. During the first six months of fiscal year 2001, Quantum repurchased 13.5 million shares of DSSG common stock and 10 million shares of HDDG common stock for a combined total of $241 million. In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At October 1, 2000, there were no outstanding balances drawn on these lines. DSSG expects to spend approximately $60 million in fiscal year 2001 for capital equipment and leasehold improvements. These capital expenditures will support the introduction and manufacturing of Super DLTtape products; manufacturing DLTtape drives in its new location, Penang, Malaysia; and DSSG's general infrastructure. DSSG believes that its existing capital resources, including the credit facilities and any cash generated from operations, will be sufficient to meet all currently planned expenditures and sustain operations for the next 12 months. However, this belief assumes that operating results and cash flow from operations will meet DSSG's expectations. In the future, Quantum may seek to raise cash through the issuance of debt or equity securities. There can be no assurance that such financing would be available on terms favorable to Quantum, if at all. Trends and Uncertainties Relating to the DLT & Storage Systems Group Holders of DSSG stock remain stockholders of Quantum Corporation, which, prior to the completion of the merger of HDDG and Maxtor, includes common stock of HDDG, and therefore, financial effects on HDDG could adversely affect DSSG. Holders of DSSG stock and HDDG stock are stockholders of a single company. DSSG and HDDG are not separate legal entities. As a result, stockholders will continue to be subject to all of the risks of an investment in Quantum and all of its businesses, assets and liabilities. The issuance of DSSG stock and HDDG stock and the allocation of assets and liabilities and stockholders' equity between DSSG and HDDG did not result in a distribution or spin-off to stockholders of any Quantum assets or liabilities and did not affect ownership of our assets or responsibility for our liabilities or those of our subsidiaries. The assets we attribute to one group could be subject to the liabilities of the other group, whether such liabilities arise from lawsuits, contracts or indebtedness that we attribute to the other group. If we are unable to satisfy one group's liabilities out of the assets we attribute to it, we may be required to satisfy those liabilities with assets we attribute to the other group. Financial effects from one group that affect our consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other 37 group and the market price of the tracking stock relating to the other group. In addition, net losses of either group and dividends and distributions on, or repurchases of, either class of tracking stock or repurchases of preferred stock at a price per share greater than par value will reduce the funds we can pay on each class of tracking stock under Delaware law. For these reasons, you should read our consolidated financial information with the financial information we provide for each group. If the contemplated combination of the HDDG business with Maxtor is not successfully completed, this could have a negative impact on Quantum's results of operations. Though Quantum has publicly announced that it currently intends to combine its HDDG business with Maxtor, the transaction remains subject to the approval of Maxtor and Quantum stockholders, expiration or termination of the applicable Hart-Scott-Rodino waiting periods, approval by the European regulatory authorities, and other customary conditions. If the transaction is not consummated, Quantum's results of operations could be negatively impacted due to, among other things, market, customer and employee perception of the terminated transaction. Competition may increase in the tape drive market as a result of large competitors introducing tape drive products based on new technology standards. DSSG competes with companies that develop, manufacture, market and sell tape drive products. DSSG's principal competitors include Exabyte Corporation, Hewlett-Packard, Seagate Technology, Inc., Sony Corporation and Storage Technology Corporation. These competitors are aggressively trying to develop new tape drive technologies to compete more successfully with products based on DLTtape technology. Hewlett-Packard, IBM Corporation and Seagate have formed a consortium to develop new linear tape drive products. DSSG expects products based on this developing technology standard to target the high-capacity data back-up market and to compete with DSSG's products based on Super DLTtape technology. Such competition could have a material adverse impact on DSSG's operating results. DSSG's operating results depend on new product introductions, which may not be successful. To compete effectively, DSSG must improve existing products and introduce new products, such as products based on Super DLTtape technology and network attached storage appliances. DSSG cannot assure you that: . It will introduce any of these new products in the time frame DSSG currently forecasts; 38 . It will not experience technical or other difficulties that could prevent or delay the introduction of these new products; . Its new products will achieve market acceptance; . Its new products will be successfully or timely qualified with DSSG's customers by meeting customer performance and quality specifications. A successful and timely customer qualification must occur before customers will place large product orders; or . It will achieve high volume production of these new products in a timely manner, if at all. These risks are magnified because DSSG expects that technological changes, changes in customer requirements and increasing competition could result in declining sales and gross margins on its existing products. Reliance on a limited number of third-party suppliers could result in significantly increased costs and delays in the event these suppliers experience shortages or quality problems. DSSG depends on a limited number of suppliers for components and sub-assemblies, including recording heads, media cartridges and integrated circuits, all of which are essential to the manufacture of DLTtape drives and tape libraries. DSSG currently purchases the DLTtape media cartridges it sells primarily from Fuji Photo Film Co., Ltd. and Hitachi Maxell, Ltd. DSSG cannot assure you that Fuji or Maxell will continue to supply an adequate number of high quality media cartridges in the future. If component shortages occur, or if DSSG experiences quality problems with component suppliers, shipments of products could be significantly delayed and/or costs significantly increased. In addition, DSSG qualifies only a single source for many components and sub-assemblies, which magnifies the risk of future shortages. DSSG's main supplier of tape heads is located in China. Political instability, trade restrictions, changes in tariff or freight rates or currency fluctuations in China could result in increased costs, delays in shipment and could have an adverse impact on DSSG's operating results. DSSG's quarterly operating results could fluctuate significantly and past quarterly operating results should not be used to predict future performance. DSSG's quarterly operating results have fluctuated significantly in the past and could fluctuate significantly in the future. As a result, you should not use DSSG's past quarterly operating results to predict future performance. Quarterly operating results could be adversely affected by: . An inadequate supply of DLTtape media cartridges; . Customers canceling, deferring or rescheduling significant orders as a result of excess inventory levels or other factors; . Declines in network server demand; 39 . Failure to complete shipments in the last month of a quarter during which a substantial portion of DSSG's products are typically shipped; or . Increased competition. A majority of sales come from a few customers and these customers have no minimum or long-term purchase commitments. DSSG's sales are concentrated with a few customers. Customers are not obligated to purchase any minimum product volume and DSSG's relationships with its customers are terminable at will. The loss of, or a significant change in demand from, one or more key customers could materially adversely impact DSSG's operating results. Unpredictable end-user demand, combined with the computer equipment manufacturer trend