Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 27, 1998
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
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of December 27, 1998: 165,941,011
QUANTUM CORPORATION
10-Q REPORT
INDEX
Page
Number
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations 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 13
PART II - OTHER INFORMATION 39
SIGNATURE 40
2
QUANTUM CORPORATION
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
Three Months Ended Nine Months Ended
December 27, December 28, December 27, December 28,
1998 1997 1998 1997
----------- ----------- ----------- -----------
Sales $ 1,325,581 $ 1,519,881 $ 3,593,315 $ 4,519,516
Cost of sales 1,086,492 1,384,208 2,995,964 3,809,826
----------- ----------- ----------- -----------
Gross profit 239,089 135,673 597,351 709,690
Operating expenses:
Research and development 87,921 88,275 254,859 236,797
Sales and marketing 51,142 45,203 134,866 128,907
General and administrative 22,380 23,375 61,275 75,114
Purchased in-process research and
Development 89,000 -- 89,000 --
----------- ----------- ----------- -----------
250,443 156,853 540,000 440,818
Income (loss) from operations (11,354) (21,180) 57,351 268,872
Other (income) expense:
Interest expense 6,909 9,806 20,136 24,135
Interest income and other, net (5,126) (10,146) (19,962) (24,658)
Loss from investee 100,700 22,651 142,050 42,222
----------- ----------- ----------- -----------
102,483 22,311 142,224 41,699
Income (loss) before income taxes (113,837) (43,491) (84,873) 227,173
Income tax provision (benefit) (7,286) (11,308) 1,403 59,065
----------- ----------- ----------- -----------
Net income (loss) $ (106,551) $ (32,183) $ (86,276) $ 168,108
=========== =========== =========== ===========
Net income (loss) per share:
Basic $ (0.64) $ (0.24) $ (0.54) $ 1.26
Diluted $ (0.64) $ (0.24) $ (0.54) $ 1.05
Weighted average common shares:
Basic 165,820 135,842 158,687 133,669
Diluted 165,820 135,842 158,687 165,642
See accompanying notes to condensed consolidated financial statements.
3
QUANTUM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 27, March 31,
1998 1998
---------- ----------
(unaudited) (Note 1)
Assets
Current assets:
Cash and cash equivalents $ 683,011 $ 642,150
Marketable securities 24,425 71,573
Accounts receivable, net of allowance for
Doubtful accounts of $11,823 and $12,928 664,238 737,928
Inventories 259,042 315,035
Deferred taxes 136,020 133,981
Other current assets 88,710 124,670
---------- ----------
Total current assets 1,855,446 2,025,337
Property and equipment, net of accumulated
Depreciation of $278,922 and $220,482 266,785 285,159
Intangibles, net 231,750 24,490
Other assets 39,587 103,425
---------- ----------
$2,393,568 $2,438,411
========== ==========
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 405,737 $ 446,243
Accrued warranty 73,611 74,017
Accrued compensation 55,601 60,344
Income taxes payable 27,659 39,777
Current portion of long-term debt 1,001 935
Other accrued liabilities 100,102 78,920
---------- ----------
Total current liabilities 663,711 700,236
Deferred taxes 73,945 38,668
Convertible subordinated debt 287,500 287,500
Long-term debt 64,225 39,985
Shareholders' equity:
Common stock 855,946 776,291
Retained earnings 448,241 595,731
---------- ----------
Total shareholders' equity 1,304,187 1,372,022
---------- ----------
$2,393,568 $2,438,411
========== ==========
See accompanying notes to condensed consolidated financial statements.
4
QUANTUM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Nine Months Ended
December 27, December 28,
1998 1997
--------- ---------
Cash flows from operating activities:
Net income (loss) $ (86,276) $ 168,108
Items not requiring the current use of cash:
Loss from investee 124,809 --
Purchased in-process research and development 89,000 --
Depreciation 69,107 57,802
Amortization 13,812 9,332
Compensation related to stock plans 4,064 3,099
Deferred income taxes 438 (346)
Changes in assets and liabilities:
Accounts receivable 73,690 64,451
Inventories 55,993 (170,643)
Accounts payable (40,506) 41,395
Income taxes payable (12,118) 16,697
Accrued warranty (406) (23,718)
Other assets and liabilities 63,972 104,468
--------- ---------
Net cash provided by operating activities 355,579 270,645
--------- ---------
Cash flows from investing activities:
Investment in property and equipment (88,572) (124,299)
Proceeds from disposition of property and equipment 139 23,932
Proceeds from sale of marketable securities 115,508 --
Purchase of marketable securities (68,360) --
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 (41,285) (37,367)
--------- ---------
Cash flows from financing activities:
Proceeds from long-term credit facilities 33,545 --
Proceeds from issuance of convertible subordinated note -- 287,500
Purchase of treasury stock (305,287) --
Principal payments on credit facilities (26,848) (180,757)
Proceeds from issuance of common stock 25,157 31,442
--------- ---------
Net cash provided by (used in) financing activities (273,433) 138,185
--------- ---------
Net increase in cash and cash equivalents 40,861 371,463
Cash and cash equivalents at beginning of period 642,150 345,125
--------- ---------
Cash and cash equivalents at end of period $ 683,011 $ 716,588
========= =========
Supplemental disclosure of cash flow information:
Conversion of redeemable preferred stock to common stock $ -- $ 3,888
Cash paid during the period for:
Interest $ 3,898 $ 11,793
Income taxes, net of (refunds) $ (1,239) $ 59,806
See accompanying notes to condensed consolidated financial statements.
5
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, 1998 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 ("Quantum" or the "Company") for the fiscal
year ended March 31, 1998 included in its Annual Report on Form 10-K filed with
the Securities and Exchange Commission.
2. Inventories
Inventories consisted of the following:
(In thousands)
December 27, March 31,
1998 1998
-------------- -------------
Materials and purchased parts $ 72,911 $ 72,990
Work in process 25,300 44,303
Finished goods 160,831 197,742
-------- --------
$259,042 $315,035
======== ========
6
3. Net income (loss) per share
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
December 27, December 28, December 27, December 28,
1998 1997 1998 1997
--------- --------- --------- ---------
Numerator:
Numerator for basic net income (loss)
per share - income (loss) available to
common stockholders $(106,551) $ (32,183) $ (86,276) $ 168,108
Effect of dilutive securities:
5% convertible subordinated notes -- -- -- 5,430
--------- --------- --------- ---------
Numerator for diluted net income
(loss) per share - income (loss)
available to common stockholders $(106,551) $ (32,183) $ (86,276) $ 173,538
========= ========= ========= =========
Denominator:
Denominator for basic net income
(loss) per share - weighted average
shares 165,820 135,842 158,687 133,669
Effect of dilutive securities:
Outstanding options -- -- -- 10,227
Series B preferred stock -- -- -- 120
5% convertible subordinated notes -- -- -- 21,626
--------- --------- --------- ---------
Denominator for diluted net income (loss)
per share - adjusted weighted
average shares and assumed conversions
165,820 135,842 158,687 165,642
========= ========= ========= =========
Basic net income (loss) per share $ (0.64) $ (0.24) $ (0.54) $ 1.26
========= ========= ========= =========
Diluted net income (loss) per share $ (0.64) $ (0.24) $ (0.54) $ 1.05
========= ========= ========= =========
The computation of diluted net loss per share for the three and nine months
ended December 27, 1998 and the three 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 have been antidilutive.
The computation of diluted net loss per share for the three and nine months
ended December 27, 1998 and the three months ended December 28, 1997 also
excluded the effect of weighted average outstanding options because the Company
reported a net loss for these periods and accordingly, the effect would be
antidilutive. At December 27, 1998, options to purchase 22,540,250 shares of the
Company's common stock were outstanding.
7
4. Debt & Capital
In September 1998, the Company issued 16.9 million shares to the shareholders of
ATL Products, Inc. ("ATL") to complete the acquisition of ATL as a wholly owned
subsidiary of the Company. In part, the Company reissued treasury stock to
complete the acquisition. The difference between the cost of the treasury stock
and the value at which the shares were reissued resulted in a $63 million
reduction to retained earnings in the quarter ended December 27, 1998. For
additional information regarding the ATL acquisition, refer to Note 6 of the
Notes to Condensed Consolidated Financial Statements.
In October 1998, the Company repurchased 2.8 million shares of its common stock
which completed the share repurchase of a total of 15.5 million shares during
the nine months ended December 27, 1998 at a cost of $305 million as authorized
by the Board of Directors. The intent of the repurchase was to minimize the
dilutive impact of the shares issued to complete the acquisition of ATL.
In December 1998, the Company entered into a senior credit facility that
provides a $35 million revolving credit line to ATL. The revolving credit line
is coterminous with the Company's $500 million revolving credit line, expiring
in June 2000. At the option of ATL, borrowings under the revolving credit line
bear interest at either LIBOR plus a margin determined by a total funded debt
ratio of the Company, or a base rate, with option periods of one to six months.
At December 27, 1998, $25 million was outstanding on ATL's revolving credit
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.
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, 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 on material
nonpublic information.
