Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 28, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
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Commission File Number 0-12390
QUANTUM CORPORATION
Incorporated Pursuant to the Laws of the State of Delaware
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IRS Employer Identification Number 94-2665054
500 McCarthy Blvd., Milpitas, California 95035
(408) 894-4000
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934,
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of December 28, 1997: 136,452,870
QUANTUM CORPORATION
10-Q REPORT
INDEX
Page
Number
------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Income 3
Condensed Consolidated Balance Sheets 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
PART II - OTHER INFORMATION 28
SIGNATURE 29
2
QUANTUM CORPORATION
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data)
(unaudited)
Three Months Ended Nine Months Ended
December 28, December 29, December 28, December 29,
1997 1996 1997 1996
----------- ----------- ----------- -----------
Sales $ 1,519,881 $ 1,477,951 $ 4,519,516 $ 3,755,598
Cost of sales 1,384,208 1,262,494 3,809,826 3,263,384
----------- ----------- ----------- -----------
Gross profit 135,673 215,457 709,690 492,214
Operating expenses:
Research and development 88,275 73,267 236,797 209,481
Sales and marketing 45,203 38,732 128,907 104,739
General and administrative 23,375 21,331 75,114 59,805
----------- ----------- ----------- -----------
156,853 133,330 440,818 374,025
Income (loss) from operations (21,180) 82,127 268,872 118,189
Other (income) expense:
Interest expense 9,806 13,855 24,135 37,861
Interest income and other income and
expense, net (10,146) (2,587) (24,658) (1,903)
Equity in loss of investee 22,651 -- 42,222 --
----------- ----------- ----------- -----------
22,311 11,268 41,699 35,958
Income (loss) before income taxes (43,491) 70,859 227,173 82,231
Income tax provision (11,308) 18,424 59,065 21,380
----------- ----------- ----------- -----------
Net income (loss) $ (32,183) $ 52,435 $ 168,108 $ 60,851
=========== =========== =========== ===========
Net income (loss) per share:
Basic $ (0.24) $ 0.45 $ 1.26 $ 0.54
Diluted $ (0.24) $ 0.36 $ 1.05 $ 0.46
Weighted average common shares:
Basic 135,842 115,921 133,669 113,728
Diluted 135,842 154,596 165,642 151,103
See accompanying notes to condensed consolidated financial statements
3
QUANTUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 28, March 31,
1997 1997
---------- ----------
(unaudited) (Note 1)
Assets
Current assets:
Cash and cash equivalents $ 716,588 $ 345,125
Accounts receivable, net of allowance for
doubtful accounts of $ 13,912 and $ 10,610 823,026 887,477
Inventories 423,445 252,802
Deferred taxes 122,908 122,899
Other current assets 105,592 80,116
---------- ----------
Total current assets 2,191,559 1,688,419
Property and equipment, net of accumulated
depreciation of $ 202,705 and $ 226,691 281,845 407,206
Purchased intangibles, net 18,290 42,131
Other assets 135,809 20,507
---------- ----------
$2,627,503 $2,158,263
========== ==========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 543,464 $ 502,069
Accrued warranty expense 71,271 94,989
Accrued compensation 74,721 63,093
Income taxes payable 47,850 31,153
Current portion of long-term debt 913 44,229
Other accrued liabilities 173,245 80,045
---------- ----------
Total current liabilities 911,464 815,578
Deferred taxes 33,250 33,587
Convertible subordinated debt 528,850 241,350
Long-term debt 40,227 177,668
Redeemable preferred stock -- 3,888
Shareholders' equity:
Common stock 520,130 459,800
Retained earnings 593,582 426,392
---------- ----------
Total shareholders' equity 1,113,712 886,192
---------- ----------
$2,627,503 $2,158,263
========== ==========
See accompanying notes to condensed consolidated financial statements
4
QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Nine Months Ended
December 28, December 29,
1997 1996
--------- ---------
Cash flows from operating activities:
Net income $ 168,108 $ 60,851
Items not requiring the current use of cash:
Depreciation 57,802 70,995
Amortization 9,332 20,552
Compensation related to stock plans 3,099 1,767
Changes in assets and liabilities:
Accounts receivable 64,451 (92,024)
Inventories (170,643) 206,714
Accounts payable 41,395 (121,454)
Income taxes payable 16,697 7,495
Accrued warranty expense (23,718) 8,428
Other assets and liabilities 104,122 (93,307)
--------- ---------
Net cash provided by operating activities 270,645 70,017
--------- ---------
Cash flows from investing activities:
Investment in property and equipment (124,299) (148,331)
Proceeds from disposition of property and equipment 23,932 14,645
Purchase of equity securities (15,000) --
Purchase of intangible assets (16,000) --
Proceeds from sale of interest in recording heads operations 94,000 --
--------- ---------
Net cash used in investing activities (37,367) (133,686)
--------- ---------
Cash flows from financing activities:
Proceeds from long-term credit facilities -- 310,091
Proceeds from issuance of convertible subordinated note 287,500 --
Proceeds from mortgage loan -- 42,105
Principal payments on credit facilities (180,757) (262,946)
Proceeds from issuance of common stock 31,442 28,982
--------- ---------
Net cash provided by financing activities 138,185 118,232
--------- ---------
Net increase in cash and cash equivalents 371,463 54,563
Cash and cash equivalents at beginning of period 345,125 164,752
--------- ---------
Cash and cash equivalents at end of period $ 716,588 $ 219,315
========= =========
Supplemental disclosure of cash flow information:
Conversion of debentures $ 42,011
Conversion of redeemable preferred stock to common stock $ 3,888
Note received on disposition of property and equipment $ 18,000
Cash paid during the period for:
Interest $ 11,793 $ 35,592
Income Taxes $ 59,806 $ 13,839
See accompanying notes to condensed consolidated financial statements.
QUANTUM CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of presentation
The accompanying unaudited condensed consolidated 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. The condensed consolidated balance sheet as of March 31, 1997 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, 1997.
2. Inventories
Inventories consisted of the following:
(In thousands)
December 28, March 31,
1997 1997
--------- ---------
Materials and purchased parts $ 69,628 $ 39,898
Work in process 44,038 48,005
Finished goods 309,779 164,899
--------- ---------
$423,445 $252,802
========= =========
3. Net income per share
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share." Statement 128
replaced the previously reported primary and fully diluted net income (loss) per
share with basic and diluted net income (loss) per share. Unlike primary net
income (loss) per share, basic net income (loss) per share excludes any dilutive
effects of options and convertible securities. Diluted net income (loss) per
share is very similar to the previously reported fully diluted net income (loss)
per share. All net income (loss) per share amounts for all periods have been
presented, and where necessary, restated to conform to the Statement 128
requirements.