toward carrying minimal inventory levels, increases the risk that DSSG will manufacture and custom configure too much or too little inventory for particular customers. Significant excess inventory could result in inventory write-downs and losses, while inventory shortages could adversely impact DSSG's relationship with its customers, either of which could adversely impact DSSG's operating results. DSSG does not control licensee pricing or licensee sales of DLTtape media cartridges and as a result DSSG's royalty revenue may decline. DSSG receives a royalty fee based on sales of DLTtape media cartridges by Fuji and Maxell. Under DSSG's license agreements with Fuji and Maxell, each of the licensees determines the pricing and number of units of DLTtape media cartridges sold by it. In addition, other companies may begin to sell DLTtape media cartridges under license agreements. As a result, DSSG's royalty revenue will vary depending upon the level of sales and prices set by Fuji, Maxell and potentially other licensees. In addition, lower licensee pricing could require DSSG to lower its prices on direct sales of DLTtape media cartridges, which would adversely impact DSSG's margins for this product. The HDDG merger could result in substantial compensation charges to Quantum In connection with the merger of HDDG and Maxtor Corporation, DSSG intends to issue restricted stock to Quantum employees that become employees of the combined HDDG/Maxtor company, in exchange for the loss of unvested DSSG stock options held by such employees. Quantum is expected to incur compensation charges. As a result the historical financial information for Quantum's DSSG business may not be representative of what its future results will be. Quantum is currently not able to quantify these compensation charges to be incurred. The November 8, 2000 DLTtape business plan could result in charges to DSSG. The plan of the DLTtape business involves the relocation of more than 100 employees from the Massachusetts to Colorado facility and the creation of a new Advanced Technology Development Lab in Massachusetts. There will be costs associated with these activities which have not yet been quantified. Third party infringement claims could result in substantial liability and significant costs. 40 From time to time, third parties allege DSSG's infringement of and need for a license under their patented or other proprietary technology. Adverse resolution of any third party infringement claim could subject DSSG to substantial liabilities and require it to refrain from manufacturing and selling certain products. In addition, the costs incurred in intellectual property litigation can be substantial, regardless of the outcome. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in Quantum's Annual Report on Form 10-K for the year ended March 31, 2000. In addition, Quantum's operating results are expected to be affected by charges to be incurred in connection with the merger of HDDG and Maxtor and the November 8, 2000 DLTtape business plan. See "Trends and Uncertainties Relating to the DLT & Storage System Group." 41 Item 1. Financial Statements QUANTUM CORPORATION HARD DISK DRIVE GROUP CONDENSED COMBINED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited)
Three Months Ended Six Months Ended October 1, September 26, October 1, September 26, 2000 1999 2000 1999 -------- -------- -------- -------- Revenue $823,667 $ 768,214 $1,687,360 $1,520,705 Cost of revenue - on net sales 756,452 745,989 1,499,505 1,470,211 Cost of revenue - special charge (benefit) (15,825) 57,068 (15,825) 57,068 -------- --------- ---------- ---------- Gross profit (loss) 83,040 (34,843) 203,680 (6,574) Operating expenses: Research and development 59,910 61,973 118,160 124,681 Sales and marketing 24,171 28,860 51,887 56,691 General and administrative 16,356 15,332 32,632 30,077 Special charge (benefit) (90) 2,338 (90) 2,338 -------- --------- ---------- ---------- 100,347 108,503 202,589 213,787 Income (loss) from operations (17,307) (143,346) 1,091 (220,361) Other income (expense): Interest income and other, net 6,998 3,423 15,053 9,387 Interest expense (2,443) (2,406) (4,675) (4,770) -------- --------- ---------- ---------- 4,555 1,017 10,378 4,617 Income (loss) before income taxes (12,752) (142,329) 11,469 (215,744) Income tax provision (benefit) (4,081) (58,642) 3,670 (88,873) -------- --------- ---------- ---------- Net income (loss ) $ (8,671) $ (83,687) $ 7,799 $ (126,871) ======== ========= ========== ========== Net income (loss) per share (1) : Basic $(0.11) $ (1.01) $0.10 $ (1.53) Diluted $(0.11) $ (1.01) $0.09 $ (1.53) Weighted average common shares (1) : Basic 77,336 82,883 79,390 83,107 Diluted 77,336 82,883 85,533 83,107 Net loss for the period from August 4, 1999 to September 26, 1999 $ (49,650) $ (49,650) ========= ========== Net loss per share: Basic $ (0.60) $ (0.60) Diluted $ (0.60) $ (0.60) Weighted average common shares: Basic 82,883 82,883 Diluted 82,883 82,883
(1) Basic and diluted net income (loss) per share and weighted average common shares for the three and six months ended September 26, 1999 are pro forma and assume the recapitalization occurred at the beginning of fiscal year 2000. See accompanying notes to condensed combined financial statements. 42 QUANTUM CORPORATION HARD DISK DRIVE GROUP CONDENSED COMBINED BALANCE SHEETS (In thousands)
October 1, March 31, 2000 2000 ---------- ---------- (unaudited) Assets ------ Current assets: Cash and cash equivalents $ 475,067 $ 581,542 Marketable securities 16,814 30,048 Accounts receivable, net of allowance for doubtful accounts of $18,732 and $19,618 380,432 395,118 Inventories 140,269 122,347 Due from the DLT & Storage Systems group - 30,100 Deferred taxes 84,008 78,713 Other current assets 57,960 58,356 ---------- ---------- Total current assets 1,154,550 1,296,224 Property and equipment, net of accumulated depreciation of $221,462 and $218,674 147,646 158,548 Intangible assets, net 274 1,915 Other assets 36,100 21,361 ---------- ---------- $1,338,570 $1,478,048 ========== ========== Liabilities and Group Equity ---------------------------- Current liabilities: Accounts payable $ 307,786 $ 375,614 Accrued warranty 41,125 46,967 Accrued compensation 39,480 54,073 Income taxes payable 25,222 44,284 Accrued special charge 5,746 22,409 Current portion of long-term debt 392 344 Other accrued liabilities 147,867 77,596 ---------- ---------- Total current liabilities 567,618 621,287 Deferred taxes 40,525 41,758 Long-term debt 12,412 12,613 Convertible subordinated debt 95,833 95,833 Group equity 622,182 706,557 ---------- ---------- $1,338,570 $1,478,048 ========== ==========
See accompanying notes to condensed combined financial statements. 43 QUANTUM CORPORATION HARD DISK DRIVE GROUP CONDENSED COMBINED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Six Months Ended October 1, September 26, 2000 1999 ---------- ------------- (unaudited) Net income (loss) $ 7,799 $(126,871) Adjustments to reconcile net income (loss) to net cash used in operations: Special charge - 58,385 Depreciation 25,463 33,119 Amortization 2,096 1,956 Deferred income taxes (1,233) 512 Compensation related to stock plans 3,267 544 Changes in assets and liabilities: Accounts receivable 14,686 25,040 Inventories (17,922) (3,608) Accounts payable (67,828) (49,024) Income taxes payable (19,062) (7,407) Accrued warranty (5,842) 5,563 Other assets and liabilities (6,942) (15,601) --------- ------------- Net cash used in operating activities (65,518) (77,392) --------- ------------- Cash flows from investing activities: Investment in equity securities (14,010) - Purchases of marketable securities - (33,367) Maturities of marketable securities - 33,314 Proceeds from disposition of property & equipment 2,831 - Investment in property and equipment (14,093) (30,125) --------- ------------- Net cash used in investing activities (25,272) (30,178) --------- ------------- Cash flows from financing activities: Proceeds from long-term credit facilities - 3,333 Principal payments on long-term credit facilities (153) (6,167) Inter-group proceeds for common stock issued - 2,835 Purchases of treasury stock (94,597) (1,558) Proceeds from factoring 70,000 - Proceeds from issuance of common stock, net 9,065 5,794 --------- ------------- Net cash provided by (used in) financing activities (15,685) 4,237 --------- ------------- Decrease in cash and cash equivalents (106,475) (103,333) Cash and cash equivalents at beginning of period 581,542 499,725 --------- ------------- Cash and cash equivalents at end of period $ 475,067 $ 396,392 ========= ============= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 4,539 $ 4,361 Income taxes, net of (refunds) $ (5,861) $ 14,475