8
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. The Court heard oral argument on plaintiffs' motion
for class certification on November 4, 1997. On March 4, 1998, the Court entered
an order denying plaintiffs' motion without prejudice. Limited discovery is
proceeding.
With respect to the federal action, defendants filed their motion to dismiss on
April 16, 1997. On August 14, 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. The hearing on defendants' motion took place on February 3, 1998. On
April 16, 1998, the Court granted defendants' motion to dismiss with prejudice.
On May 19, 1998, plaintiff filed a notice of appeal of the District Court's
dismissal in the United States Court of Appeals for the Ninth Circuit. On
September 25, 1998, plaintiff filed his opening appellate brief. Defendants
filed their answering brief on November 30, 1998. Plaintiff's reply brief was
filed on January 14, 1999.
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.
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. On Quantum's motion, the suit has been
moved to the Northern District of California. 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, Quantum has not yet had time to make
a complete study of all the patents asserted by Papst and there can be no
assurance that the Company has not infringed on these or other patents owned by
Papst. The final results of this litigation, as with any litigation, are
uncertain. If required, there can be no assurance that licenses to any
technology owned by Papst or any other third party alleging infringement could
be obtained on commercially reasonable terms if at all. Adverse resolution of
the Papst litigation or any other intellectual property litigation could subject
the Company to substantial liabilities and require it to refrain from
manufacturing certain products which could have a material adverse effect on the
Company's business, financial condition or results of operations. In addition,
the costs of engaging in the Papst litigation or other intellectual property
litigation could be substantial, regardless of the outcome.
The Company is also subject to other legal proceedings and claims that arise in
the ordinary course of its business. 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
9
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.
6. Business Combinations
On September 28, 1998, the Company completed the acquisition of ATL. ATL
designs, manufactures, markets and services automated tape libraries for the
networked computer market. ATL's products incorporate DLTtapeTM drives as well
as ATL's proprietary IntelliGripTM automation technology. The acquisition has
been accounted for as a purchase with a total cost of $335 million. The
acquisition was completed with the issuance of 16.9 million shares of Quantum
common stock valued at $265 million on the date of acquisition in exchange for
all outstanding shares of ATL, the conversion of outstanding ATL stock options
into options valued at $22 million to purchase 1.8 million shares of Quantum
common stock and the assumption of $45 million of ATL liabilities. ATL's results
of operations are included in the financial statements as of the date of
acquisition, and the assets and liabilities acquired were recorded based on
their fair values as of the date of acquisition.
The excess of the purchase price over the fair value of the net tangible assets
acquired has been allocated to the following identifiable intangible assets:
goodwill, trade marks and trade names, original equipment manufacturer and value
added reseller customer relationships, non-compete agreements, workforce in
place, developed technology and in-process research and development. As of the
acquisition date, technological feasibility of the in-process technology has not
been established and the technology has no alternative future use. Therefore,
the Company has expensed the amount of the purchase price allocated to
in-process research and development, which based on a preliminary valuation, the
Company has estimated at $89 million as of the date of acquisition. The
remaining identifiable intangible assets will be amortized on a straight-line
basis over periods ranging from two to fifteen years.
The amount of the purchase price allocated to in-process research and
development was determined by estimating the stage of development of each
in-process research and development project at the date of acquisition,
estimating cash flows resulting from the expected revenues generated from such
projects, and discounting the net cash flows back to their present value using a
discount rate of 20%, which represents a premium to the Company's cost of
capital. The estimated revenues assume an average compound annual revenue growth
rate of 37% during fiscal years 1999 to 2007. Estimated total revenues from the
purchased in-process projects peak in fiscal year 2002 and then begin to decline
as other new products are expected to be introduced. These projections are based
on management's estimates of market size and growth, expected trends in
technology and the expected timing of new product introductions. If these
projects are not successfully developed, the Company may not realize the value
assigned to the in-process research and development projects. In addition, the
value of the other acquired intangible assets may also become impaired.
The following unaudited pro forma information has been prepared assuming that
the acquisition had taken place at the beginning of the respective periods
presented. The pro forma financial information is not necessarily indicative of
the combined results that would have occurred had the acquisition
10
taken place at the beginning of the periods, nor is it necessarily indicative of
results that may occur in the future.
(In thousands) Three Months Ended Nine Months Ended
December 27, December 28, December 27, December 28,
1998 1997 1998 1997
---- ---- ---- ----
Sales $1,325,581 $1,536,833 $3,633,626 $4,563,654
Net income (loss) $ (106,551) $ (36,692) $ (96,986) $ 154,032
Net income (loss) per share:
Basic $ (0.64) $ (0.27) $ (0.59) $ 1.14
Diluted $ (0.64) $ (0.27) $ (0.59) $ 0.95
7. Loss from Investee
On May 16, 1997, the Company sold a 51% majority interest in its recording heads
operations to Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE"), thereby
forming a recording heads joint venture with MKE, named MKE-Quantum Components
LLC ("MKQC"). MKQC was involved in the research, development, and manufacture of
MR recording heads used in the Company's disk drive products manufactured by
MKE.
On October 28, 1998, the Company and MKE agreed to dissolve MKQC because MKQC
had not been able to produce MR recording heads on a cost-effective basis. In
connection with the dissolution, MKE has taken control and ownership of MKQC's
manufacturing operations in Batam, Indonesia; MKQC's domestic operations have
substantially ceased as of December 27, 1998; and its domestic assets are in
liquidation. The Company recorded a $101 million loss from investee which
includes a write-off of Quantum's investment in MKQC; a write-down of Quantum's
interest in facilities in Louisville, Colorado, and Shrewsbury, Massachusetts
that were occupied by MKQC; warranty costs resulting from MR recording heads
manufactured by MKQC; and Quantum's 49% pro rata share in funding MKQC's
repayment of its obligations, primarily bank debt, accounts payable, and other
liabilities through June 1999 when the liquidation of MKQC is expected to be
completed.
For the quarter ended December 27, 1998, the Company accounted for its 49%
interest in MKQC based on estimated liquidation values and costs. From May 16,
1997 to September 27, 1998, the Company accounted for its 49% interest in MKQC
using the equity method of accounting. MKQC's net loss for the six months ended
September 27, 1998 was $84 million on sales of $62 million. The results of the
Company's involvement in recording heads through May 15, 1997 were consolidated.
During the first three quarters of fiscal year 1999, the Company provided
support services to MKQC. The support services were primarily comprised of
finance, human resources, facilities, legal, and information service support.
The loss from investee includes support services expected to be provided
throughout the liquidation of MKQC.
11
8. Comprehensive Income (Loss)
As of April 1, 1998, the Company adopted Statement of Financial Accounting
Standards, ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, it has no impact on the Company's net income or
shareholders' equity. SFAS 130 requires foreign currency translation
adjustments, which prior to adoption were reported only in shareholders' equity,
to be included in the determination of comprehensive income.
The components of comprehensive income (loss), net of tax, are as follows:
(In thousands) Three Months Ended Nine Months Ended
December 27, December 28, December 27,December 28,
1998 1997 1998 1997
---- ---- ---- ----
Net income (loss) $(106,551) $ (32,183) $ (86,276) $ 168,108
Change in cumulative
Translation adjustment 1,377 (1,341) 1,500 (1,090)
--------- --------- --------- ---------
Comprehensive income
(loss) $(105,174) $ (33,524) $ (84,776) $ 167,018
========= ========= ========= =========
12
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 27, 1998 with the results of operations in the
corresponding periods in fiscal year 1998.
o Year 2000 update.
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.
Forward-Looking Statements
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 can be identified
by the use of forward-looking terminology, such as "may," "will," "project,"
"estimate," "anticipate," "expect," "continue," "potential," "opportunity" or
the negative thereof or other variations thereon or comparable terminology or
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") is a
diversified mass storage company with leadership positions in both the fixed and
removable storage markets. In calendar year 1998, Quantum was the highest-volume
global supplier of hard disk drives for personal computers and the worldwide
revenue leader for all classes of tape drives.
Quantum designs, develops, and markets information storage products, including
high-performance, high-quality half-inch cartridge tape drives, tape media, tape
autoloaders and libraries, hard disk drives, and solid state disk drives.
Quantum also manufactures the half-inch cartridge tape drives and solid state
disk drives, and the Company's wholly owned subsidiary,
13
ATL Products, Inc. ("ATL"), manufactures tape autoloaders and libraries. 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. MKE manufactures all of Quantum's hard disk drives.
The Company's strategy is to offer a diversified storage product portfolio that
features leading-edge technology and high-quality manufacturing for a broad
range of storage applications. Inherent in this strategy is a focus on
anticipating and meeting customers' information storage needs and on the
research and development of storage technology.
Quantum's products meet the storage requirements of mid-range to high-end
computer systems, workstations, network servers, high-end to entry-level desktop
personal computers, and storage subsystems. The Company directly markets its
products to major original equipment manufacturers ("OEMs") and through a broad
range of distributors, resellers, and systems integrators worldwide.
The Company's information storage business currently includes two units, the
Specialty Storage Products Group and the Enterprise and Personal Storage
Products Group. The primary business activities of these two groups are
discussed below.