6
The following table sets forth the computation of basic and diluted net income
(loss) per share:
(In thousands except per share data) Three Months Ended Nine Months Ended
Dec 28, Dec 29, Dec 28, Dec 29,
1997 1996 1997 1996
------------- ------------- ------------- -------------
Numerator:
Numerator for basic net income (loss) per
share - income (loss) available to common
stockholders $ (32,183) $ 52,435 $168,108 $ 60,851
Effect of dilutive securities:
6 3/8% Convertible subordinated notes 922 2,984
5% Convertible subordinated notes 1,810 5,430 5,430
------------- ------------- ------------- -------------
Numerator for diluted net income (loss)
per share - income (loss) available to
common stockholders $ (32,183) $ 55,167 $173,538 $ 69,265
------------- ------------- ------------- -------------
Denominator:
Denominator for basic net income (loss)
per share - weighted average shares 135,842 115,921 133,669 113,728
Effect of dilutive securities:
Outstanding options 6,423 10,347 4,286
6 3/8% convertible subordinated notes 10,626 11,463
5% convertible subordinated notes 21,626 21,626 21,626
------------- ------------- ------------- -------------
Denominator for diluted net income (loss)
per share - adjusted weighted average
shares and assumed conversions 135,842 154,596 165,642 151,103
============= ============= ============= =============
Basic net income (loss) per share $ (0.24) $ 0.45 $ 1.26 $ 0.54
============= ============= ============= =============
Diluted net income (loss) per share $ (0.24) $ 0.36 $ 1.05 $ 0.46
============= ============= ============= =============
The computation of diluted net income (loss) per share for the three and nine
months ended December 28, 1997, excluded the effect of the 7% convertible
subordinated notes issued in July 1997, which are convertible into 6,206,152
shares at a conversion price of $46.325 per share, because the effect would be
antidilutive. In addition, the computation of diluted net income (loss) per
share for the three months ended December 28, 1997, excluded the effect of the
5% convertible subordinated notes issued in February 1996, which are convertible
into 21,626,344 shares at a conversion price of $11.16 per share, because the
effect would be antidilutive.
For the nine month period ended December 28, 1997, options to purchase 1,450,016
shares of common stock were outstanding during the period, but were not included
in the computation of diluted net income (loss) per share because certain of the
options' exercise prices were greater than the average market price of the
common shares, and therefore, the effect would be antidilutive; and because of
the use of weighted average shares outstanding to compute diluted net income
(loss) per share. For the three month period ended December 28, 1997, total
outstanding options to purchase 18,216,761 shares of common stock were
outstanding at December 28, 1997, but the
7
corresponding weighted average outstanding options were not included in the
computation of diluted net income (loss) per share because the Company reported
a net loss for the period and accordingly the effect would be antidilutive.
Actual shares outstanding as of December 28, 1997 were 136,452,870.
4. Debt & Capital
The previously outstanding revolving credit line, term loan, and equipment loan,
which had carrying amounts of $110 million, $56 million, and $14 million,
respectively, as of March 31, 1997, were repaid and terminated in the first
fiscal 1998 quarter.
In June 1997, the Company entered into an unsecured senior credit facility which
provides a $500 million revolving credit line and expires in June 2000. At the
option of the Company, borrowings under the revolving credit line bear interest
at either LIBOR plus a margin determined by a total funded debt ratio, or a base
rate, with option periods of one to six months. As of December 28, 1997, there
was no outstanding balance drawn on this line.
In July 1997, the Company issued $288 million of 7% convertible subordinated
notes. The notes mature on August 1, 2004, and are convertible at the option of
the holder at any time prior to maturity, unless previously redeemed, into
shares of the Company's common stock at a conversion price of $46.325 per share.
The notes are redeemable at the Company's option on or after August 1, 1999 and
prior to August 1, 2001, under certain conditions related to the price of the
Company's common stock. Subsequent to August 1, 2001, the notes are redeemable
at the Company's option at any time. In the event of certain changes involving
all or substantially all of the Company's common stock, the notes would become
redeemable at the option of the holder. Redemption prices range from 107% of the
principal to 100% at maturity. The notes are unsecured obligations subordinated
in right of payment to all existing and future senior indebtedness of the
Company.
The Company extended until September 1998 an $85 million unsecured Letter of
Credit facility with certain banks to issue letters of credit to
Matsushita-Kotobuki Electronics ("MKE") and its affiliates.
The holder of the 90,000 shares of Redeemable Convertible Participating Series B
Preferred Stock exercised its right to convert the shares to Quantum common
stock. The Company issued 180,000 shares of its common stock pursuant to the
conversion.
5. Litigation
The Company and certain of its current and former officers and directors have
been named as defendants in two class action lawsuits, one filed on August 28,
1996, in the Superior Court of Santa Clara County, California, and one filed on
August 30, 1996, in the U.S. District Court of the Northern District of
California. The plaintiff in both class actions purports to represent a class of
all persons who purchased the Company's common stock between February 26, 1996,
and June 13,
8
1996. The complaints allege that the defendants violated various federal
securities laws and California statutes by concealing and/or misrepresenting
material adverse information about the Company and that individual defendants
sold shares of the Company's stock based upon material nonpublic information.
On February 25, 1997, in the Santa Clara County action, the Court sustained
defendants' demurrer to most of the causes of action in the complaint, with
leave to amend. At a June 12, 1997, demurrer hearing in state court, the judge
dismissed the action as to four of the individual defendants with prejudice and
as to three of the individual defendants without prejudice. The demurrer as to
the Company was overruled. Defendants' motion that the action not be permitted
to proceed as a class action was denied without prejudice. The Court heard oral
argument on plaintiffs' motion for class certification on November 4, 1997. To
date, there has been no ruling on that motion. On October 30, 1997, the Court
granted defendants' motion for creation of an ethical wall. Plaintiffs' motion
for reconsideration of the Court's order was denied on December 15, 1997.
With respect to the federal action, defendants filed their motion to dismiss on
April 16, 1997. The Court granted defendants' motion to dismiss without
prejudice. On September 11, 1997, plaintiff filed an amended complaint.
Defendants filed a motion to dismiss the amended complaint on October 24, 1997.
A hearing on that motion is scheduled for February 3, 1998.
Certain of the Company's current and former officers and directors were also
named as defendants in a derivative lawsuit, which was filed on November 8,
1996, in the Superior Court of Santa Clara County. The derivative complaint was
based on factual allegations substantially similar to those alleged in the class
action lawsuits. Defendants' demurrer to the derivative complaint was sustained
without prejudice on April 14, 1997. Plaintiffs did not file an amended
complaint. On August 7, 1997, the Court issued an order of dismissal and entered
final judgment dismissing the complaint.
6. MKE/Quantum Joint Venture
On May 16, 1997, the Company sold a controlling interest in its recording heads
operations (RHO) to MKE. RHO designs, develops, and manufactures MR recording
heads used in the Company's disk drive products. The sale was achieved through
MKE acquiring a 51% interest in a new joint venture (JV) entity, MKE-Quantum
Components LLC, that was formed to hold the operations, assets, and certain
liabilities of RHO.
Pursuant to the terms of the transaction, Quantum contributed certain RHO assets
and operations and leased certain premises to the JV and retained a 49%
ownership interest in the JV; the JV assumed $51 million of debt payable to
Quantum; and MKE paid Quantum $94 million and contributed $110 million to the JV
in exchange for a 51% controlling ownership interest in the JV.