See accompanying notes to condensed combined financial statements. 44 QUANTUM CORPORATION HARD DISK DRIVE GROUP NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (unaudited) 1. Basis of Presentation The accompanying unaudited condensed combined financial statements of the Hard Disk Drive group ("HDDG"), together with the condensed combined financial statements of the DLT & Storage Systems group ("DSSG"), include all of the accounts in the condensed consolidated financial statements of Quantum. The separate group condensed combined financial statements give effect to the accounting policies applicable with the implementation of the tracking stock proposal. The separate HDDG and DSSG financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (i) the historical balance sheets, results of operations, and cash flows of businesses that comprise each of the groups, with all significant intragroup transactions and balances eliminated, (ii) in the case of HDDG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with HDDG, including allocated portions of Quantum's debt and selling, general and administrative costs, and (iii) in the case of DSSG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with DSSG, including allocated portions of Quantum's debt and selling, general and administrative costs. Intergroup transactions and balances are not eliminated in the separate financial statements of HDDG or DSSG. The condensed combined financial statements of the Hard Disk Drive group provide HDDG stockholders with financial information about the Hard Disk Drive group operations. Holders of HDDG stock and DSSG stock are Quantum stockholders and are subject to all of the risks of an investment in Quantum and all of Quantum's businesses, assets and liabilities. Quantum retains ownership and control of all of the assets and operations of each group. Financial effects arising from one group that affect Quantum's consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the other group's stock. Any net losses of HDDG or DSSG, and dividends or distributions on, or repurchases of DSSG stock, or repurchases of preferred stock at a price per share greater than par value, will reduce the funds of Quantum legally available for payment of dividends on HDDG stock. As a result, HDDG's condensed combined financial statements should be read in conjunction with Quantum's condensed consolidated financial statements and DSSG's condensed combined financial statements. The condensed combined balance sheet as of March 31, 2000 has been derived from the audited financial statements of Quantum Corporation included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim financial statements reflect all adjustments, consisting only of normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. Certain prior period amounts have been reclassified to conform to the current period's presentation. 45 2. Securitized Assets HDDG has an asset securitization program with Capital Factors Inc., under which we sell them our eligible accounts receivable, on a with recourse basis. At October 1, 2000, $70 million of our accounts receivable were securitized under the program. Given the with recourse nature of the arrangement, the securitized accounts receivable are included within the accounts receivable balance, with the corresponding credit being included in other liabilities. 3. Inventories Inventories consisted of the following: (In thousands)
October 1, March 31, 2000 2000 ----------- --------- Materials and purchased parts $ 4,008 $ 7,387 Work in process 4,222 5,299 Finished goods 132,039 109,661 -------- -------- $140,269 $122,347 ======== ========
4. Net Income (Loss) Per Share As a result of the recapitalization, net income (loss) per share for HDDG has been calculated based on the group's net income (loss) subsequent to August 3, 1999. It was not calculated on a group basis for periods prior to the recapitalization because HDDG stock was not part of Quantum's capital structure at that time. The following table sets forth the computation of basic and diluted net income (loss) per share for HDDG:
(In thousands, except per share data) Three Months Period from Six Months Ended August 4, 1999 to Ended October 1, September 26, October 1, 2000 1999 2000 -------------- ------------------- ------------ Numerator: Numerator for diluted net income (loss) per share - income (loss) available to common stockholders $(8,671) $(49,650) $ 7,799 ============== =================== ============ Denominator: Denominator for basic net income (loss) per share - weighted average shares 77,336 82,883 79,390 Effect of dilutive securities: Outstanding options - - 6,143 -------------- ------------------- ------------ Denominator for diluted net income (loss) per share - adjusted weighted average shares 77,336 82,883 85,533 ============== =================== ============ Basic net income (loss) per share $( 0.11) $ (0.60) $ 0.10 ============== =================== ============ Diluted net income (loss) per share $( 0.11) $ (0.60) $ 0.09 ============== =================== ============
46 The computation of diluted net income (loss) per share for the three and six months ended October 1, 2000, and for the period August 4, 1999 through September 26, 1999, excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 3,103,076 shares of HDDG common stock, or 10.793 shares per $1,000 note, because the effect would have been antidilutive. Options to purchase 18,723,101 and 15,234,101 shares of HDDG common stock were outstanding at October 1, 2000 and September 26, 1999, respectively. However, the corresponding weighted average outstanding options were not included in the computation of diluted net loss per share for HDDG for the three months ended October 1, 2000, and the period August 4, 1999 through September 26, 1999, because the effect would have been antidilutive. Options to purchase 7,360,119 shares of HDDG common stock were outstanding for the six months ended October 1, 2000, but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 5. Common Stock Repurchase During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of its common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock. An additional $100 million was authorized for repurchase of HDDG common stock. Under these authorizations, as of October 1, 2000, Quantum had repurchased a total of 3.9 million shares of Quantum common stock, 29.2 million shares of DSSG common stock and 13.5 million shares of HDDG common stock for a combined total of $566 million. During the first six months of fiscal year 2001, Quantum repurchased 13.5 million shares of DSSG common stock and 10 million shares of HDDG common stock for a combined total of $241 million. 6. Credit Line In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At October 1, 2000, there were no outstanding balances drawn on these lines. 7. Litigation On August 7, 1998, Quantum was named as one of several defendants in a patent infringement lawsuit filed in the U.S. District Court for the Northern District of Illinois, Eastern Division. The plaintiff, Papst Licensing GmbH, owns at least 24 U.S. patents which it asserts that Quantum has infringed. Quantum has studied many of these patents before and, of the patents it has studied believes that defenses of patent invalidity and non-infringement can be asserted. However, Quantum has not completed a full study of all the patents asserted by Papst and there can be no assurance that Quantum has not infringed these or other patents owned by Papst. In October, 1999 the case was transferred to a federal district court in New 47 Orleans, Louisiana, where it has been joined with suits brought against Papst by Hewlett-Packard, Maxtor Corporation and Minebea Company, Ltd. for the purposes of coordinated discovery under multi-district litigation rules. Hewlett-Packard settled its dispute in April, 2000 with Papst and has withdrawn from the litigation. To date, discovery has not begun to any significant extent. Quantum does not believe that the transfer will affect the final disposition of this matter in a significant way. The final results of this litigation, as with any litigation, are uncertain. In addition, the costs of engaging in litigation with Papst will be substantial. Quantum is also subject to other legal proceedings and claims that arise in the ordinary course of its business. For example, in fiscal year 2000, Discovision Associates brought patents they hold to Quantum's attention. While management currently believes the amount of ultimate liability, if any, with respect to these actions will not materially affect the financial position, results of operations, or liquidity of Quantum, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur, the impact could be material to Quantum. 