Specialty Storage Products. Quantum designs, develops, manufactures,
and markets half-inch cartridge tape drives, autoloaders and libraries
based on patented DLTtape(TM) technology, and solid state disk drives.
Quantum also designs, develops, and markets DLTtape media. In addition,
the DLTtape technology has been licensed to Tandberg Data ASA for the
manufacture and marketing of DLTtape drives based on current DLTtape
and future Super DLTtape technology, as well as to Fuji and Maxell for
the manufacture of tape media. The DLTtape drives (20 gigabytes to 70
gigabytes capacity, compressed) use advanced linear recording
technology and a highly accurate tape guide system to perform
mission-critical data backup for mid-range and high-end computer
systems. Quantum has worldwide manufacturing rights for DLTtape drive
and media technology and is currently the sole manufacturer of DLTtape
drives. The Company believes that DLTtape drives are the de facto
market standard in the mid-range segment of the tape storage market.
The Company's solid state disk drives have high execution speeds
required for applications such as imaging, multimedia, video-on-demand,
online transaction processing, material requirements planning, and
scientific modeling.
The Company's current DLTtape drive and DLTtape media product offerings
include:
Quantum DLT 7000 tape drive. The DLT 7000 provides a combination of 35
gigabytes ("GB") native capacity (70 GB compressed) and a sustained
data transfer rate of 5 megabytes ("MB") per second (10 MB per second
compressed). The DLT 7000 tape drive features a SCSI-2 fast/wide
interface with single-ended and differential options.
Quantum DLT 4000 tape drive. This product features a native storage
capacity of 20 GB per cartridge and a sustained data transfer rate of
1.5 MB per second.
14
Quantum DLTtape III, IIIXT, IV tape media and cleaning cartridges. The
DLTtape family of half-inch cartridge tapes are designed and formulated
specifically for Quantum DLTtape drives, autoloaders and libraries. The
capacity of the DLTtape media is up to 35 GB, or 70 GB in compressed
mode. By combining both solid and liquid lubricants in the tape binder
system, tape and head wear are reduced while repelling airborne
particles that could affect read/write head performance. In addition,
by using a uniform particle shape, a dense binding system, a smooth
coating surface, and a specially selected base film, Quantum's
half-inch cartridge tapes take advantage of shorter wavelength
recording schemes to ensure read compatibility with future generations
of DLT brand tape drives.
The Company's current library and automation product offerings include:
P3000 Series library. The P3000 series is the first DLT library with
High Availability features designed for data intensive applications.
This product also features the Prism Library ArchitectureTM, which
incorporates a high performance PCI expansion bus. A Prism-enabled
library can be upgraded by adding library building blocks, which
harness the power of high-speed PCI adapter cards. This enables network
and fibre connectivity, provides the capability to embed single-card
CPUs and drives, and allows for added functionality such as tape
mirroring and auto tape copy. Features also include the IntelligripTM
precision cartridge handling technology, designed to accurately load
and unload. The P3000 Series library supports up to 16 DLT7000 drives
and 326 cartridges for a native data transfer rate of 288 GB per hour
and a native capacity of 11.4 Terabytes ("TB"). Up to five P3000
modules can be connected to form a single library system with up to 80
DLT7000 drives and 1,630 cartridges for a native transfer rate of 1.44
TB per hour, and a native capacity of 57 TB.
PL50 Library Hub. This external library controller offers the
capability of connecting up to three backup servers to a single
automated DLT library. The PL50 Library Hub features a server equipped
with four SCSI ports, a monitor, and ATL's advanced Library Hub
software. Three of the PL50's four SCSI ports are interfaces to backup
servers. The fourth port is for connection to the ATL library robotics
controller. The PL50 presents a virtual library to each backup server
by allowing a user to assign specific cartridge slots and drive
partitions.
P1000 Series library. Features the Prism Library Architecture, the
IntelliGrip precision cartridge handling technology, option to
accommodate from 2 to 4 DLT4000 or 7000 drives, 16 or 30 cartridge slot
capacity, a native storage capacity of 1.05TB, and maximum native
throughput of 144 GB per hour.
7100 Series library. Features the Intelligrip precision cartridge
handling technology, option to accommodate from 2 to 4 DLT4000 or 7000
drives, maximum native storage capacity of 1.8 TB at speeds of up to
126 GB per hour, and a sustained data transfer rate of 5 MB per second.
520 Series library. Features the Intelligrip precision cartridge
handling technology, option to accommodate from 2 to 4 DLT4000 or 7000
drives, maximum native storage capacity of 1.8 TB, and a sustained data
transfer rate of 5 MB per second.
15
StorLink Series library. Features the Intelligrip precision cartridge
handling technology, option to accommodate up to 528 DLT cartridges or
18 DLT drives, maximum native storage capacity of 37 TB and capacity of
up to 648 GB per hour of backup and restore performance.
2640 Series library. Features the Intelligrip precision cartridge
handling technology, option to accommodate up to nine DLT4000 or 7000
drives and 264 cartridges, storage capacity of up to 9.24 TB, library
throughput of up to 162 GB per hour, and a sustained data transfer rate
of 5 MB per second.
PowerStor(TM) L500 library. Features a 14-cartridge capacity and
accommodates up to three DLTtape drives. A fully configured PowerStor
Library provides a maximum native storage capacity of 490 GB and a
sustained data transfer rate of 15 MB per second.
PowerStor L200 autoloader. Accommodates a DLT 4000 or DLT 7000 tape
drive and delivers a maximum native storage capacity of 280 GB and a
sustained data transfer rate of 5 MB per second.
DLT 4500, 4700 autoloaders. The DLT 4500 five-cartridge autoloader
provides native storage capacity of 100 GB. The DLT 4700
seven-cartridge autoloader provides native storage capacity of 140 GB.
These autoloaders have a sustained data transfer rate of 1.5 MB per
second.
The Company's current solid state disk drive product offerings include:
Quantum Rushmore(TM) NTE family of solid state disk drives includes the
ESP3000 and ESP5000 series. These drives are available in capacities
ranging from 134 MB to 950 MB and have a data access time that is up to
15 times faster than magnetic hard disk drives.
Quantum Rushmore Ultra family of solid state disk drives includes the
RU3000 and RU5000 series. These drives are available in capacities
ranging from 134 MB to 1.66 GB and have a data access time that is up
to 10 times faster than magnetic hard disk drives.
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"), servers,
and workstations for use in both home and business environments; and
for the data-intensive storage needs of high-end desktop systems,
workstations, high-performance network servers, and storage subsystems.
The high-end disk drives are designed for data-intensive applications,
such as data warehousing, digital content creation, digital video, file
servers, financial services, Internet and intranet services, mechanical
CAD, multimedia, online transaction processing, RAID storage, software
development, and workgroup computing.
16
The Company's current desktop disk drive product offerings include:
Quantum Bigfoot(TM) TS. The Bigfoot TS is the first 5.25-inch drive
with the award winning Shock Protection System(TM), a technology that
protects the mechanical platform against the impact of mishandling
during shipping or integration into a PC. The Bigfoot TS features
capacities of 6.4 GB, 8.4 GB, 12.7 GB and 19.2 GB, Ultra ATA interface,
MR heads, a PRML read channel, burst data transfer rates of up to 33 MB
per second, internal data rates up to 168 MB per second, average seek
time of 10.5 milliseconds ("ms"), and a rotational speed of 4,000 RPM.
Quantum Bigfoot TX. Features capacities of 4 GB, 6 GB, 8 GB and 12 GB,
Ultra ATA interface, MR heads, a PRML read channel, burst data transfer
rates of up to 33 MB per second, internal data rates up to 142 MB per
second, average seek time of 12 ms, and a rotational speed of 4,000
RPM.
Quantum Fireball(TM) Plus KA. Announced in December 1998, Fireball Plus
KA is expected to begin mass production in late first quarter of
calendar year 1999. The Fireball Plus KA is the first 7200 RPM drive
with the Quantum-developed Ultra ATA/66 interface (patent pending)
which enhances data integrity through improved timing margins and
Cyclical Redundancy Check, a data protection scheme which helps assure
the integrity of transferred data. Additional features include the Data
Protection System, a technology which tests the health of Quantum
desktop hard drives and determines if the disk drive is the source of
system failure, Shock Protection System, capacities of 6.4 GB, 9.1 GB,
13.6 GB and 18.2 GB, MR Heads, internal data rates up to 235 MB per
second, and an average seek time of 8.5 ms.
Quantum Fireball CR. Announced in November 1998, Fireball CR began mass
production in January 1999. Features include Shock Protection System,
capacities of 4.3 GB, 6.4 GB, 8.4 GB and 12.7 GB, Ultra ATA/66
interface, MR heads, internal data rates of up to 190 MB per second,
average seek times of 9.5 ms, and a rotational speed of 5,400 RPM.
Quantum Fireball EX. Features Shock Protection System, capacities of
3.2 GB, 5.1 GB, 6.4 GB, 10.2 GB and 12.7 GB, Ultra ATA interface, MR
heads, buffer-to-host data transfer rates of up to 33 MB per second,
internal data rates up to 187 MB per second, average seek times of 9.5
ms, and a rotational speed of 5,400 RPM.