The RHO assets which Quantum contributed to the JV are primarily comprised of
inventory, equipment, accounts receivable, premises and intangibles, which
aggregated approximately $210 million and the third party liabilities totaled
approximately $32 million. In addition, the JV will lease certain premises from
Quantum, and RHO employees will become employees of the JV. One
9
of these leases results, in substance, in a transfer of premises with an
approximate carrying value of $48 million to the JV.
MKE and the Company will share pro rata in the capital funding requirements, if
any, and results of operations of the JV. The Company plans to continue to
utilize the recording heads manufactured by the JV in its disk drive products
manufactured by MKE.
Subsequent to May 16, 1997, the Company began to account for its 49% interest in
the JV using the equity method of accounting. The Company's equity interest in
the operating results of the JV were reported in other (income) expense. The
results of RHO through May 15, 1997 were consolidated.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's discussion and analysis includes:
o Business overview.
o Strategic developments.
o A comparison of Quantum's results of operations in the three and nine
months ended December 28, 1997 with the results in the corresponding
periods in fiscal 1997.
o A discussion of Quantum's operating liquidity and capital resources.
o A discussion of trends and uncertainties, which include those related to
the information storage industry and those related to more specific
characteristics of Quantum.
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 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 below under Trends and Uncertainties. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date hereof.
Business Overview
Founded in 1980, Quantum Corporation ("Quantum" or the "Company"), has developed
leadership positions in both fixed and removable storage products. As the leader
in the mid-range tape market and one of the highest volume global suppliers of
hard disk drives, Quantum is widely recognized as the storage industry's quality
leader. The Company sells a broad range of storage products to original
equipment manufacturers ("OEMs") and distribution customers worldwide.
Quantum designs, develops, and markets information storage products, including
high-performance, high-quality half-inch cartridge tape drives, tape media, hard
disk drives, and solid state disk drives. The half-inch cartridge tape drives
and solid state disk drives are manufactured by the Company. The Company
combines its engineering and design expertise with the high-volume manufacturing
capabilities of its exclusive manufacturing partner, Matsushita-Kotobuki
Electronics Industries, Ltd. ("MKE") of Japan, a subsidiary of Matsushita
Electric Industrial Co., Ltd., to produce high-quality hard disk drives. Quantum
is also involved, through a joint venture
11
with MKE, in the research, development and manufacture of magnetoresistive
("MR") recording heads that are used in hard disk drives produced for the
Company.
The Company's strategy is to offer a diversified product portfolio that features
leading-edge technology and high-quality manufacturing for a broad range of
market applications. Inherent in this strategy is a focus on meeting and
anticipating customers' information storage needs and on the research and
development of storage product technology.
The Company's information storage business currently includes the following two
components:
Specialty Storage Products. Quantum designs, develops, manufactures,
and markets half-inch cartridge tape drives based on DLTTM technology
and solid state disk drives. Quantum also designs, develops and markets
the DLTTM tape media. The DLTTM tape drives (30GB to 70GB) use advanced
linear recording technology and a highly accurate tape guide system to
perform data backup for mid-range and high-end computer systems.
Quantum has exclusive worldwide manufacturing rights for the DLTTM
technology and is the sole manufacturer of DLTTM tape drives. The
Company believes that DLTTM tape drives have become the primary market
standard in the mid-range segment of the storage tape market. The
Company's solid state disk drives have high execution speeds required
for applications such as imaging, multimedia, video-on-demand, on-line
transaction processing, material requirements planning, and scientific
modeling.
The Company's current DLTTM tape drive and automation product offerings
include:
Quantum DLT(TM) 2000XT, DLT(TM) 4000 and DLT(TM) 7000 tape drives. The
Quantum DLT(TM) 2000XT tape drive features a native storage capacity of
15 gigabytes ("GB") and a sustained data transfer rate of 1.25MB per
second. The Quantum DLT(TM) 4000 features a native storage capacity of
20GB per cartridge and a sustained data transfer rate of 1.5MB per
second. The Quantum DLT(TM) 7000 tape drive offers a combination of
35GB native capacity and a sustained data transfer rate of 5MB per
second.
Quantum DLTstor(TM) autoloader and libraries. Each autoloader consists
of an elevator mechanism that provides random or sequential cartridge
access between a tape drive and cartridge magazines. The libraries and
autoloaders are available as 5, 7 and 14 cartridge units.
The Company's current solid state disk drives product offerings
include:
The Quantum Rushmore(TM) NTE ESP3000 and ESP5000. These products have a
data access time that is up to 15 times faster than magnetic disk
drives and are available in megabyte (MB) capacities ranging from 134MB
to 950MB.
The Rushmore(TM) Ultra family of solid state disk drives consists of
the RU3000 and RU5000 series. These drives offer capacities ranging
from 134 MB to 1.66GB at an access time up to 10 times faster than
conventional hard drives.
12
Enterprise and Personal Storage Products. Quantum designs, develops,
and markets technologically advanced desktop and high-end hard disk
drives. These drives are designed to meet the storage needs of
entry-level to high-end desktop personal computers ("PCs") for use in
both home and business environments, and for the demanding storage
needs of high-end desktop systems, workstations, network servers,
minicomputers and storage subsystems. The high-end disk drives are
designed for storage-intensive applications, such as graphics, disk
arrays, desktop publishing systems, multimedia computing systems,
networked data bases, and file servers.
The Company's current desktop disk drive product offerings include:
The Quantum Bigfoot family of 5.25-inch drives, with 1.2 to 12GB of
storage. These drives give home PC users an economical high-capacity
desktop storage solution.
The latest drives in the Quantum Bigfoot family, which began volume
shipment in the third quarter of fiscal 1998, are the Quantum Bigfoot
TX series of 5.25-inch hard disk drives. The Quantum Bigfoot TX series
feature capacities of 4GB, 6GB, 8GB and 12GB; and feature MR heads, a
PRML read channel, high internal data rates and an Ultra ATA interface.
The Bigfoot TX drive series is intended to meet the storage
requirements of entry-level commercial systems as well as mainstream
PCs.
The Quantum Fireball family of 3.5-inch drives, includes the Fireball
SE series in capacities of 2.1GB to 8.4GB, the Fireball ST series in
capacities from 1.6GB to 6.4GB, and the Fireball TM series in
capacities from 1.0GB to 3.8GB. The Fireball family of drives are
targeted for use in power and corporate business PCs, as well as
entry-level workstations and servers. The Quantum Fireball drive family
is intended to meet the storage requirements of powerful central
processing units ("CPUs"), and complex operating systems and
applications. By combining MR head and PRML read channel technologies,
the Fireball drive family provides leading areal density and innovative
technology for capacity-demanding desktop systems and servers.
The Quantum Pioneer SG drives are available in 1.0GB and 2.1GB
capacities, and are Quantum's first drives with proximity recording
head technology. The Pioneer SG drives fulfill the storage needs of
corporate and small office/home office computer users.
The Company's current high-end disk drive product offerings include:
The Quantum Viking (7,200 RPM) hard disk drive which is intended to
meet the requirements of desktop workstations and PC-based servers. The
Viking drives include capacities of 2.2GB and 4.5GB, MR heads, PRML
read channels, a high internal data rate of 83 to 139 megabits per
second, and a wide selection of Ultra SCSI-3 interfaces which provide
burst data transfer rates up to 40MB per second.