8. Special Charge During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with streamlining HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in the customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to streamlining the global logistics model and changes in customer service strategy, $7.8 million in severance and benefits for terminated employees, and approximately $12 million in other costs associated with the plan. The facilities costs noted above include lease payments on facilities to be vacated in and around Milpitas, California and Singapore, the write-off of related leasehold improvements, and other maintenance expenses associated with the vacated facilities. HDDG expects that the affected facilities will be vacated by the end of the third quarter of fiscal year 2001. Subsequent to the end of the second quarter fiscal year 2000, HDDG revised its estimate of costs required to implement the restructuring plan. HDDG estimated that severance and benefits, inventory and other costs, which included the disposition of additional capital assets, would be more than previously estimated as a result of the planned changes in the customer service strategy. HDDG also estimated that costs associated with vacating leased facilities would be less than previously estimated as a result of disposing of a major facility earlier than previously expected. Accordingly, HDDG reallocated amounts between these categories during the second half of fiscal year 2000. In the second quarter of fiscal year 2001, HDDG reversed $15.9 million as a special charge benefit on the income statement. This reversal was primarily due to negotiated lease cancellations and reduced severance and benefits due to the redeployment of certain employees. 48 In connection with the charge, HDDG currently expects a workforce reduction of approximately 513 employees, down from the original expectation of 600 employees. In addition, approximately 100 open and budgeted positions have been eliminated. The reduction in force primarily affects employees at HDDG's drive configuration centers and warehouses in Milpitas, California and Dundalk, Ireland and employees within the desktop drive business. As of October 1, 2000, 481 employees have been terminated. The remaining employees will be terminated by the end of the third quarter of fiscal year 2001. As of October 1, 2000, HDDG had incurred $9 million in cash expenditures associated with employee severance and benefits, facilities and other costs. HDDG expects to incur additional cash expenditures associated with the plan of approximately $6 million. The following table summarizes activity related to the special charge at October 1, 2000.
(In thousands) Severance And Facilities Other Benefits Costs Inventory Costs Total -------- ----- --------- ----- ----- Special charge provision $ 7,833 $26,359 $ 13,214 $12,000 $ 59,406 Cash Payments (5,963) (1,559) - (1,883) (9,405) Non-cash charges - (7,296) (15,588) (5,502) (28,386) Adjustments 1,166 (7,852) 2,374 4,312 - Special charge benefit (2,284) (7,787) - (5,798) (15,869) ------- ------- -------- ------- -------- Balance at October 1, 2000 $ 752 $ 1,865 $ - $ 3,129 $ 5,746 ======= ======= ======== ======= ========
9. Comprehensive Income Accumulated other comprehensive income included in group equity on the condensed combined balance sheets of the Hard Disk Drive group consists of unrealized gains on available for sale investments and foreign currency translation adjustments. Total comprehensive income for the three months and six months ended October 1, 2000 and September 26, 1999 is presented in the following table:
(In thousands) Three Months Ended Six Months Ended ---------------------------- ----------------------------- October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ---------- -------- -------- --------- Net income (loss) $ (8,671) $(83,687) $ 7,799 $(126,871) Other comprehensive income - Change in unrealized gain on investments (8,135) -- (7,940) -- Foreign currency translation adjustments (1,739) 1,693 (1,969) 773 --------- -------- -------- --------- Comprehensive income $(18,545) $(81,994) $ (2,110) $(126,098) ========= ======== ======== =========
10. Business Units 49 The Hard Disk Drive group currently has two primary product lines, desktop hard disk drives and high-end hard disk drives. HDDG has two separate business units that support these two product lines. The desktop business unit designs, develops and markets desktop hard disk drives designed to meet the storage requirements of entry-level to high-end desktop personal computers in home and business environments. The high-end business unit designs, develops and markets high-end hard disk drives designed to meet the storage requirements of network servers, workstations and storage subsystems. In the future, the two HDDG business units may become a single business unit as their markets begin to converge and be reported on a combined basis. Results for HDDG's business units for the three months and six months ended October 1, 2000 and September 26, 1999 are presented in the following table:
(In millions) Three Months Ended Six Months Ended ---------------------------- ----------------------------- October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ---------- -------- -------- --------- Business unit: Desktop Revenue $656 $ 661 $1,330 $1,298 Unit operating loss (35) (133) (25) (194) High-end Revenue 168 107 357 222 Unit operating income (loss) 18 (10) 26 (26)
(In millions) Three Months Ended Six Months Ended ---------------------------- ----------------------------- October 1, September 26, October 1, September 26, 2000 1999 2000 1999 ---------- -------- -------- --------- Loss reconciliation: Total unit operating income (loss) $(17) $(143) $ 1 $(220) Unallocated amounts: Interest and other income 4 1 10 4 ---- ----- --- ----- Income (loss) before income taxes $(13) $(142) $11 $(216) ==== ===== === =====
11. Subsequent Event On October 3, 2000 Quantum entered into a definitive agreement with Maxtor Corporation to combine Maxtor and HDDG in an all-stock transaction. The merger agreement envisages that HDDG stockholders will receive 1.52 shares of Maxtor common stock for every share of HDDG common stock they own. The transaction, which was unanimously approved by the Boards of Directors of both companies, is expected be completed in early calendar 2001. The transaction is expected to be tax-free to Quantum stockholders. This transaction is subject to stockholders and regulatory approval. These expectations are forward-looking statements and actual results may differ. 50 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Hard Disk Drive Group This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements usually are phrased in the future tense or contain the words "estimate," "anticipate," "expect," or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties. These uncertainties could cause actual results to differ materially from those expected for the reasons set forth under Trends and Uncertainties relating to the Hard Disk Drive group. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Business Overview The Hard Disk Drive group ("HDDG") designs, develops and markets a diversified product portfolio of hard disk drives featuring leading-edge technology. HDDG's hard disk drives are designed for the desktop market which requires economy and reliability and the high-end market, which requires faster and higher capacity disk drives--as well as the emerging market for hard disk drives specially designed for consumer electronics devices such as personal video recorders, personal audio recorders, cable and set-top boxes, Internet appliances and digital video editing. HDDG has been a leading volume supplier of hard disk drives for the desktop market for each of the past seven years. HDDG designs desktop hard disk drives to meet the storage requirements of entry- level to high-performance desktop PCs in home and business environments. HDDG also designs high-end hard disk drives to store data on large computing systems such as network servers. These high-end hard disk drives are generally used for: . dedicated sites that store large volumes of data; . network servers such as those used for Internet and intranet services, online transaction processing and enterprise wide applications; . high-speed computers used for specialized engineering design software; and . computer systems incorporating a large number of shared hard disk drives. HDDG also pioneered hard disk drive applications for the developing consumer electronics market. These hard disk drive applications utilize Quantum QuickView(TM)--HDDG's hard disk drive technology designed especially for consumer electronics. Quantum QuickView technology makes it possible to simultaneously record and play back audio and video content and to instantly and inexpensively access large amounts of audio and video content--capabilities that are not as well suited to competing technologies such as video tape and optical media. 51 On October 3, 2000, the Company entered into a definitive agreement with Maxtor Corporation to combine Maxtor and HDDG in an all-stock transaction. The merger agreement envisages that HDDG stockholders will receive 1.52 shares of Maxtor common stock for every share of HDDG common stock they own. The transaction, which was unanimously approved by the Boards of Directors of both companies, is expected to be completed in early calendar 2001. The transaction is expected to be tax-free to Quantum stockholders. This transaction is subject to stockholders and regulatory approval. These expectations are forward- looking statements and actual results may differ. Products Desktop products. HDDG offers two families of desktop hard disk drives--the Quantum Fireball(TM) and Quantum Fireball Plus. The Quantum Fireball family offers 3.5-inch hard disk drives for consumer and commercial PCs, as well as entry-level workstations and network servers. Fireball Plus offers superior performance for power users. HDDG offers the Shock Protection SystemTM, Shock Protection System II and Data Protection SystemTM with its desktop products. These features substantially reduce failure rates and provide increased reliability and performance. Shock Protection System II provides enhanced protection against both operating and non-operating shock. Along with providing enhanced protection against shock during handling and integration, Shock Protection System II guards against kicks and jolts while the PC is running to reduce field failures. HDDG has also incorporated feature enhancements of the Quiet Drive Technology into recently introduced Quantum desktop drives. This technology has been pioneered through a combination of proprietary design innovations and unique drive features that enable Quantum to develop drives that emit dramatically reduced levels of noise. It was first introduced over a year ago in Quantum QuickView drives targeted for the noise-sensitive consumer electronics market and has continued to be refined with technology and feature enhancements. High-end products. HDDG also offers a broad line of high-end 3.5-inch hard disk drives--the Quantum Atlas(TM) and Quantum Atlas 10K families. The Quantum Atlas families offer high-capacity hard disk drives for high performance storage- intensive applications such as enterprise servers and storage subsystems. HDDG also offers the Shock Protection System, Shock Protection System II, Data Protection System and Quiet Drive Technology with its high-end products, and has incorporated the Shock Protection System III into its recently introduced Atlas 10K III. Shock Protection System III is a further enhancement to Shock Protection I & II, guarding against one of the leading causes of hard disk drive failure - mistreatment during handling and integration. 52 The table below sets forth key performance characteristics for HDDG's current products:
Capacity Product Rotational per Disk Capacity Speed Products (GB) (GB) (RPM) Platform -------- ---- ---- ----- -------- Fireball lct 10 10.3 5.1 to 30.0 5,400 Desktop PCs--Value, with Ultra ATA/66 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Fireball lct 15 15.0 7.5 to 30.0 4,400 Desktop PCs--Value, with Ultra ATA/66 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Fireball lct 20 20.4 10.0 to 40.0 4,500 Desktop PCs--Value, with Ultra ATA/100 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Fireball Plus LM 10.3 10.2 to 30.0 7,200 Desktop PCs--Performance, with Ultra ATA/66 interface, Shock Protection System and Data Protection System Fireball Plus AS 20.0 10.2 to 60.0 7,200 Desktop PCs--Performance, with Ultra ATA/100 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Atlas V 9.1 9.1 to 36.7 7,200 Servers, Workstations and Storage Subsystems, with Ultra 160 SCSI interface, Shock Protection System II and Data Protection System Atlas 10K II 7.3 9.2 to 73.4 10,000 Enterprise Servers, Workstations and Storage Subsystems, with Ultra 160 SCSI interface, Shock Protection System II, Data Protection System and Quiet Drive Technology
Results of Operations Revenue. Revenue in the three and six months ended October 1, 2000 was $824 million and $1.687 billion, respectively, compared to $768 million and $1.521 billion, respectively, for the corresponding periods in fiscal year 2000. The increase in revenue for the three and six month periods primarily reflected increased revenue from sales of high-end hard disk drives. The increase in revenue in the six month period also reflected increased revenue from sales of desktop hard disk drives. Desktop hard disk drive revenue in the three and six months ended October 1, 2000 was $656 million and $1.331 billion, respectively, compared to $661 million and $1.298 billion, respectively, for the corresponding periods in fiscal year 2000. Desktop hard disk drive shipments reached a record high in the second quarter of fiscal year 2001 reflecting strong demand in the desktop market. However, intense pricing pressures resulted in lower average unit prices, resulting in decreased revenue in the three month period and a moderate increase in revenue in the six month period. 53 High-end hard disk drive revenue in the three and six months ended October 1, 2000 was $168 million and $357 million, respectively, compared to $107 million and $222 million, respectively, for the corresponding periods in fiscal year 2000. The increase in revenue reflected increased shipments as a result of strong demand, particularly from computer equipment manufacturers, as HDDG transitioned to new high performance products, as well as a mix shift toward higher capacity products which carry higher average unit prices. Sales to the top five customers in the three and six months ended October 1, 2000 represented 52% and 50% of revenue, respectively, compared to 51% and 49% of revenue, respectively, in the corresponding periods in fiscal year 2000. These amounts reflected a retroactive combination of the sales to Ingram Micro and Electronic Resources as a result of their merger in July 1999. Sales to Dell Computer were 14% and 13% of revenue in the three and six months ended October 1, 2000, respectively, compared to 10% and less than 10% of revenue in the three and six months ended September 26, 1999, respectively. Sales to Compaq were 13% and 11% of revenue in the three and six months ended October 1, 2000, respectively, compared to less than 10% of revenue in the corresponding periods of fiscal year 2000. Sales to Ingram Micro were less than 10% of revenue in the three and six months ended October 1, 2000, compared to 13% and less than 10% of revenue in the three and six months ended September 26, 1999, respectively, including sales to Electronic Resources. Sales to Hewlett-Packard were 11% and less than 10% of revenue in the three and six months ended October 1, 2000, respectively, compared to 10% and 12% of revenue in the three and six months ended September 26, 1999, respectively. Sales to computer equipment manufacturers and distribution channel customers were 67% and 33% of revenue, respectively, in the three months ended October 1, 2000, compared to 57% and 43% of revenue, respectively, in the three months ended September 26, 1999. For the six months ended October 1, 2000, computer equipment manufacturers and distribution channel sales were 65% and 35% of revenue, respectively, compared to 56% and 44% of