Quantum Fireball EL. Features Shock Protection System, capacities of
2.5 GB, 5.1 GB, 7.6 GB and 10.2 GB, Ultra ATA interface, MR heads,
buffer-to-host data transfer rates of up to 33 MB per second, internal
data rates up to 162 MB per second, average seek times of 9.5 ms, and a
rotational speed of 5,400 RPM.
Quantum Fireball SE. Features capacities of 2.1 GB, 3.2 GB, 4.3 GB, 6.4
GB and 8.4 GB, Ultra ATA interface, MR heads, buffer-to-host data
transfer rates of up to 33 MB per second, internal data rates up to 158
MB per second, average seek times of 9.5 ms, and a rotational speed of
5,400 RPM.
17
The Company's current high-end disk drive product offerings include:
Quantum Viking(TM) II. The Viking II 3.5-inch hard disk drive is
available in capacities of 4.5 GB and 9.1 GB with high bandwidth Ultra2
SCSI Low Voltage Differential (LVD) or Ultra SCSI interface. The Viking
II also features MR heads, burst data transfer rates of up to 80 MB per
second, internal data rates of up to 170 MB per second, an average seek
time of 7.5 ms, and a rotational speed of 7200 RPM.
Quantum Atlas(TM) 10K. Announced in October 1998, the Atlas 10K is
expected to begin mass production in the second quarter of calendar
year 1999. The Atlas 10K family is among the first to offer 36.4 GB
capacity in a half-height, 3.5-inch form factor, as well as 18.2 GB and
9.1 GB capacities in a low-profile, 1-inch-high footprint. The drive
features the Shock Protection System and advanced SCSI interface -
Ultra 160/m SCSI interface supports up to 160 MB per second and is
fully compatible with the Ultra2 and Ultra SCSI systems. Additional
features include the leading-edge Fibre Channel option interface, full
duplex, command on second port, 200 MB/sec peak bus throughout, Class 3
and FC-AL2 compliant, third party XOR and 4 MB buffer, internal data
rates up to 315 MB per second, average seek time of 5 ms, and a
rotational speed of 10,000 RPM.
Quantum Atlas IV. Announced in October 1998, the Atlas IV is expected
to begin mass production in late first quarter of calendar year 1999.
The Atlas IV drive family is also among the first to offer 36.4GB
capacity in a half-height, 3.5-inch form factor, as well as 18.2 GB and
9.1 GB capacities in a low-profile, 1-inch-high footprint. Atlas IV
supports the Ultra160/m SCSI interface, Ultra2 and Ultra SCSI systems.
Additional features include the Shock Protection System, buffer-to-host
data transfer rates of up to 160 MB per second, internal data rates up
to 257 MB per second, average seek time of 6.9 ms, 21 MB/sec maximum
sustained data throughput, and a rotational speed of 7,200 RPM.
Quantum Atlas III. The Atlas III multimode 3.5-inch hard disk drive is
available in capacities of 9.1 GB and 18.2 GB. It supports both the
high-speed Ultra2 SCSI LVD interface and the Ultra SCSI interface. The
Atlas III features broad interface availability with new Ultra-2 LVD
SCSI-3, Ultra single-ended SCSI-3 and Fibre Channel Arbitrated Loop
(FC-AL). The drive's performance includes burst data transfer rates of
up to 80 MB per second, internal data rates up to 180 MB per second,
average seek time of 7.8 ms, and a rotational speed of 7200 RPM.
The Company is currently concentrating its product research and development
efforts on broadening its existing tape, tape automation, and disk drive product
lines through the introduction of new products. These development efforts span
the Company's business and focus on the development of new tape drives,
autoloaders and libraries, desktop and high-end hard disk drives, including disk
drives designed for consumer electronics applications, and other storage
solutions. A key initiative involves Super DLTtape technology, which includes
four new tape drive technologies that the Company plans to develop into a major
extension of its DLTtape architecture. The Company expects to deliver its first
tape storage product based on the Super DLTtape technology in the second half of
calendar year 1999.
18
Strategic Developments
Dissolution of MKQC. On October 28, 1998, the Company and MKE agreed to dissolve
MKE-Quantum Components LLC ("MKQC") because MKQC had not been able to produce MR
recording heads on a cost-effective basis. MKQC was formed on May 16, 1997, when
the Company sold a 51% majority interest in its recording heads operations to
Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE"). In connection with the
dissolution, MKE has taken control and ownership of MKQC's manufacturing
operations in Batam, Indonesia; MKQC's domestic operations have substantially
ceased as of December 27, 1998; and its domestic assets are in liquidation. The
Company recorded a $101 million loss from investee which includes a write-off of
Quantum's investment in MKQC; a write-down of Quantum's interest in facilities
in Louisville, Colorado, and Shrewsbury, Massachusetts that were occupied by
MKQC; warranty costs resulting from MR recording heads manufactured by MKQC; and
Quantum's 49% pro rata share in funding MKQC's repayment of its obligations,
primarily bank debt, accounts payable, and other liabilities.
Quantum and TiVo Inc. - Strategic Cooperation. In December 1998, the Company
announced a strategic alliance with TiVo, Inc., a company which has created
personalized television through the combination of an innovative new television
service and patented consumer electronics technology that enables viewers to
control what, when and how they watch TV. Under the terms of the agreement, the
Company will provide the Quantum QuickView(TM) hard drive technology for
integration into the TiVo receiver, an in-home center for the TiVo personalized
television service. Quantum QuickView hard drive technology was optimized for
the TiVo center to enable time-shifting capability and provide instant access to
content. The technology allows viewers to pause, rewind, slow-motion and instant
replay any live TV broadcast as well as automatically time-shift their favorite
TV shows for viewing anytime. Availability of the TiVo service is expected to
begin in early calendar year 1999.
Results of Operations
Sales. Sales for the three and nine months ended December 27, 1998 were $1.326
billion and $3.593 billion, respectively, compared to $1.520 billion and $4.520
billion, respectively, for the corresponding periods in fiscal year 1998. The
decrease in sales reflected lower revenues from sales of desktop and high-end
hard disk drives, partially offset by an increase in DLTtape media revenues and
the acquisition of ATL and consolidation of ATL's sales effective September 28,
1998. The three month comparative period reflected record sales of DLTtape
drives, automation products and media royalty revenues as the Company continued
to experience favorable market conditions for DLT brand products, despite the
decline in overall revenues for the period. The decline in desktop hard disk
drive revenues for the three and nine month comparative periods reflected a
decline in shipments and average unit prices. However, a strong PC market in the
third quarter of fiscal year 1999 resulted in some easing of the intense
competitive pricing pressures of prior quarters. Although high-end hard disk
drive shipments increased in the three and nine month comparative periods of
fiscal year 1999, increased competitive pricing pressures, especially in the
third quarter of fiscal year 1999, resulted in reduced average unit prices and
lower high-end hard disk drive revenue.
19
Sales to the Company's top five customers for the three and nine months ended
December 27, 1998 represented 40% and 43% of sales, respectively, compared to
44% and 45% of sales, respectively, for the corresponding periods in fiscal year
1998 (these amounts reflect a retroactive combination of the sales to Compaq
Computer, Inc. and Digital Equipment Corporation as a result of their merger in
June 1998). Sales to Compaq Computer, Inc. were 14% and 15% of sales for the
three and nine months ended December 27, 1998, respectively, compared to 15% and
18% of sales, respectively, for the corresponding periods in fiscal year 1998
(including sales made to Digital Equipment Corporation). Sales to
Hewlett-Packard were 12% and 14% of sales, respectively, for the three and nine
months ended December 27, 1998, compared to 13% and 12% of sales, respectively,
for the corresponding periods in fiscal year 1998.
The OEM and distribution channel sales were 62% and 34% of sales for the quarter
ended December 27, 1998, respectively, compared to 63% and 37% of sales for the
quarter ended December 28, 1997. For the first nine months of fiscal year 1999,
OEM and distribution channel sales were 64% and 34% of sales, respectively,
compared to 62% and 38% of sales for the corresponding periods of fiscal year
1998. The remaining sales in fiscal year 1999 represented media royalty revenues
and sales to value added resellers.
Gross Margin Rate. The gross margin rate for the quarter ended December 27, 1998
increased to 18.0% from 8.9% in the quarter ended December 28, 1997. The gross
margin rate for the first nine months of fiscal year 1999 was 16.6%, compared to
12.9% in the corresponding period in fiscal year 1998.
The gross margin rate for the third quarter and first nine months of fiscal year
1998 reflected the impact of a $103 million special charge taken in the third
quarter related to the transition to a new generation of high-end disk drive
products, and consisted primarily 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.