The Company has announced but has not begun shipment of the Quantum
Viking II (7,200 RPM) hard disk drive which will feature new Ultra-2
low voltage differential (LVD) SCSI-3
13
interface that doubles the burst data transfer rates up to 80MB per
second. The Viking II drives will include capacities of 4.5GB and
9.1GB, and are intended to meet the requirements of high-end desktop
computers, workstations and PC-based servers.
The Quantum Atlas II (7,200RPM) hard disk drive includes the capacity,
performance and reliability required by high-end systems such as video
and database servers, RAID subsystems, mid-range workstations and
mini-computers. Atlas II drives include capacities of 2.2GB, 4.5GB and
9.1GB, MR heads, Ultra SCSI-3 and fibre channel interfaces to meet the
requirements of the high-end marketplace.
The Company has announced but has not yet begun shipment of the Quantum
Atlas III (7,200 RPM) hard disk drive which will offer capacities up to
18.2GB for storage-intensive applications such as data warehousing. The
Atlas III will have broad interface availability with new Ultra-2 LVD
SCSI-3, Ultra single-ended SCSI-3 and Fibre Channel Arbitrated Loop
(FC-AL).
The Quantum Viking and Quantum Atlas II products are Quantum's first
high-end drives to be manufactured by MKE.
Effective May 1997, the Company's involvement in the design, development, and
manufacture of MR recording heads is through a 49% ownership interest in a joint
venture with MKE, named MKE-Quantum Components LLC ("MKQC"). The MR recording
heads are used in the Company's products. The Company believes that MR
technology, which provides higher capacity per disk than conventional thin-film
heads, is replacing thin-film heads as the leading recording head technology.
MKQC does not currently market MR heads to other companies.
Quantum operates in an industry characterized by rapid technological change. The
Company is currently concentrating its product development efforts on broadening
its existing tape and disk drive product lines through the introduction of new
products, including new tape drives, new high-capacity hard disk drive products
to be manufactured by MKE, as well as new products targeted specifically for the
increasing storage needs of the desktop market. The Company is also focusing its
efforts on applying its MR technology to new generations of disk drives.
Strategic Developments
Changes to Improve Operation of Quantum's High-End Hard Disk Drive Business.
Quantum established changes to its hard disk drive business designed to enhance
product development focus, improve time to market competitiveness, and as a
result improve the operating results of this business. The key decisions and
changes include:
o Adopt a common architecture for all of the Company's high-end products.
o Refocusing on high-end product design platforms.
o Simplifying the Company's product development plans for future products.
14
o Focusing resources to develop platforms which can be modified for
utilization in both desktop or high-end applications.
o Realigning certain development program engineering resources.
o Combining the infrastructure supporting the desktop (Desktop and Portable
Storage Group) and high-end products (Workstation and Systems Storage
Group) into one organizational unit, the Enterprise & Personal Storage
Group.
The President of the Enterprise & Personal Storage Group is Mr. Young Sohn,
formerly President of the Desktop and Portable Storage Group. Mr. Kenneth Lee
will continue as the Company's Chief Technical Officer.
These changes eliminated the need for a previously planned expansion in the hard
drive business headcount, resulted in a small number of reassignments, and will
result in the elimination of a small number of jobs next spring.
In conjunction with these changes, and as a result of the intensified
competitive dynamics in the high-end disk drive marketplace, the Company has
begun to transition to the Company's next generation of high-end products. As a
result, the Company recorded a $103 million special charge which primarily
consists of inventory write-offs and adjustments, and losses related to firm
inventory purchase commitments.
MKQC Strategic Actions. In the third quarter of fiscal 1998, MKQC took strategic
actions to streamline its operations in order to improve its operating
efficiency and negative operating results. The primary strategic action was to
combine the manufacturing launch activity previously performed in Louisville,
Colorado, for wafer and Slider/HGA products with the existing volume
manufacturing of these products in Shrewsbury, Massachusets, and Batam,
Indonesia, respectively. Consequently, the operation of the Louisville, Colorado
facility will be refocused on research and development. As a result of these
actions, MKQC recorded a charge for severance, equipment write-off, lease
termination, and other costs. The charge impacted Quantum's 49% equity share in
MKQC's loss by approximately $5 million.
Results of Operations
Sales. Sales for the three and nine months ended December 28, 1997, were $1.520
billion and $4.520 billion, respectively, compared to $1.478 billion and $3.756
billion, respectively, for the corresponding periods in fiscal 1997. These sales
increases reflected an increase in shipments of DLT TM tape drives. The nine
month comparative sales increase also reflected an increase in DLT TM tape media
sales. The DLT TM increases reflects a steady increase in production volume,
which during the quarter were at levels that met product demand. Although unit
sales of hard disk drives increased in the three and nine months comparative
periods, declines in average unit prices resulted in a decline in hard disk
drive revenue. For the fourth quarter of fiscal 1998, the Company expects sales
shipments and prices to be roughly flat or decline slightly compared to the
sales level achieved in the third quarter of fiscal 1998.
15
Sales of desktop and high-end hard drives for the three and nine months ended
December 28, 1997, represented 78% and 79% of total sales, respectively, and the
Company anticipates that desktop products will continue to constitute a majority
of sales in the future. Sales of DLT TM products continued to increase and
represented 22% and 21% of sales in the three and nine months ended December 28,
1997, respectively, compared to 14% and 13%, respectively, in the corresponding
periods in fiscal 1997. The Company expects that sales of DLT TM products will
continue to increase as a percentage of the Company's total sales in the future.
Sales of DLT TM products are expected to grow at a rate which is consistent with
the growth rate for the mid-range server market, which is expected to be less
than the DLT TM product sales growth rate for the past year.
Sales to the Company's top five customers for the three and nine months ended
December 28, 1997, represented 39% and 40% of sales, respectively, compared to
40% and 39% of sales, respectively, for the corresponding periods in fiscal
1997. Sales to Hewlett-Packard were 13% and 12% of sales in the three and nine
months ended December 28, 1997, respectively, compared to 11% and 10% of sales,
respectively, in the corresponding periods in fiscal 1997. Sales to Compaq
Computer, Inc. were less than 10% of sales in the three and nine months ended
December 28, 1997, respectively, compared to 12% in the corresponding periods of
fiscal 1997.
Gross Margin Rate. The gross margin rate for the quarter ended December 28, 1997
decreased 5.7 percentage points to 8.9% from 14.6% in the quarter ended December
29, 1996. The gross margin rate for the first nine months of fiscal 1998
increased 2.6 percentage points to 15.7%, from 13.1% in the corresponding period
in fiscal 1997.
The quarterly and fiscal year to date comparative margin rate changes reflected
the impact of the previously discused $103 million special charge. The special
charge was related to the transition to the Company's next generation high-end
disk drive products; and primarily consisted of inventory write-offs and
adjustments, and losses related to firm inventory purchase commitments. The
gross margin excluding the impact of the charge was 15.7% and 18.0% in the three
and nine month periods ended December 28, 1997.