revenue, respectively, for the corresponding period of fiscal year 2000. Gross Margin Rate. The gross margin rate in the three months ended October 1, 2000 increased to 10.1% from -4.5% in the three months ended September 26, 1999. The gross margin rate for the first six months of fiscal year 2001 was 12.1%, compared to -0.4% in the corresponding period of fiscal year 2000. The gross margin rate in the three and six month periods of fiscal year 2001 reflected the impact of a $15.8 million special charge benefit. The benefit was primarily due to negotiated lease cancellations and reduced severance and benefits due to the redeployment of employees. The gross margin excluding the impact of the benefit was 8.2% and 11.1% in the three and six month periods ended October 1, 2000. The gross margin rate in the three and six month periods of fiscal year 2000 reflected the impact of a $57.1 million special charge related to HDDG's strategy to modify the hard disk drive business to more closely align product development and the business's operating model with the requirements of the rapidly growing low-cost PC market. The gross margin rate excluding the impact of the charge was 2.9% and 3.3% in the three and six month periods ended September 26, 1999. The desktop gross margin rate for the three and six months ended October 1, 2000 was 5.4% and 8.4%, respectively, compared to -8.6% and -3.7% for the corresponding periods in fiscal year 2000. Excluding the desktop portion of the special charge benefit of $15.5 million in fiscal year 2001, the gross margin rate was 3.0% and 7.2% for the three and six month periods ended October 1, 2000. Excluding the desktop portion of the special charge of $51.4 million in fiscal year 2000, the gross margin rate was -0.8% and 0.3% for the three and six month periods ended September 26, 1999. Excluding the impact of the benefit and charge, the increase in gross margin rate reflected the transition to new lower cost, higher margin products in an environment characterized by continued competitive pricing pressures. 54 The high-end gross margin rate for the three and six months ended October 1, 2000 was 28.4% and 25.9%, respectively, compared to 20.6% and 18.5% for the corresponding periods in fiscal year 2000. Excluding the high-end portion of the special charge benefit of $0.3 million in fiscal year 2001, the gross margin rate was 28.2% and 25.8% in the three and six month periods ended October 1, 2000. Excluding the high-end portion of the special charge of $5.7 million in fiscal year 2000, the gross margin rate was 25.9% and 21.1% in the three and six month periods ended September 26, 1999. Excluding the impact of the benefit and charge, the increase in the gross margin rate reflected higher sales volumes, the transaction to new high performance products and the mix shift towards higher capacity, higher margin products. Research and Development Expenses. Research and development expenses in the three and six months ended October 1, 2000, were $60 million, or 7.3% of revenue, and $118 million, or 7% of revenue, respectively, compared to $62 million, or 8.1% of revenue, and $125 million, or 8.2% of revenue, respectively, in the corresponding periods of fiscal year 2000. The decrease in research and development expenses for the three and six month periods reflected cost reductions associated with the special charge taken in the second quarter of fiscal year 2000. We expect the amount of research and development expenses to increase in the third quarter of fiscal year 2001, primarily as a result of next generation drive pre-production builds. Sales and Marketing Expenses. Sales and marketing expenses in the three and six months ended October 1, 2000, were $24 million, or 2.9% of revenue, and $52 million, or 3.1% of revenue, respectively, compared to $29 million, or 3.8% of revenue, and $57 million, or 3.7% of revenue, respectively, in the corresponding periods of fiscal year 2000. The decrease in sales and marketing expenses for the three and six month periods primarily reflected decreased advertising. General and Administrative Expenses. General and administrative expenses in the three and six months ended October 1, 2000, were $16 million, or 2% of revenue, and $33 million, or 1.9% of revenue, respectively, compared to $15 million, or 2% of revenue, and $30 million, or 2% of revenue, respectively, in the corresponding periods of fiscal year 2000. The increase in general and administrative expenses for the three and six month periods reflected an increase in human resource spending in support of change management, process reengineering and retention. Special Charge. During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with streamlining HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to streamlining the global logistics model and changes in customer service strategy, $7.8 million in severance and benefits for terminated employees, and approximately $12 million in other costs associated with the plan. 55 HDDG is proceeding according to plan and expects to realize more than $100 million in cost savings per year, beginning in fiscal year 2001. The majority of the savings are expected in cost of revenue as a result of a more efficient distribution system and reduced customer service costs, with the remaining savings in research and development, as a result of the consolidation of product development programs. As compared to fiscal year 2000, HDDG expects operating expenses to be relatively flat in fiscal year 2001, with increased investments in disk drive and other storage products, primarily reflected in research and development, offsetting the operating cost savings resulting from the special charge. These expectations are forward-looking statements and actual results may differ. In the second quarter of fiscal year 2001, HDDG reversed $15.9 million as a special charge benefit on the incomes statement. This reversal was primarily due to negotiated lease cancellations and reduced severance and benefits due to attrition and redeployment of certain employees. In addition, fixed assets that were intended to be written-off are now being utilized elsewhere in the organization as a result of technology and product roadmap plans. Interest and Other Income/Expense. Net interest and other income for the three and six months ended October 1, 2000 were $4.6 million and $10.4 million, respectively, compared to net interest and other income of $1 million and $4.6 million, respectively, for the corresponding periods of fiscal year 2000. The increase reflected increased interest income as a result of a higher average cash balance and an increase in gain on currency translation. Income Taxes. HDDG recorded a tax benefit of approximately $4 million and a tax provision of approximately $4 million for the three and six months ended October 1, 2000, respectively, for effective benefit and provision rates of 32%, as compared to an effective benefit rate of 41% for the corresponding periods in fiscal year 2000. The difference in rates is primarily attributable to pre-tax profits in the current year compared to pre-tax losses in the prior year. Liquidity and Capital Resources Cash, cash equivalents and marketable securities were $492 million at October 1, 2000 compared to $612 million at March 31, 2000. HDDG used cash in the six months ended October 1, 2000 to purchase $95 million of treasury stock, as discussed below. Other uses of cash included approximately $14 million for investments in property and equipment and $14 million in equity securities. Cash used in operating activities was $66 million, primarily reflecting net income of $8 million and a decrease in accounts receivable, offset by decreases in accounts payable, income taxes payable and an increase in inventories. Other sources of cash were $79 million in proceeds from factoring and the issuance of common stock. HDDG has an asset securitization program with Capital Factors Inc, under which we sell our eligible accounts receivable on a with recourse basis. At October 1, 2000, $70 million of accounts receivable were securitized under the program and included in our accounts receivable balance, the related credit was recorded as other liabilities. During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of its common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock. An additional $100 million was authorized for repurchase of HDDG common stock. Under these authorizations, as of October 1, 2000, Quantum had