Excluding the impact of the special charge in the three and nine month
comparative periods, the increase in the gross margin rate for the fiscal third
quarter of 1999 reflected increased revenues of DLTtape drives, automation
products and DLTtape media royalties which have significantly higher margins
compared to the Company's other products. The decline in the gross margin rate
for the nine month comparative period reflected the decline in prices and gross
margins earned on desktop hard disk drives, partially offset by increased media
royalties and the proportion of revenue coming from the sale of higher margin
DLTtape drive and automation products, although at generally lower margin rates
compared to the prior year period. The decline in desktop hard disk drive
margins for the nine month comparative period reflected intense competition and
aggressive pricing, especially in the first two quarters of fiscal year 1999, in
part, reflecting the growth of the value PC market. For the fourth quarter of
fiscal year 1999, the Company expects to experience continued gross margin
pressure with respect to its desktop and high-end hard disk drive products.
20
Research and Development Expenses. Research and development expenses in the
three and nine months ended December 27, 1998, were $88 million, or 6.6% of
sales, and $255 million, or 7.1% of sales, respectively, compared to $88
million, or 5.8% of sales, and $237 million, or 5.2% of sales, respectively, in
the corresponding periods in fiscal year 1998. The increase in research and
development expenses as a percentage of sales reflected decreased sales, while
the increase in research and development expenses for the first nine months of
fiscal year 1999 reflected higher research and development expenses related to
new hard disk drive products, as well as research and development expenses
related to new information storage products and technologies, including the
Super DLTtape drive and optical storage technology. The amount of research and
development expenses is expected to increase in the fourth quarter of fiscal
year 1999 as compared to the third quarter of fiscal year 1999.
Sales and Marketing Expenses. Sales and marketing expenses in the three and nine
months ended December 27, 1998, were $51 million, or 3.9% of sales, and $135
million, or 3.8% of sales, respectively, compared to $45 million, or 3.0% of
sales, and $129 million, or 2.9% of sales, respectively, in the corresponding
periods of fiscal year 1998. The increase in sales and marketing expenses
reflected the consolidation of ATL's expenses and an increase in marketing and
advertising costs associated with DLTtape products. The amount of sales and
marketing expenses is expected to increase in the fourth quarter of fiscal year
1999 as compared to the third quarter of fiscal year 1999.
General and Administrative Expenses. General and administrative expenses in the
three and nine months ended December 27, 1998, were $22 million, or 1.7% of
sales, and $61 million, or 1.7% of sales, respectively, compared to $23 million,
or 1.5% of sales, and $75 million, or 1.7% of sales, respectively, in the
corresponding periods of fiscal year 1998. The decrease in general and
administrative expenses reflected the impact of cost control efforts, including
reduced bonus expenses, in response to the lower level of earnings and sales.
Purchased In-process Research and Development. Purchased in-process research and
development costs pursuant to the acquisition of ATL were expensed in the
quarter ending December 27, 1998. Based on a preliminary valuation, the Company
has estimated these costs at $89 million. For additional information regarding
the ATL acquisition and the costs allocated to in-process research and
development, refer to Note 6 of the Notes to Condensed Consolidated Financial
Statements.
Interest and Other Income/Expense. Net interest and other income and expense in
the three and nine months ended December 27, 1998 was $1.8 million and $0.2
million net expense, respectively, compared to $0.3 million and $0.5 million net
income, respectively, in the corresponding periods of fiscal year 1998.
Loss From Investee. On October 28, 1998, the Company and MKE agreed to dissolve
MKQC. In connection with the dissolution, the Company recorded a $101 million
loss in the period ended
21
December 27, 1998 which included a write-off of Quantum's investment in MKQC; a
write-down of Quantum's interest in facilities in Louisville, Colorado, and
Shrewsbury, Massachusetts that were occupied by MKQC; warranty costs resulting
from MR recording heads manufactured by MKQC; and Quantum's 49% pro rata share
in funding MKQC's repayment of its obligations, primarily bank debt, accounts
payable, and other liabilities. Refer to Note 7 of the Notes to Consolidated
Condensed Financial Statements for additional discussion of the dissolution of
MKQC.
Income Taxes. No tax benefit was recognizable for the charge for purchased
in-process research and development. The Company recorded a provision for income
taxes at an effective rate of 33% of pretax earnings before the charge for the
nine months ended December 27, 1998 as compared to 26% for the corresponding
period in fiscal year 1998. The higher effective tax rate for the nine months
ended December 27, 1998 was primarily attributable to a decreased percentage of
foreign earnings taxed at less than the U.S. rate and nondeductible goodwill
amortization.
Year 2000
A year 2000 computer issue is raised by the possibility that unless
modifications are made, by midnight on December 31, 1999, computer systems may
not be able to distinguish the year 2000 from the year 1900. There are two other
date-related issues which may contribute to the year 2000 problem: i) certain
systems have associated special values with date fields (i.e., 9/9/99), and ii)
these same systems may fail to recognize that year 2000 is a leap year. The
pervasive use and dependency on computer technology in all facets of modern
commerce means that the inherent risks to companies, including Quantum, from
year 2000 issues is potentially quite vast. For example, risks are associated
with potential disruptions or failures within Quantum (i.e., Quantum's products
and operations), within Quantum's suppliers, customers and service providers
(i.e., their products and operations), and so on. Because the year 2000 issue
can impact Quantum indirectly through its suppliers, service providers and
customers, an assessment and prediction of the impact of the year 2000 issue on
the Company is difficult.
The Company is in the process of implementing plans to address year 2000 issues
both within and outside of Quantum. In addressing the year 2000 issues and
risks, the Company has focused, and will continue to focus, its efforts on the
Company's enterprise-wide and departmental operations, products, critical
suppliers (including service providers), and key customers. Within Quantum,
these efforts are intended to encompass all major categories of computer systems
and operating equipment in use by the Company, including those utilized in
manufacturing, research and development, sales, finance, and human resources. To
ensure year 2000 compliance for all of Quantum's systems, the Company has
adopted a resolution approach based on the U.S. General Accounting Office Year
2000 Assessment Guide. The approach utilizes a multi-phased model, with major
phases consisting of the following: inventory, assessment, resolution, testing,
and certification. Briefly described, the inventory phase is the process where
all hardware, software, equipment, infrastructure, and desktop tools and
applications are listed and reviewed for criticality and risk. Thereafter, it is
determined in the assessment phase whether to convert, replace, or eliminate the
impacted system or application. A formal plan is developed and carried out in
the resolution phase. Under stringent procedures in the
22
testing phase, the system or application is validated on its functionality to
perform seamlessly in the year 2000. All test results are documented and
verified in the certification phase.
Within each of the major categories of computer systems and operating equipment,
the Company prioritizes its year 2000 issues and risks on three levels:
critical, key, or active. The critical level proposes short-term failure to have
a severe impact on business operations, resulting in significant downtime or a
manual effort to perform the required functions. Without this system or
application, the business could not function. Key level applications or systems,
although required by the Company, are not mandatory for business survival. The
failure of key level applications is not expected to cause significant
disruption to the Company's operations. The work can be deferred or manual
back-up procedures will be devised to handle the interim needs. Active level
applications, although currently in use, are not required for the Company's
normal operations. Their failure is not expected to result in any disruption to
the business.
Quantum has made significant progress in its preparedness for year 2000. The
inventory phase is 85% complete for all levels, with an expected completion date
of mid February 1999. The Company is acting to remedy issues as they are
revealed while it simultaneously completes its assessment of year 2000 risks.
Quantum currently anticipates that it will have assessed and remedied all
critical areas of its own operations by the end of February 1999, and that it
will be prepared to internally certify readiness of these critical areas by the
end of March 1999. Assessment, resolution, testing, and certification of
critical third parties is expected to be completed by the end of March 1999.
Quantum also plans to develop contingency plans based, in part, on the
assessment results.
The Company's estimated timetable for assessment, resolution, testing, and
certification of critical level-year 2000 issues is summarized in the following
table:
23
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
Assessment Resolution Testing Certification
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
Information 85 % Complete 75% Complete 5% Complete 0% Complete
Technology
Expected Expected completion Expected completion Expected completion
completion date, date, February 28, date, March 31, 1999 date, March 31, 1999
February 28, 1999 1999
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
Operating
Equipment with 90% Complete 75% Complete 50% Complete 0% Complete
Embedded Chips or
Software Expected completion Expected completion Expected completion Expected completion
date, February 28, date, February 28, date, March 31, 1999 date, March 31, 1999
1999 1999
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
Products 100% Complete 100% Complete 100% Complete 100% Complete
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
3rd Party 90% Complete for 40% Complete for 20% Complete for 0% Complete for system
system interface; system interface. system interface. interface
80% Complete for
all other material Develop contingency Expected completion Expected completion date
exposures plans as appropriate, date for system for system interface
March 31, 1999 interface work, work, March 31, 1999
Expected completion March 31, 1999
date for surveying Implement contingency
all third parties, plans or other
February 28, 1999 alternatives as
necessary, March 31, 1999
- ------------------- ---------------------- ------------------------ ---------------------- ---------------------------
The Company's failure to complete critical readiness assessments, critical
corrective actions or implement viable contingency plans in a timely matter
could have a material, adverse effect on the Company's business, financial
condition and results of operations.