The quarterly and fiscal year-to-date comparative margin rate increase,
excluding the impact of the special charge, reflected increases in DLT TM tape
drive product margins and margin contribution, and of the impact of the
application of the equity method of accounting to the Company's involvement in
the recording heads operations, subsequent to May 16, 1997. The increase in
DLT TM tape drive product margins and margin contribution reflected an increase
in overall sales mix to tape drive products, and within this product group the
sales mix has shifted to higher-capacity higher-margin tape drive products,
particularly to the Quantum DLT TM 7000 tape drive. These increases were
partially offset by declines in margins earned on hard disk drives, particularly
on desktop drives. The decline in hard disk drive margins reflected competitive
pricing pressure.
Research and Development Expenses. In the three and nine months ended December
28, 1997, the Company's research and development expenses were $88 million, or
5.8% of sales, and $237 million, or 5.2% of sales, respectively; compared to $73
million, or 5.0% of sales, and $209 million, or 5.6% of sales, respectively, in
the corresponding periods of fiscal 1997. These
16
increases in research and development expenses reflect pre-production activity
on new products; as well as expenses related to new information storage products
and technologies, including optical storage technology.
Sales and Marketing Expenses. Sales and marketing expenses in the three and nine
months ended December 28, 1997, were $45 million, or 3.0% of sales, and $129
million, or 2.9% of sales, respectively, compared to $39 million, or 2.6% of
sales, and $105 million, or 2.8% of sales, respectively, in the corresponding
periods in fiscal 1997. The increases in sales and marketing expenses were
related to the costs of supporting the Company's higher volumes of sales.
General and Administrative Expenses. General and administrative expenses in the
three and nine months ended December 28, 1997, were $23 million, or 1.5% of
sales, and $75 million, or 1.7% of sales, respectively, compared to $21 million,
or 1.4% of sales, and $60 million, or 1.6% of sales, respectively, in the
corresponding periods in fiscal 1997. The increases in general and
administrative expenses reflected expansion of the Company's infrastructure.
Other Income/Expense. Net other income and expense in the three and nine months
ended December 28, 1997 was a net expense of $22 million and $42 million,
respectively, compared to $11 million and $36 million, respectively, in the
corresponding periods in fiscal 1997. The change in interest expense reflected
decreases in the average amount of debt outstanding. The change in interest
income and other income and expense, net reflects an increase in interest income
corresponding to an increase in average cash balances. The equity in loss of
investee reflected the Company's equity share in the operating losses of MKQC
since May 16, 1997, when this joint venture was established. Prior to May 16,
1997, the recording head operations of Quantum, which became the operations of
MKQC, were fully consolidated by Quantum. The equity in loss of investee in the
third quarter of fiscal 1998 included approximately $5 million representing the
Company's share of the charge included in MKQC's operating results for
severance, equipment write-off, lease termination, and other costs associated
with MKQC's strategic actions. A combination of operating costs, manufacturing
yields, product transitions, and soft demand related to Quantum's performance in
the high-end of the hard disk drive market have resulted in sequentially
declining performance of MKQC. These adverse conditions are expected to continue
in the fourth fiscal 1998 quarter.
Income Taxes. The effective tax rate for the three and nine months ended
December 28, 1997, at 26%, was flat compared to the rate in the corresponding
periods ended December 29, 1996. The effective tax rate is expected to increase
in fiscal 1999, due to the expected contribution of DLT TM products to operating
results which are taxed at standard U.S. corporate tax rates.
Liquidity and Capital Resources
At December 28, 1997, the Company had $717 million in cash and cash equivalents,
compared to $345 million at March 31, 1997. For the nine month period ended
December 28, 1997, cash was
17
provided by operating and financing activities. Operating activities included
cash provided from net income, an increase in other accrued liabilities and a
decrease in accounts receivable; which was partially offset by an increase in
inventory. Financing activities included $288 million of proceeds from the
issuance of 7% convertible subordinated notes. Cash provided by financing
activities was partially offset by the repayment of the outstanding senior
credit facility in the first fiscal 1998 quarter. Cash used in investing
activities, primarily for investment in property and equipment, was largely
offset by cash provided from a $94 million payment from MKE as part of the
formation of the recording heads joint venture company, MKQC.
The revolving credit line, term loan, and equipment loan, which were paid off
and terminated in the first fiscal 1998 quarter had carrying amounts of $110
million, $56 million, and $14 million, respectively, as of March 31, 1997.
In June 1997, the Company entered into an unsecured senior credit facility which
provides a $500 million revolving credit line and expires in June 2000. At the
option of the Company, borrowings under the revolving credit line bear interest
at either LIBOR plus a margin determined by a total funded debt ratio, or a base
rate, with option periods of one to six months. As of December 28, 1997, there
was no outstanding balance drawn on this line.
The Company has filed a registration statement which became effective on July
24, 1997, pursuant to which the Company may issue debt or equity securities, in
one or more series or issuances, limited to $450 million aggregate public
offering price. Under the registration statement, in July 1997, the Company
issued $288 million of 7% convertible subordinated notes. The notes mature on
August 1, 2004, and are convertible at the option of the holder at any time
prior to maturity, unless previously redeemed, into shares of the Company's
common stock at a conversion price of $46.325 per share. The notes are
redeemable at the Company's option on or after August 1, 1999 and prior to
August 1, 2001, under certain conditions related to the price of the Company's
common stock. Subsequent to August 1, 2001, the notes are redeemable at the
Company's option at any time. In the event of certain changes involving all or
substantially all of the Company's common stock, the notes would become
redeemable at the option of the holder. Redemption prices range from 107% of the
principal to 100% at maturity. The notes are unsecured obligations subordinated
in right of payment to all existing and future senior indebtedness of the
Company.
In the second fiscal 1998 quarter, the Company extended until September 1998 an
$85 million unsecured Letter of Credit facility with certain banks to issue
letters of credit to Matsushita-Kotobuki Electronics and its affiliates.
The holder of the 90,000 shares of Redeemable Convertible Participating Series B
Preferred Stock exercised its right to convert the shares to Quantum common
stock. The Company issued 180,000 shares of its common stock pursuant to the
conversion.
The Company expects to spend approximately $185 million for capital equipment,
expansion of the Company's facilities, and leasehold improvements in fiscal
1998. These capital expenditures will support the tape business, research and
development, and general corporate operations. Refer to the Future Capital Needs
section of the Trends and Uncertainties section for additional discussion of
capital.
18
The Company believes that its existing and available capital resources,
including its unsecured senior credit facility 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 the Company's
expectations, and actual results could vary due to certain of the factors
described in the Trends and Uncertainties section that follows.
Trends and Uncertainties
Operating in the information storage industry, Quantum is affected by numerous
trends and uncertainties, some of which are specific to the industry while
others relate more specifically to Quantum. These are discussed below.