repurchased a total of 3.9 million shares of Quantum common stock, 29.2 million shares of DSSG common stock and 13.5 million shares of HDDG common stock for a combined total of $566 million. During the first six 56 months of fiscal year 2001, Quantum repurchased 13.5 million shares of DSSG common stock and 10 million shares of HDDG common stock for a combined total of $241 million. In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At October 1, 2000, there were no outstanding balances drawn on these lines. HDDG expects to spend approximately $38 million in fiscal year 2001 for capital equipment and leasehold improvements. These capital expenditures will support the development and introduction of new disk drive products. HDDG believes that its existing capital resources, including the credit facilities and any cash generated from operations, will be sufficient to meet all currently planned expenditures and sustain operations for the next 12 months. However, this belief assumes that operating results and cash flow from operations will meet HDDG's expectations. In the future, Quantum may seek to raise cash through the issuance of debt or equity securities. There can be no assurance that such financing would be available on terms favorable to Quantum, if at all. Trends and Uncertainties Relating to the Hard Disk Drive Group Holders of HDDG stock remain stockholders of Quantum Corporation, which , prior to the completion of the merger of HDDG and Maxtor, includes common stock of DSSG, and, therefore, financial effects on DSSG could adversely affect HDDG. Holders of HDDG stock and DSSG stock are stockholders of a single company. HDDG and DSSG are not separate legal entities. As a result, stockholders will continue to be subject to all of the risks of an investment in Quantum and all of its businesses, assets and liabilities. The issuance of the HDDG stock and the DSSG stock and the allocation of assets and liabilities and stockholders' equity between HDDG and DSSG did not result in a distribution or spin-off to stockholders of any Quantum assets or liabilities and did not affect ownership of our assets or responsibility for our liabilities or those of our subsidiaries. The assets we attribute to one group could be subject to the liabilities of the other group, whether such liabilities arise from lawsuits, contracts or indebtedness that we attribute to the other group. If we are unable to satisfy one group's liabilities out of the assets we attribute to it, we may be required to satisfy those liabilities with assets we attribute to the other group. Financial effects from one group that affect our consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the tracking stock relating to the other group. In addition, net losses of either group and dividends and distributions on, or repurchases of, either class of tracking stock or repurchases of preferred stock at a price per share greater than par value will reduce the funds we can pay on each class of tracking stock under Delaware law. For these reasons, you should read our consolidated financial information with the financial information we provide for each group. If the contemplated combination of the HDDG business with Maxtor is not successfully completed, this could have a negative impact on Quantum's results of operations. Though Quantum has publicly announced that it currently intends to combine its HDDG business with Maxtor, the transaction remains subject to the approval of Maxtor and Quantum stockholders, expiration or termination of the applicable Hart-Scott-Rodino waiting periods, approval by the European regulatory authorities, and other customary conditions. If the transaction is not consummated, Quantum's results of operations could be negatively impacted due to, among other things, market, customer and employee perception of the terminated transaction. 57 HDDG's operating results depend on new product introductions, which may not be successful To compete effectively, HDDG must frequently introduce new hard disk drives. HDDG cannot assure you that: . it will successfully or timely develop or market any new hard disk drives in response to technological changes or evolving industry standards; . it will not experience technical or other difficulties that could delay or prevent the successful development, introduction or marketing of new hard disk drives; . it will successfully qualify new hard disk drives, particularly high-end disk drives, with HDDG's customers by meeting customer performance and quality specifications. A successful and timely customer qualification must occur before customers will place large product orders; . it will quickly achieve high volume production of new hard disk drives; or . its new products will achieve market acceptance. These risks are magnified because HDDG expects technological changes, short product life cycles and intense competitive pressures to result in declining sales and gross margins on its current generation products. HDDG's quarterly operating results could fluctuate significantly and past quarterly operating results should not be used to predict future performance HDDG's quarterly operating results have fluctuated significantly in the past and may fluctuate significantly in the future. As a result, you should not use HDDG's past quarterly operating results to predict future performance. Quarterly operating results could be adversely affected by: . the ability of MKE, HDDG's exclusive manufacturer, to quickly achieve high volume production of HDDG's hard disk drives; . customers canceling, deferring or rescheduling significant orders; . returns by customers of unsold hard disk drives for credit; . decline in PC demand; or . failure to complete shipments in the last month of a quarter during which a substantial portion of HDDG's products are typically shipped. HDDG's prices and margins are subject to declines due to unpredictable end-user demand and oversupply of hard disk drives 58 End-user demand for the computer systems that contain HDDG's hard disk drives has historically been subject to rapid and unpredictable fluctuations. As a result, the hard disk drive market tends to experience periods of excess capacity, which typically lead to intense price competition. If intense price competition occurs, HDDG may be forced to lower prices sooner and more than expected and transition to new products sooner than expected. For example, in the second quarter of fiscal year 2001, as a result of oversupply in the desktop hard disk drive market, aggressive pricing and corresponding margin reductions materially adversely impacted HDDG's operating results. Growth of the lower priced PC markets is putting downward pressure on HDDG's desktop hard disk drive prices The growth of the lower priced PC market has led to a shift toward lower priced desktop hard disk drives. HDDG expects the trend toward lower prices on hard disk drives to continue. If HDDG is unable to lower the cost of its desktop hard disk drives accordingly, operating results could be materially adversely affected. Intense competition in the desktop and high-end hard disk drive market could adversely impact HDDG's operating results In the desktop hard disk drive market, HDDG's primary competitors are Fujitsu Limited, IBM, Maxtor Corporation, Samsung Electronics Co., Ltd., Seagate Technologies, Inc. and Western Digital Corporation. The desktop hard disk drive market is characterized by more competitiveness than that seen in the computer industry in general. HDDG's operating results and competitive position could be negatively impacted by the introduction of competitive products with higher performance, higher reliability and/or lower cost than HDDG's products. For example, in the first half of fiscal year 2000, certain competitors reduced prices for their products significantly. As a result, HDDG's operating results were materially adversely affected. In the high-end hard disk drive market, HDDG's primary competitors are Fujitsu, Hitachi, IBM and Seagate. Currently, Seagate and IBM have the largest market share for high-end hard disk drives. A majority of sales come from a few customers that have no minimum or long-term purchase commitments HDDG's sales are concentrated with a few customers. Customers are not obligated to purchase any minimum product volume and HDDG's customer relationships are terminable at will. The loss of, or a significant change in demand from, one or more key HDDG customers could have a material