As indicated above, the Company's risk assessment includes understanding the
year 2000 readiness of its suppliers. The Company's risk assessment process
associated with suppliers includes soliciting and analyzing responses to
questionnaires distributed to these suppliers, as well as onsite interviews with
certain critical suppliers. The Company has received 100% of responses from an
initial survey sent to suppliers, and has received 100% of responses from a
second follow-up survey sent to those identified as critical suppliers. Certain
critical suppliers will receive an on-site visit by Quantum, to commence in
February 1999, and to be completed by March 1999.
The Company's manufacturing partner, MKE and its year 2000 readiness are of
particular importance. MKE has implemented a year 2000 compliance project plan
in April 1998, similar in content and structure to that employed by Quantum. MKE
is expected to have all of its critical processes, applications and hardware
tested and year 2000 compliant and certified by the end of March 1999. All key
and active processes, applications and hardware are expected to be year 2000
compliant and certified by the end of June 1999. Regular meetings are held
between Quantum and
24
MKE to verify that MKE is, and will remain, on schedule. Additionally, the
Company will perform limited on-site evaluations of MKE operations in Japan,
Singapore, and Ireland during February and March 1999. Quantum's reliance on MKE
and other critical suppliers, and therefore, on the proper functioning of their
information systems and software, means that any failure by these critical
suppliers to address year 2000 issues could have a material adverse impact on
the Company's business, financial condition and results of operations. Based on
the level of risk assessed of critical suppliers, the Company may develop
contingency plans, including the possibility of a planned increase in inventory
or other measures.
The Company is also working closely with key customers to evaluate their
readiness for year 2000 and expects to perform site visits if deemed necessary.
The ability of customers to deal with year 2000 issues may affect their
operations and their ability to order and pay for products. Based on the level
of risk assessed, the Company may develop contingency plans to address possible
changes in customer order patterns.
Quantum believes that its most reasonably likely worst case scenario would be
attributed to third party factors, rather than its internal systems and
applications. For example, since the Company deals heavily with third parties to
manufacture and transport products and services, a failure of third party
systems could result in a disruption of service, which could result in delays in
shipments of the Company's products. For internal systems, the Company is
developing workarounds, which may involve providing manual or other automated
systems in lieu of normal procedures.
Although the year 2000 issue is resident in both software and hardware, it is
created by those system components that effect or calculate time and date. The
disk drive and tape sub-system does not retain software that has date and time
information but only as generated by the system clock or software application.
Quantum products are inherently year 2000 compliant; the family of disk drives,
whether for desktop, workstation and systems, or solid state disks has no
internal date clocks, and therefore is not impacted by the year 2000 problem.
Quantum's DLT tape drives use a four-character string to describe the year in
the internal buffer and will not be affected by the year 2000 change.
Additionally, no modifications need to be made to any disk or tape drive's
internal firmware to accommodate the transition to the year 2000. The Company
considers a disk drive or tape product to be year 2000 compliant when used in
accordance with Quantum's product information and will not generate an error in
data related to the year change from December 31, 1999 to January 1, 2000.
Furthermore, year 2000 compliant products will correctly handle leap years,
including leap years beginning January 1, 2000 and thereafter. However, the
assessment of whether a complete computer system operates correctly depends on
factors such as the operating system, BIOS, software and components, which are
provided by companies other than Quantum.
Costs incurred to date in addressing the year 2000 issue were approximately
$6.25 million at December 27, 1998. Based on assessment and resolution projects
underway, the Company currently expects that the total cost of addressing the
year 2000 issue, including both incremental spending and redeployed resources,
will not exceed $15 million. A majority of the cost is expected to relate to the
redeployed resources. However, as the year 2000 efforts continue, Quantum may
use third-party vendors, auditors, and/or service providers as necessary to
assure that program milestones are successfully met. The expected costs related
to the year 2000 effort in fiscal year 1999 represent approximately 10% of the
total information technology budget for the fiscal year. No significant
25
system projects have been deferred due to the year 2000 program. As the
Company's risk assessment and correction activities continue, these costs may
change. In addition, the Company's total cost estimate does not include
potential costs related to any customer or other claims resulting from the
Company's failure to adequately correct year 2000 issues.
Based on assessment and remediation completed to date, the Company does not
expect any significant disruption to its operations or operating results as a
result of year 2000 issues. The Company is taking all steps it believes are
appropriate to identify and resolve any year 2000 issues; however, it is
uncertain to what extent the Company may be affected by such matters. There can
be no assurance that the Company will be able to assess, identify and correct
year 2000 issues in a timely or successful manner. In addition, there can be no
assurance that the failure to ensure year 2000 capability by suppliers, service
providers, customers, or other third parties would not have a material adverse
affect on the Company's financial condition or results of operations.
The foregoing statements regarding the Company's year 2000 plans and the
Company's expectations for resolving these issues and the costs associated
therewith are forward-looking statements and actual results could vary. The
Company's success in addressing year 2000 issues could be impacted by the
severity of the problems to be resolved within the Company, by year 2000 issues
affecting its suppliers and service providers, and by the costs associated with
third party consultants and software necessary to address these issues.
Liquidity and Capital Resources
Cash, cash equivalents and marketable securities were $707 million at December
27, 1998, compared to $714 million at March 31, 1998. The major uses of cash
were the purchase of $305 million of treasury stock, as discussed below, and
investment in property and equipment. Offsetting this use of cash was cash
provided by operating activities, primarily sales, the collection of accounts
receivable, and the reduction in inventories.
In September 1998, the Company issued 16.9 million shares to the shareholders of
ATL to complete the acquisition of ATL as a wholly owned subsidiary of the
Company. In part, the Company reissued treasury stock to complete the
acquisition. The difference between the cost of the treasury stock and the value
at which the shares were reissued resulted in a $63 million reduction to
retained earnings in the quarter ended December 27, 1998. For additional
information regarding the ATL acquisition, refer to Note 6 of the Notes to
Condensed Consolidated Financial Statements.
In October 1998, the Company repurchased 2.8 million shares of its common stock
which completed the share repurchase of a total of 15.5 million shares during
the nine months ended December 27, 1998 at a cost of $305 million as authorized
by the Board of Directors. The intent of the repurchase was to minimize the
dilutive impact of the shares issued to complete the acquisition of ATL.
In December 1998, the Company entered into a senior credit facility that
provides a $35 million revolving credit line to ATL. The revolving credit line
is coterminous with the Company's $500 million revolving credit line, expiring
in June 2000. At the option of ATL, borrowings under the
26
revolving credit line bear interest at either LIBOR plus a margin determined by
a total funded debt ratio of the Company, or a base rate, with option periods of
one to six months. At December 27, 1998, $25 million was outstanding on ATL's
revolving credit line.
In June 1997, the Company entered into an unsecured senior credit facility that
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. At September 27, 1998, there was
no outstanding balance drawn on this line.
In September 1996, the Company entered into a $42 million mortgage financing
related to certain domestic facilities at an effective interest rate of
approximately 10.1%. The term of the mortgage is 10 years, with monthly payments
based on a 20-year amortization period, and a balloon payment at the end of the
10-year term.
Based on the adverse conditions in the hard disk drive market in fiscal year
1999, the Company has reduced capital spending and expects to spend less than
$130 million for capital equipment, expansion of the Company's facilities, and
leasehold improvements in the fiscal year. These capital expenditures will
support the disk drive and tape drive businesses, 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.
The Company believes that its existing capital resources, including the 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 factors described in the Trends and Uncertainties section that follows.
Trends and Uncertainties
By 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.
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 hard 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.
27
o Declining desktop hard disk drive prices - In conjunction with intense
competition, the growth of the low-cost PC market, often referred to as
the "sub $1,000" PC market, has led to a shift in the storage market
toward lower priced hard disk drives.
o Rapid technological change - Technology advancement in the information
storage industry is increasingly rapid and the customer qualification
process is difficult.
o Customer concentration - High-purchase-volume customers for information
storage products are concentrated within a small number of computer
system manufacturers, distribution channels, and systems 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 is in turn affected by computer system product
cycles and prevailing economic conditions.
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 is materially adversely affected. The hard disk drive market, 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 can materially adversely affect the Company. For example, in the
first nine months of fiscal year 1999 and the second half of fiscal year 1998,
periods of excess inventory in the desktop hard disk drive market, aggressive
pricing and corresponding margin reduction adversely impacted the Company's
operating results during these periods, although with less of an adverse impact
in the third quarter of fiscal year 1999. The Company experienced similar
conditions in the high-end of the hard disk drive market during most of fiscal
year 1998 and in the first nine months of fiscal year 1999, although with less
of an adverse impact in the first nine months of fiscal year 1999. As a result
of these conditions, the Company had diminished profitability, at near
breakeven, in the first quarter of fiscal year 1999 and fourth quarter of fiscal
year 1998. Furthermore, losses in the third quarter of fiscal year 1998 were
largely attributable to a $103 million special charge primarily for high-end
hard disk drive inventory write-offs and firm inventory purchase commitments. If
competition and pricing further intensifies, the Company's operating results
could be further adversely affected.