Trends and Uncertainties - Information Storage Industry
Key trends and uncertainties inherent in the information storage industry and
how these trends and uncertainties specifically impact the Company are
summarized below.
o Intense competition - The information storage products industry
in general, and the disk drive market in particular, is
characterized by intense competition that results in rapid price
erosion; short product life cycles; and continuous introduction
of new, more cost-effective products offering increased levels of
capacity and performance.
o Rapid technological change - Technology advancement in the
information storage industry is very rapid.
o Customer concentration - High-purchase-volume customers for
information storage products are concentrated within a small
number of computer system manufacturers, distribution channels,
and system integrators.
o Fluctuating product demand - The demand for hard disk drive
products depends on the demand for the computer systems in which
hard disk drives are used, which in turn is affected by computer
system product cycles and by prevailing economic conditions.
o Intellectual property conflicts - The hard disk drive industry
has been characterized by significant litigation relating to
patent and other intellectual property rights.
Intensely Competitive Industry. To compete within the information storage
industry, Quantum frequently introduces new products and transitions to newer
versions of existing products. Product introductions and transitions are
significant to the operating results of Quantum, and if they are not successful,
the Company would be materially and adversely affected. The hard disk drive
market,
19
in particular, also tends to experience periods of excess product inventory and
intense price competition. If price competition intensifies, the Company may be
forced to lower prices more than expected and transition products sooner than
expected, which could materially adversely affect the Company. For example, in
the third quarter of fiscal 1998, excess inventory in the hard drive market,
aggressive pricing and corresponding margin reduction, particularly in the
distribution channel for desktop hard disk drives, and the transition related to
the Company's high-end disk drives have adversely impacted the Company's
operating results in the third fiscal 1998 quarter. As a result, the Company
recorded a $103 million special charge which primarily consists of inventory
write-offs and adjustments, and losses related to firm inventory purchase
commitments. The special charge is based on estimates and assumptions made by
management based on information available as of the date of the financial
statements. The use of estimates and assumptions are inherently uncertain and
actual results may differ. If demand, competition and pricing prove to be
significantly more adverse than estimated, the Company's operating results could
be further adversely affected.
In addition, the Company's customers could commence the manufacture of disk and
tape drives for their own use or for sale to others. Any such loss of customers
could have a material adverse effect on the Company.
Quantum faces direct competition from a number of companies, including Seagate,
Western Digital, IBM, Maxtor, Exabyte, Sony and Fujitsu. In the event that the
Company is unable to compete effectively with these companies, any other
company, or any collaboration of companies, the Company would be materially
adversely affected. The Company's information storage product competition can be
further broken down as follows:
Specialty Storage Products. In the market for tape drives, the Company
competes with other companies that have tape drive product offerings and
alternative formats, including Hewlett Packard, Exabyte, Storage
Technology, and Sony. The Company targets a market segment that requires a
mission critical backup system and archiving, and competes in this segment
based on the reliability, data integrity, performance, capacity and
scalability of its tape drives. Although the Company has experienced
excellent market acceptance and conditions for its tape drive products,
the market would become more competitive if other companies individually
or collaboratively broaden their product lines in this market. As a
result, the Company could experience increased price and performance
competition. If price or performance competition increases, the Company
could be required to lower prices, resulting in decreased margins, in
which case the Company' operating results could be materially adversely
affected.
Desktop Storage Products. In the market for desktop products, Quantum
competes primarily with Seagate, Western Digital, Maxtor, IBM and Fujitsu.
Quantum and its competitors have developed and continue to develop a
number of products targeted at particular segments of this market, such as
business users and home PC buyers, and factors such as time to market,
cost, product performance, quality and reliability can have a significant
effect on the success of any particular product. The desktop market is
characterized by more competitiveness and shorter product life cycles than
the information storage industry in general.
20
Workstation and System Storage Products. The Company faces competition in
the high-capacity disk drive market primarily from Seagate, IBM and
Fujitsu. Seagate has the largest share of the market for high-end disk
drives. Although the same competitive factors identified above as being
generally applicable to the overall disk drive industry apply to high-end
disk drives, the Company believes that the performance, quality and
reliability of its products are even more important to the users in this
market than to users in the desktop market. However, this does not lessen
the intensely competitive nature of the high-end of the hard disk drive
market. For example, in the third fiscal 1998 quarter, the impact of
intense competition, lower demand and pricing pressure was reflected in
the transition related to the Company's high-end products. The Company
does not anticipate that the high-end disk drive products will return to
profitability prior to shipping next generation products and there can be
no assurance as to the profitability of next generation products. The
Company's operating results in the high-capacity market during the
foreseeable future is dependent on the successful development, timely
introduction, market acceptance, and product transition of key new
products, as to which there can be no positive assurance.
Rapid Technological Change, New Product Development, and Qualification. In the
hard disk drive market, the combination of an environment of rapid technological
changes, short product life cycles and intense competitive pressures results in
gross margins on specific products decreasing rapidly. Accordingly, any delay in
the introduction of more advanced and more cost-effective products can result in
significantly lower sales and gross margins. The Company's future is therefore
dependent on its ability to anticipate what customers will demand and to develop
the new products to meet this demand and which effectively compete with the
products of competitors. The Company must also qualify new products with its
customers, successfully introduce these products to the market on a timely
basis, and commence and achieve volume production to meet customer demands. Due
to these factors, the Company expects that sales of new products will continue
to account for a significant portion of its future hard disk drive sales and
that sales of older products will decline accordingly.
The Company is frequently in the process of qualifying new products with its
customers. The customer qualification process for disk drive products,
particularly high-capacity products, can be lengthy, complex, and difficult. In
addition, the Company transitioned the manufacturing of its high-capacity
products to MKE during the first half of fiscal 1997. In the event that the
Company is unable to obtain additional customer qualifications for new products
in a timely manner, or at all, or in the event that MKE is unable to continue to
manufacture such products in volume and with consistent high quality, the
Company would be materially adversely affected.
In the mid-range tape drive market, the Company has experienced significantly
less rapid technological change, as well as less technology and performance
based competition as compared to that experienced in the hard disk drive market.
This has resulted in generally favorable and stable product gross margins on
sales of the Company's DLT brand tape products. These favorable margins, in
conjunction with the eroded gross margins in the hard disk drive market, has
resulted in the Company's earnings on the sale of tape drive and related media
products becoming the primary source of the Company's operating income in the
third fiscal 1998 quarter. In the third fiscal 1998
21
quarter, tape drive and related media operating results contributions partially
offset the poor results and special charge associated with the Company's hard
disk drive operations, particularly that related to high-end disk drive
products. Given the favorable tape drive market conditions that the Company has
experienced, competitors are likely to be aggressively trying to make
technological advances and take other steps in order to more successfully
compete with the Company's DLT brand tape products. Successful competitor
product offerings, which target the market in which the Company's DLT brand tape
products compete, could have a material adverse effect on the Company.
Additionally, in the event that the Company is not able to maintain the
competitiveness of the Company's DLT brand tape product's technology,
performance, quality and reliability or otherwise not meet the requirements that
the market demands it could lose market share and experience declining sales and
gross margins which would have a material adverse effect on the Company.