adverse impact on HDDG's operating results. Because HDDG depends on MKE for the manufacture of all hard disk drives, adverse material developments in this critical manufacturing relationship would adversely affect HDDG's operating results HDDG's relationship with MKE is critical to the Hard Disk Drive group's operating results and overall business performance. HDDG's dependence on MKE includes the following principal risks: 59 . Quality and Delivery. HDDG relies on MKE to quickly achieve volume production of new hard disk drives at a competitive cost, to meet HDDG's stringent quality requirements and to respond quickly to changing product delivery schedules. Failure of MKE to satisfy these requirements could have a material adverse impact on HDDG's operating results. . Purchase Forecasts. MKE's production schedule is based on HDDG's forecasts of its purchase requirements, and HDDG has limited rights to modify short- term purchase orders. The failure of HDDG to accurately forecast its requirements or successfully adjust MKE's production schedule could lead to inventory shortages or surpluses. . Pricing. HDDG negotiates pricing arrangements with MKE on a quarterly basis. Any failure to reach competitive pricing arrangements would have a material adverse impact on HDDG's operating results. . Capital Commitment. HDDG's future growth will require that MKE continue to devote substantial financial resources to property, plant and equipment to support the manufacture of HDDG's products. . Manufacturing Capacity. If MKE is unable or unwilling to meet HDDG's manufacturing requirements, an alternative manufacturing source may not be available in the near term. MKE depends on a limited number of component and sub-assembly suppliers and component shortages and quality problems or delays from these suppliers could result in increased costs and reduced sales MKE depends on a limited number of qualified suppliers for components and sub- assemblies, including recording heads, media and integrated circuits, all of which are essential to the manufacture of HDDG's hard disk drives. MKE may qualify only a single source for certain components and sub-assemblies, which can magnify the risk of component shortages. Component shortages have constrained HDDG's sales growth in the past, and HDDG believes that it will periodically experience component shortages in the future. If MKE experiences quality problems with its component suppliers, HDDG's hard disk drive shipments could be significantly delayed or costs could be significantly increased. Unexpected warranty costs could have a material adverse impact on operating results HDDG warrants its products against defects for a period of one to five years. Actual warranty costs could have a material adverse impact on HDDG's operating results if the actual unit failure rate or unit repair costs are greater than those for which HDDG established a warranty accrual. Third party infringement claims could result in substantial liability and significant costs From time to time, third parties allege HDDG's infringement of and need for a license under their patented or other proprietary technology. For example, in August 1998 Quantum was named as one of several defendants in a patent infringement lawsuit. The plaintiff, Papst Licensing GmbH, owns at least 24 U.S. patents, which it asserts that HDDG has infringed. In fiscal year 2000, Discovision 60 Associates brought some of its patents to HDDG's attention. Adverse resolution of the Papst or any other third party infringement claim could subject HDDG to substantial liabilities and require it to refrain from manufacturing and selling certain products. HDDG cannot assure you that licenses to any technology owned by Papst or any other third party alleging infringement could be obtained on commercially reasonable terms, or at all. In addition, the costs of litigation could be substantial, regardless of the outcome. HDDG's foreign manufacturing costs could be adversely impacted by fluctuations in currency exchange rates MKE generally purchases manufacturing components at prices denominated in U.S. dollars. However, significant increases in currency exchange rates against the U.S. dollar could increase MKE's manufacturing costs and could result in higher product prices and/or declining margins for HDDG's products. 61 Item 3. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in Quantum's Annual Report on Form 10-K for the year ended March 31, 2000. HDDG is exposed to equity price risk on its investment in TiVo, Inc. common stock. HDDG does not attempt to reduce or eliminate its market exposure on this security. HDDG entered into a strategic alliance with TiVo in fiscal year 1999 to supply hard disk drives utilizing Quantum's QuickView technology for integration into TiVo's Personal Video Recorder. At October 1, 2000, the fair market value of HDDG's investment was approximately $17 million. As TiVo is a relatively new company and has introduced a new product in the consumer electronics market, HDDG does not believe it is possible to reasonably estimate any future price movement of TiVo common stock. 62 QUANTUM CORPORATION PART II - OTHER INFORMATION Item 1. Legal proceedings The information contained in Note 7 of the Notes to Condensed Consolidated Financial Statements and Note 6 of the Notes to Condensed Combined Financial Statements of the Hard Disk Drive group is incorporated into this Part II, Item 1 by reference. Item 2. Changes in securities - Not Applicable Item 3. Defaults upon senior securities - Not Applicable Item 4. Submission of matters to a vote of security holders The 2000 Annual Meeting of Stockholders was held on August 22, 2000 to consider and vote on proposals to elect management's candidates for the Board of Directors, to ratify the appointment of Ernst & Young LLP as Quantum's independent auditors for the fiscal year ending March 31, 2001 and to approve and ratify the adoption of the Annual Incentive Plan for Quantum's Chief Executive Officer. The stockholders elected each of management's candidates for the Board of Directors. The votes were as follows: For Withheld Authority --- ------------------ Stephen M. Berkley 205,410,227 3,528,222 David A. Brown 205,399,774 3,538,675 Michael A. Brown 205,171,245 3,767,204 Robert J. Casale 207,085,109 1,853,340 Edward M. Esber, Jr. 207,078,203 1,860,246 Gregory W. Slayton 207,074,526 1,863,923 The stockholders ratified the appointment of Ernst & Young LLP as Quantum's independent auditors for the fiscal year ending March 31, 2001. The number of votes "For" were 208,275,564; the number of votes "Against" were 385,379; the number of votes "Abstain" were 277,506. The stockholders also approved and ratified the adoption of the Annual Incentive Plan for Quantum's Chief Executive Officer. The number of votes "For" were 197,787,584; the number of votes "Against" were 9,450,553; and the number of votes "Abstain" were 1,700,312. Item 5. Other information - Not Applicable 63 Item 6. Exhibits and reports on Form 8-K. (a) Exhibits. The exhibits listed on the accompanying index to -------- exhibits immediately following the signature page are filed as part of this report. (b) Reports on Form 8-K. ------------------- On October 13, 2000, Quantum filed a Form 8-K reporting that the Company entered into a definitive agreement with Maxtor Corporation to combine Maxtor and HDDG in an all-stock transaction. The merger agreement envisages that HDDG's stockholders will receive 1.52 shares of Maxtor common stock for every share of HDDG common stock they own. The transaction, which was unanimously approved by the Boards of Directors of both companies, is expected to be completed in early calendar 2001. 64 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. QUANTUM CORPORATION (Registrant) Date: November 14, 2000 By: /s/ Richard L. Clemmer ---------------------- Richard L. Clemmer Executive Vice President, Finance and Chief Financial Officer 65 QUANTUM CORPORATION INDEX TO EXHIBITS Exhibit Number Exhibit 10.1 AMENDED AND RESTATED PARTICIPATION AGREEMENT, dated July 12, 2000, among Registrant, as Lessee, Selco Service Corporation, as Lessor and as a Participant, The Bank of Nova Scotia, Keybank National Association and Union Bank of California, N.A., as Participants, and The Bank of Nova Scotia, as Agent 10.2 AMENDED AND RESTATED MASTER LEASE, dated July 12, 2000, between Selco Service Corporation, as the Lessor and Registrant, as the Lessee 27.1 Financial Data Schedule