Another competitive risk is that 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 Exabyte,
Fujitsu, Hewlett-Packard, IBM, Maxtor, Seagate, Sony, and Western Digital. 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:
28
Specialty Storage Products. In the market for tape storage products, the
Company competes with other companies that have tape storage product
offerings and alternative formats, including Exabyte, Hewlett-Packard,
Sony, and Storage Technology. In addition, Hewlett-Packard, IBM, and
Seagate formed a consortium to develop two tape drive products, one of
which targets high-capacity data storage. The Company targets and has the
market leadership position in the storage product market that provides
mission-critical backup systems, archiving, and disaster recovery for
mid-range servers. The Company has achieved market leadership and competes
in this segment based on the reliability, data integrity, performance,
capacity, and scalability of its tape and automation storage products.
Although the Company has experienced excellent market acceptance and
conditions for its tape storage 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 that could materially adversely
affect the Company's operating results.
Hard Disk Drive Products. In the market for desktop products, Quantum
competes primarily with Fujitsu, IBM, Maxtor, Samsung, Seagate, and
Western Digital. 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 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. This
competitiveness, which intensified in the second half of fiscal year 1998
and continued in the first nine months of fiscal year 1999, resulted in
significantly reduced gross profit margins on desktop disk drive products
during these periods.
The Company faces competition in the high-end hard disk drive market
primarily from Fujitsu, Hitachi, IBM, and Seagate. Seagate and IBM have
the largest share of the market for high-end hard 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 performance, quality, and reliability
are even more important to the users of high-end products 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, intense competition has lead to the trend of losses on the
Company's high-end hard disk drive products over the past six quarters,
although with decreased losses in the first nine months of fiscal year
1999. 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.
Declining Desktop Hard Disk Drive Prices. As discussed above, intense
competition has resulted in aggressive pricing in the desktop hard disk drive
market. The intense competition, when
29
combined with the growth of the low-cost PC market, often referred to as the
"sub $1,000" PC market, has led to a shift in the storage market toward lower
priced desktop hard disk drives. To be successful as a hard disk drive supplier
in general as well as to the low-cost PC market, cost structure, including
corporate infrastructure, materials, distribution and warranty costs must be
appropriately aligned to the product performance and price required to compete
in this market. The Company is currently implementing plans to bring the cost
structure of desktop hard disk drives into alignment with prices; however, there
can be no assurance that the Company's plans will be successful or implemented
timely. Continued growth of the low cost market as a portion of the overall hard
disk drive market could result in increasingly adverse pricing having an
increasingly adverse impact on the Company's results of operations. The Company
will continue to evaluate its business model for its desktop hard disk products
given the challenging environment in this market.
Rapid Technological Change, New Product Development and Qualification, and
Technology Investments. In the hard disk drive market, the combination of an
environment of increasingly rapid technological changes, short product life
cycles, and intense competitive pressures results in rapidly decreasing gross
margins on specific products. 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
that meet this demand and effectively compete with the products of competitors.
For example, magnetoresistive ("MR") recording heads represent an important
technology and component related to the performance and competitiveness of the
Company's products. In particular, MR recording heads have been important to
achieving competitive storage density for the Company's products. The
anticipated next generation of MR recording heads is referred to as "Giant" MR
("GMR") recording heads. In calendar year 1999, the Company expects
industry-wide competition in products incorporating GMR technology to have an
impact on technology leadership and competitiveness. In this regard, the
alliance between IBM and Western Digital that includes a purchasing agreement
and technology licensing involving GMR recording heads has increased the
competition in products incorporating GMR technology. The Company can make no
assurance regarding its ability to incorporate GMR recording heads into its
products and, if successful, the competitiveness of the Company's products.
The Company's future is also dependent on its ability to qualify new products
with customers, to successfully introduce these products to the market on a
timely basis, and to commence and achieve volume production that meets customer
demand. Because of these factors, the Company expects sales of new products to
continue to account for a significant portion of its future hard disk drive
sales, and that sales of older products will decline rapidly.
The Company is frequently in the process of qualifying new products with its
customers. The customer qualification process for disk drive products,
particularly high-end products, can be lengthy, complex, and difficult. The
Company would be materially adversely affected if it were unable to achieve
customer qualifications for new products in a timely manner, or at all, or if
30
MKE were unable to continue to manufacture qualified products in volume with
consistent high quality.
In the mid-range tape drive market, the Company has experienced less rapid
technological change, as well as less technology and performance based
competition compared with the hard disk drive market. This has resulted in
favorable gross margins on sales of the Company's DLTtape brand products. Higher
margins on DLTtape products, as compared with the eroded gross margins on hard
disk drives, have resulted in tape drive and related media products becoming the
primary source of the Company's operating income in the first nine months of
fiscal year 1999 and the second half of fiscal year 1998. Given the favorable
tape drive market conditions that the Company has experienced, competitors are
aggressively trying to make technological advances and take other steps in order
to more successfully compete with the Company's DLTtape products. Successful
competitor product offerings that target the market in which the Company's
DLTtape products compete could have a material adverse effect on the Company. In
addition, in the event that the Company is not able to maintain DLTtape
technology competitiveness based on its performance, quality, reliability and
scalability, or otherwise not meet the requirements of the market, 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 or achieve market
acceptance. These significant risks apply to all new products, including those
expected to be based on optical and Super DLTtape technologies. 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 and substantially lower prices than the
Company's products. Furthermore, 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, for technological
or other reasons, the Company is unable 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 optical technology through its
strategic alliance with and investment in TeraStor. In addition, the Company is
developing technologies for consumer electronics applications, including the
strategic alliance with TiVo, Inc., as discussed in the Strategic Developments
section. 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 that could have a material
adverse effect on the Company.
31
Customer Concentration. In addition to the concentration of the information
storage industry and the Company's customer base, customers are generally 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. In
June 1998, two Quantum customers, Compaq Computer, Inc. and Digital Equipment
Corporation merged, thereby increasing the Company's customer concentration and
associated risk.
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 first nine months of fiscal year 1999 and in fiscal year 1998. Sales to the
Company's top five customers in the nine months ended December 27, 1998
represented 43% of sales, compared to 45% of sales in the corresponding period
in fiscal year 1998 (percentage of sales reflects a retroactive combination of
the sales to Compaq Computer, Inc. and Digital Equipment Corporation as a result
of their merger in June 1998). Because of the rapid and unpredictable changes in
market conditions, and the short product life cycles for its customers'
products, the Company is unable to predict whether 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
results in fluctuations in operating results. Demand for the computer systems in
which the Company's storage products are used 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, either 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 will be at a slower rate than
the rate experienced in recent years.
Sales of DLTtape drives and media have tended to be more stable and were a
significant component of sales for the Company. In addition, 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 can be no assurance that this trend will continue. Beginning in the third
quarter of fiscal year 1998, sales of tape drives and media achieved gross
margins that significantly exceeded gross margins from the sale of the Company's
hard drive products. In this regard the Company expects sales of DLTtape and
automation products, which represented 28% of sales in the third quarter of
fiscal year 1999 and 21% of sales in fiscal year 1998, and a majority of
operating profits in both periods, will continue to represent a major portion of
the Company's operating profits in the future. The Company expects the rate of
sales growth to lessen in fiscal year 1999 compared with the rate of growth
achieved in fiscal year 1998. However, there can be no assurance that any growth
expectations will be achieved or that current market conditions will continue.
32
The Company's shipments tend to be highest in the third month of each quarter.
Failure by the Company to complete shipments in the final month of a quarter
resulting from a decline in customer demand, manufacturing problems, or other
factors would adversely affect the Company's operating results for that quarter.
Because the Company has no long-term purchase commitments from its customers,
future demand is difficult to predict. 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.
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 intellectual property matters, the acquisition
of ATL, the Tandberg manufacturing license and marketing agreement, inventory
risk, dependence on MKE for the manufacture of the hard disk drives that Quantum
develops and markets, the dissolution of MKQC, risks from conversion to a single
European currency, dependence on suppliers, component shortages, future capital
needs, warranty costs, foreign manufacturing and sales, foreign exchange
contracts, and price volatility of Quantum's common stock. For information
regarding litigation, refer to Note 5 of the Notes to Condensed Consolidated
Financial Statements.
Intellectual Property Matters. From time to time, the Company is approached by
companies and individuals alleging Quantum's infringement of and need for a
license under patented or proprietary technology that Quantum assertedly uses.
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. On Quantum's motion, the suit has been
moved to the Northern District of California. 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, Quantum has not yet had time to make
a complete 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. The final results of this litigation, as with any litigation, are
uncertain. If required, there can be no assurance that licenses to any
technology owned by Papst or any other third party alleging infringement could
be obtained on commercially reasonable terms if at all. Adverse resolution of
the Papst litigation or any other intellectual property litigation could subject
the Company to substantial liabilities and require it to refrain from
manufacturing certain products which could have a material adverse effect on the
Company's business, financial condition or results of operations. In addition,
the costs of engaging in the Papst litigation or other intellectual property
litigation could be substantial, regardless of the outcome.