In the information storage industry in general, there can be no assurance that
the Company will be successful in the development and marketing of any new
products and components in response to technological change or evolving industry
standards, that the Company will not experience difficulties that could delay or
prevent the successful development, introduction and marketing of these products
and components; or that the Company's new products and components will
adequately meet the requirements of the marketplace and achieve market
acceptance. In addition, technological advances in magnetic, optical or other
technologies, or the development of new technologies, could result in the
introduction of competitive products with superior performance to and
substantially lower prices than the Company's products. Further, the Company's
new products and components are subject to significant technological risks. If
the Company experiences delays in the commencement of commercial shipments of
new products or components, the Company could experience delays or loss of
product sales. If the Company is unable, for technological or other reasons, to
develop and introduce new products in a timely manner in response to changing
market conditions or customer requirements, the Company would be materially
adversely affected.
As part of the Company's strategy to remain technologically competitive, the
Company has invested in technologies, such as in Near Field Recording TM through
a strategic alliance with and investment in TeraStor, and its investment in MR
recording heads through the joint venture, MKQC. There can be no assurance that
the technologies, companies and ventures in which the Company has invested will
be profitable in the information storage industry. Adverse technological or
operating outcomes could result in impairment and write down of associated
investments which could have a material adverse effect on the Company.
Customer Concentration. In addition to the information storage industry and the
Company's customer base being concentrated, the customers generally are not
obligated to purchase any minimum volume of the Company's products, and the
Company's relationships with its customers are generally terminable at will by
its customers.
Sales of the Company's desktop and tape products, which together comprise a
majority of its overall sales, were concentrated with several key customers in
the nine months ended December 28, 1997, and the fiscal year ended March 31,
1997. Sales to the Company's top five customers
22
for the nine months ended December 28, 1997, and for the fiscal year ended March
31, 1997, represented 40% and 38% of sales, respectively. In the nine month
period ended December 28, 1997, revenue from the top five customers was derived
from both the OEM and Distribution sales channel, 29% and 11% respectively. One
OEM, Hewlett Packard, represented 12% of total revenue for the nine months ended
December 28, 1997. No single distribution channel customer represented 10% or
more of total revenue. Because of the rapid and unpredictable changes in market
conditions, the Company is unable to predict whether or not there will be any
significant change in demand for any of its customers' products in the future.
In the event that any such changes result in decreased demand for the Company's
products, whether by loss of or delays in orders, the Company could be
materially adversely affected. In addition, the loss of one or more key
customers could materially adversely affect the Company.
Fluctuation in Product Demand. Fluctuation in demand for the Company's products
generally results in fluctuations in the Company's operating results. Demand for
computer systems, especially in the PC market segment, where the Company derives
a significant amount of its disk drive sales has historically been subject to
significant fluctuations. Such fluctuations in end-user demand have in the past,
and may in the future, result in the deferral or cancellation of orders for the
Company's products, each of which could have a material adverse effect on the
Company. During the past several years, there has been significant growth in the
demand for PCs, a portion of which represented sales of PCs for use in the home.
However, many analysts predict that future growth may be at a moderately slower
rate than the rate experienced in recent years.
Sales of tape drives and tape drive-related products have tended to be more
stable and have become a significant component of sales for the Company.
Beginning in the third quarter of fiscal 1998, sales of DLTTM tape drives and
DLTTM tape drive-related products achieved gross margin and profitability which
significantly exceeded that achieved from the sale of the Company's desktop hard
drive products. In this regard the company expects sales of DLTTM products,
which represented 21% of sales and a majority of operating profits for the nine
months ended December 28, 1997, will continue to represent a major portion of
the Company's operating profits in the future. On a sequential quarterly basis
in fiscal 1998, the Company expects the rate of sales growth to lessen compared
to the rates achieved over the past year. In addition, there can be no assurance
that any growth expectations will be achieved or that current market conditions
will continue.
The Company has experienced longer product cycles for its tape drives and tape
drive-related products compared with the short product cycles of disk drive
products. However, there is no assurance that this trend will continue.
The Company could experience decreases in demand for any of its products in the
future, which could have a material adverse effect on the Company. For the
fourth fiscal 1998 quarter, the Company expects to experience continued gross
margin pressure with respect to its high-end and desktop hard disk drive
products.
The hard disk drive industry has also been subject, from time to time, to
seasonal fluctuations in demand. The Company has typically experienced the
market to demonstrate relatively flat to
23
slightly declining demand in the quarter ending in March compared with the
quarter ending in December. The Company expects this trend to continue with
respect to the quarter ending March 31, 1998. In addition, the Company's
shipments tend to be highest in the third month of each quarter, which occurred
in the quarter ended December 28, 1997 and which the Company expects to occur
again in the quarter ending March 31, 1998. As a result, and because the Company
has no long-term purchase commitments from its customers, future demand is
difficult to predict. The failure by the Company to complete shipments in the
final month of a quarter due to a decline in customer demand, manufacturing
problems or other factors would adversely affect the Company's operating results
for that quarter.
Intellectual Property Matters. From time to time, the Company is approached by
companies and individuals alleging Quantum's need for a license under patented
technology that Quantum assertedly uses. If required, there can be no assurance
that licenses to any such technology could be obtained or obtained on
commercially reasonable terms. Adverse resolution of any intellectual property
litigation could subject the Company to substantial liabilities and require it
to refrain from manufacturing certain products. In addition, the costs of
engaging in such litigation may be substantial, regardless of the outcome.
Trends and Uncertainties More Specific to Quantum
Certain trends and uncertainties relate more specifically to Quantum and are not
necessarily indicative of the information storage industry as a whole. These
trends and uncertainties include dependence on MKE for the manufacture of the
disk drives that Quantum develops and markets; costs associated with MKQC, which
is the MR recording heads joint venture with MKE; dependence on suppliers;
component shortages; future capital needs; warranty costs; foreign
manufacturing; and price volatility of Quantum common stock. For information
regarding litigation refer to Note 5 of the Notes to Condensed Consolidated
Financial Statements.
Dependence on MKE Relationship. Quantum is dependent on MKE for the manufacture
of its disk drive products. Approximately 79% of the Company's sales in the nine
months ended December 28, 1997, and 81% of the sales in year ended March
31,1997, were derived from products manufactured by MKE. In addition, the
formation of the MKQC joint venture with MKE to develop and produce recording
heads used in disk drive production, and the transition of the manufacturing of
the Company's high-capacity products to MKE in fiscal 1997 has resulted in an
increased dependence on MKE. The Company's relationship with MKE is therefore
critical to the Company's business and financial performance.
In May 1997, Quantum completed renegotiation of its master agreement with MKE,
which covers the general terms of the business relationship. The agreement was
extended for a period of 10 years, unless terminated sooner as a result of
certain specified events including a change-in-control of either Quantum or MKE.
MKE currently manufactures all of the hard disk drives developed and marketed by
Quantum. Quantum's relationship with MKE, which dates from
24
1984, is built on Quantum's engineering and design expertise and MKE's
high-volume, high-quality manufacturing expertise.