Acquisition of ATL. As discussed in Note 6 of the Notes to Condensed
Consolidated Financial Statements, on September 28, 1998 the Company completed
the acquisition of ATL. In connection with the acquisition, the Company expensed
the amount of the purchase price
33
allocated to in-process research and development, which based on a preliminary
valuation, the Company has estimated at $89 million. Recent actions and comments
from the Securities and Exchange Commission have indicated they are reviewing
the current valuation methodology of purchased in-process research and
development related to business combinations. The Commission is concerned that
some companies are writing off more of the value of an acquisition than is
appropriate. The Company believes it is in compliance with all of the rules and
related guidance as they currently exist. However, there can be no assurance
that the Commission will not seek to retroactively apply new guidance and reduce
the amount of purchased in-process research and development previously expensed
by the Company. This could result in the restatement of previously filed
financial statements of the Company and could have a material adverse impact on
financial results for periods subsequent to the acquisition.
In addition, the acquisition of ATL by the Company entails a number of risks.
The success of Quantum and ATL is dependent, in part, on the retention and
integration of key management, technical, marketing, sales and customer support
personnel of ATL, in particular its President and Chief Executive Officer, Kevin
C. Daly, Ph.D. However, there can be no assurance that key personnel will remain
with Quantum for any specified period. Quantum's success with the acquisition
also depends in large part upon its ability to attract, retain and motivate
highly skilled employees. Competition for such employees, particularly
development engineers and experienced senior management, is intense, and there
can be no assurance that Quantum will be able to continue to attract and retain
sufficient numbers of such highly skilled employees. Quantum's inability to
attract and retain additional key employees or the loss of one or more of its
current key employees could have a material adverse effect on the Company's
business, financial condition and results of operations.
The success of Quantum and ATL is also dependent, in part, on the retention of
key customers of both Quantum and ATL. A number of ATL's competitors are
Quantum's customers and therefore the acquisition may increase the Company's
competition with its customers. Although Quantum already competes with a number
of its key customers, increased competition could result in customers shifting
storage strategies and purchases away from Quantum products. A loss of a key
customer could have a material adverse effect on the Company's financial
condition and results of operations.
Tandberg Manufacturing License and Marketing Agreement. In September 1998,
Quantum and Tandberg entered into a manufacturing license and marketing
agreement through which Tandberg can become an independent second source for
DLTtape drives, including products under development based on Quantum's Super
DLTtape technology as well as current DLTtape technology. Tandberg expects to
implement full DLTtape manufacturing operations by the second half of calendar
year 1999. As part of the agreement, Tandberg intends to market a full spectrum
of DLTtape products, including drives, media, and libraries. With Tandberg's
strong name recognition and established distribution channels in the European
market, Tandberg is expected to be a synergistic partner. Tandberg will need
Quantum's assistance to ramp-up its production of DLTtape drives. There are a
number of risks associated with this agreement, including that Tandberg may not
be successful or timely in ramping-up its production of DLTtape drives for
technical, operational, cost or other reasons; if the Quantum/Tandberg alliance
is unsuccessful, more broadly licensed
34
competitive products may be able to gain market share in the mid-range tape
market; manufacturing capacity added by Tandberg could lead to over supply and
price declines if demand in the mid-range tape storage market begins to slow
down. There can be no assurance that the agreement will be successful,
synergistic, or will not have an adverse impact on the Company's financial
position and results of operations.
Inventory Risk. As discussed in the "Customer Concentration" and "Fluctuation in
Product Demand" sections, the Company's customers generally are not obligated to
purchase any minimum volume of the Company's products and fluctuations in
end-user demand may result in the deferral or cancellation of orders for the
Company's products. These risk factors, when combined with the OEM trend toward
carrying minimal inventory levels related to just-in-time and build-to-order
type manufacturing processes, increase the risk that Quantum, as a supplier,
will manufacture and custom configure too much or too little inventory in
support of OEM manufacturing processes. Significant excess inventory conditions
could result in inventory write-downs and losses that could adversely impact the
Company's results of operations, whereas inventory shortages could adversely
impact the Company's relationship with its customers and the Company's results
of operations.
Dependence on MKE Relationship. Quantum is dependent on MKE for the manufacture
of all of its hard disk drive products. Approximately 75% and 79% of the
Company's sales in the first nine months of fiscal year 1999 and in fiscal year
1998, respectively, were derived from products manufactured by MKE. The
Company's relationship with MKE is therefore critical to the Company's business
and financial performance.
Quantum's master agreement with MKE, which covers the general terms of the
business relationship is effective through May 2007. The agreement may be
terminated sooner as a result of certain specified events including a
change-in-control of either Quantum or MKE. Quantum's relationship with MKE,
which dates from 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 to the Company's operations. As a result, the Company
would be materially adversely affected.
35
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 disk drive 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 year 1998 reflected losses
on firm inventory commitments associated with high-end disk drive
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 for the next 12 months. 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.
Dissolution of MKQC. Since the acquisition of MR recording heads technology in
fiscal year 1995 as part of the purchase 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. On
October 28, 1998, the Company and MKE agreed to dissolve MKE-Quantum Components
LLC ("MKQC"). MKQC was formed on May 16, 1997, when the Company sold a 51%
majority interest in its recording heads operations to Matsushita-Kotobuki
Electronics Industries, Ltd. ("MKE").
Although the Company does not expect to be further adversely impacted by the
dissolution of MKQC, the $101 million loss from investee that the Company
recorded in the third quarter of fiscal year 1999 is based, in part, on the
Company's estimated cash outflow required to liquidate MKQC and there are
inherent uncertainties involved in such estimates. For example, if the assets of
MKQC are sold for amounts that are less than estimated by MKQC or if buyers
cannot be found, MKQC would require additional funding to repay its bank debt,
accounts payable and other liabilities, and the Company would be expected to
fund cash shortfalls on a 49% pro rata basis. If the Company's cash outflows to
complete the dissolution of MKQC are greater than estimated, the Company could
be further adversely impacted.
Risks from Conversion to Single European Currency. On January 1, 1999, certain
member states of the European Economic Community fixed their respective
currencies to a new currency, the Single European Currency ("Euro"). On that day
the Euro became a functional legal currency within these countries. During the
three years beginning on January 1, 1999, business in these countries can be
36
conducted both in the former national currency as well as the Euro. Companies
operating in or conducting business in these countries need to ensure that their
financial and other software systems are capable of processing transactions and
properly handling the existing currencies and the Euro. Quantum is still
assessing the impact that the introduction and use of the Euro will have on its
internal systems. The Company will take corrective actions based on such
assessment but does not presently expect that introduction and use of the Euro
will materially affect the Company's foreign exchange and hedging activities or
use of derivative instruments or will result in any material increase in costs
to the Company. While Quantum will continue to evaluate the impact of the Euro
introduction over time, based on currently available information, management
does not believe that the introduction of the Euro will have a material adverse
impact on the Company's financial condition or overall trends in results of
operations.
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, 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 over 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, research, and development
expenditures, which could adversely affect the Company.
Warranty. Quantum generally warrants its products against defects for a period
of three to five years. A provision for estimated future costs relating to
warranty expense is recorded when products are shipped. Actual warranty costs
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 used
to estimate the warranty expense accrual.
37
Risks Associated with Foreign Manufacturing and Sales. Many of the Company's
products and product components are currently manufactured outside the United
States. In addition, close to half of the Company's revenue comes from sales
outside the United States, including sales to the overseas operations of
domestic companies. 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. In
addition, several Asian countries have recently experienced significant economic
downturns and significant declines in the value of their currencies relative to
the U.S. dollar. In the four quarters ending with the first quarter of fiscal
year 1999, the Company experienced a year-over-year reduction in sales to
certain Asian countries due, in part, to the effects of these factors. With most
of the Company's non-U.S. sales being denominated in U.S. dollars, the Company
is unable to predict what effect, if any, these factors will have on its ability
to maintain or increase its sales in these markets, general economic conditions,
and the Company's customers.
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.
38
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 - Not Applicable
Item 3. Defaults upon senior securities - Not Applicable
Item 4. Submission of matters to a vote of security holders - Not Applicable
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.
39
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: February 9, 1999 By: /s/ Richard L. Clemmer
----------------------
Richard L. Clemmer
Executive Vice President, Finance
and Chief Financial Officer
40
QUANTUM CORPORATION
INDEX TO EXHIBITS
Exhibit
Number Exhibit
10.1 SECOND AMENDMENT TO CREDIT AGREEMENT, dated December 18, 1998,
among Quantum Corporation, certain financial institutions
(collectively, the "Banks"), Canadian Imperial Bank of
Commerce, as administrative agent for the Banks, ABN AMRO Bank,
N.V., as syndication agent for the Banks and Bank of America
National Trust & Savings Association, as documentation agent
for the Banks.
10.2 CREDIT AGREEMENT, dated December 18, 1998, among ATL Products,
Inc., certain financial institutions (collectively, the
"Banks") and Fleet National Bank as agent for the Banks.
10.3 INDUSTRIAL LEASE, dated July 17, 1998, between The Irvine
Company as lessor, and ATL Products, Inc. as lessee.
27.1 Financial Data Schedule
Footnotes to
Exhibits Footnote
None
41