The Company's dependence on MKE entails, among others, the following principal
risks:
Quality and Delivery. The Company relies on MKE's ability to bring new
products rapidly to volume production at low cost, to meet the Company's
stringent quality requirements, and to respond quickly to changing product
delivery schedules from the Company. This requires, among other things,
close and continuous collaboration between the Company and MKE in all
phases of design, engineering, and production. The Company's business and
financial results would be adversely affected if products manufactured by
MKE fail to satisfy the Company's quality requirements or if MKE is unable
to meet the Company's delivery commitments. In the event MKE is unable to
satisfy Quantum's production requirements, the Company would not have an
alternative manufacturing source to meet the demand without substantial
delay and disruption of the Company's operations. As a result, the Company
would be materially adversely affected.
Volume and Pricing. MKE's production schedule is based on the Company's
forecasts of its product purchase requirements, and the Company has
limited contractual rights to modify short-term purchase orders issued to
MKE. Further, the demand in the desktop business is inherently volatile,
and there is no assurance that the Company's forecasts are accurate. In
addition, the Company periodically negotiates pricing arrangements with
MKE. The failure of the Company to accurately forecast its requirements or
successfully adjust MKE's production schedule, which could lead to
inventory shortages or surpluses, or the failure to reach pricing
agreements reasonable to the Company would have a material adverse effect
on the Company. For example, a portion of the $103 million special charge
recorded in the third quarter of fiscal 1998 reflects losses on firm
inventory commitments associated with high-end disk drive product
production at MKE.
Manufacturing Capacity and Capital Commitment. The Company believes that
MKE's current and committed manufacturing capacity should be adequate to
meet the Company's requirements at least through the end of fiscal 1998.
The Company's future growth will require, however, that MKE continue to
devote substantial financial resources to property, plant and equipment
and working capital to support manufacture of the Company's products, as
to which there can be no assurance. In the event that MKE is unable or
unwilling to meet the Company's manufacturing requirements, there can be
no assurance that the Company would be able to obtain an alternate source
of supply. Any such failure to obtain an alternative source would have a
material adverse effect on the Company.
MKQC - Joint Venture for MR Recording Heads Development and Manufacturing. Since
the fiscal 1995 acquisition of MR recording heads technology as part of the
acquisition of certain businesses of the Storage Business Unit of Digital
Equipment Corporation, Quantum has made significant efforts to advance the
development of its MR recording heads capability. To further this effort, MKE
and Quantum formed a joint venture, MKQC, in the first quarter of fiscal 1998 to
partner in the research, development, and production of MR heads and technology.
However,
25
MR technology is relatively complex and, to date, the Company and MKQC's
manufacturing yields for its MR heads have been lower than would be necessary
for cost effective production of MR recording heads. The Company does not expect
cost-effective production of MR recording heads to be realized in the near term.
Until that time, the Company will incur losses based on its pro rata ownership
interest in the new joint venture. However, there can be no assurance that the
anticipated benefits of the joint venture will be realized on a timely basis or
at all. The Company currently obtains 80% to 85% of its MR heads from outside
sources.
In the third quarter of fiscal 1998, MKQC took strategic actions to streamline
its operations in order to improve its operating efficiency and negative
operating results. The primary strategic action was to combine the manufacturing
launch activity previously performed in Louisville, Colorado, for wafer and
Slider/HGA products with the existing volume manufacturing of these products in
Shrewsbury, Massachusetts, and Batam, Indonesia, respectively. As a result of
the change, the operation of the Louisville, Colorado facility will be refocused
on research and development. There can be no assurance that MKQC's strategic
actions will be implemented successfully or will be successful in improving the
operating efficiency or the negative operating results of MKQC.
Dependence on Suppliers of Components and Sub-Assemblies; Component Shortages.
Both the Company and its manufacturing partner, MKE, are dependent on qualified
suppliers for components and sub-assemblies, including recording heads, media,
and integrated circuits, which are essential to the manufacture of the Company's
disk drive and tape drive products. In connection with certain products, the
Company and MKE qualify only a single source for certain components and
sub-assemblies, which can magnify the risk of shortages. Component shortages
have constrained the Company's sales growth in the past, and the Company
believes that the industry will periodically experience component shortages. If
component shortages occur, or if the Company experiences quality problems with
component suppliers, shipments of products could be significantly delayed or
costs significantly increased, which would have a material adverse effect on the
Company.
Future Capital Needs. The information storage industry is capital and research
and development intensive and the Company will need to maintain adequate
financial resources for capital expenditures, working capital, and research and
development, in order to remain competitive in the information storage business.
The Company believes that it will be able to fund these capital requirements at
least the next 12 months. However, if the Company decides to increase its
capital expenditures further, or sooner than presently contemplated, or if
results of operations do not meet the Company's expectations, the Company could
require additional debt or equity financing. There can be no assurance that such
additional funds will be available to the Company or will be available on
favorable terms. The Company may also require additional capital for other
purposes not presently contemplated. If the Company is unable to obtain
sufficient capital, it could be required to curtail its capital equipment and
research and development expenditures, which could adversely affect the Company.
26
Warranty. Quantum generally warrants its products against defects for a period
of one to five years. A provision for estimated future costs relating to
warranty expense is recorded when products are shipped. The actual warranty
expenditures could have a material unfavorable impact on the Company if the
actual rate of unit failure or the cost to repair a unit is greater than what
the Company has used in estimating the warranty expense accrual.
Risks Associated with Foreign Manufacturing. Many of the Company's products and
product components are currently manufactured outside the United States. As a
result, the Company is subject to certain risks associated with contracting with
foreign manufacturers, including obtaining requisite United States and foreign
governmental permits and approvals, currency exchange fluctuations, currency
restrictions, political instability, labor problems, trade restrictions, and
changes in tariff and freight rates.
Foreign Exchange Contracts. The Company manages the impact of foreign currency
exchange rate changes on certain foreign currency receivables and payables using
foreign currency forward exchange contracts. With this approach the Company
expects to minimize the impact of changing foreign exchange rates on the
Company's net income. However, there can be no assurance that all foreign
currency exposures will be adequately managed, and the Company could incur
material charges as a result of changing foreign exchange rates.
Volatility of Stock Price. The market price of the Company's common stock has
been, and may continue to be, extremely volatile. Factors such as new product
announcements by the Company or its competitors; quarterly fluctuations in the
operating results of the Company, its competitors, and other technology
companies; and general conditions in the information storage and computer market
may have a significant impact on the market price of the common stock. In
particular, when the Company reports operating results that are less than the
expectations of analysts, the market price of the common stock can be materially
adversely affected.
27
QUANTUM CORPORATION
PART II - OTHER INFORMATION
Item 1. Legal proceedings
Refer to Note 5 of the Notes to Condensed Consolidated Financial Statements.
Item 2. Changes in securities
The holder of the 90,000 shares of Redeemable Convertible Participating Series B
Preferred Stock exercised the right to convert the shares to Quantum common
stock. The Company issued 180,000 shares of its common stock pursuant to the
conversion.
Item 3. Defaults upon senior securities - Not Applicable
Item 4. Submission of matters to a vote of security holders
Item 5. Other information - Not Applicable
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.
None
28
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: January 26, 1998 By: /s/ Richard L. Clemmer
----------------------
Richard L. Clemmer
Executive Vice President, Finance
and Chief Financial Officer
29
QUANTUM CORPORATION
INDEX TO EXHIBITS
Exhibit
Number
27 Financial Data Schedule
30