UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q -------------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended July 2, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------------- Commission File Number 0-12390 QUANTUM CORPORATION Incorporated Pursuant to the Laws of the State of Delaware -------------------- IRS Employer Identification Number 94-2665054 500 McCarthy Blvd., Milpitas, California 95035 (408) 894-4000 -------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ ----- As of the close of business on July 30, 2000, Quantum Corporation had 148,965,905 shares of DLT & Storage Systems group common stock outstanding and 79,217,861 shares of Hard Disk Drive group common stock outstanding. QUANTUM CORPORATION INDEX
Page Number ------ PART I - FINANCIAL INFORMATION Quantum Corporation - Condensed Consolidated Financial Statements Condensed Consolidated Statements of Operations 3 Condensed Consolidated Balance Sheets 4 Condensed Consolidated Statements of Cash Flows 5 Notes to Condensed Consolidated Financial Statements 6 Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Quantitative and Qualitative Disclosures About Market Risk 18 Quantum Corporation DLT & Storage Systems Group - Condensed Combined Financial Statements Condensed Combined Statements of Operations 19 Condensed Combined Balance Sheets 20 Condensed Combined Statements of Cash Flows 21 Notes to Condensed Combined Financial Statements 22 Management's Discussion and Analysis of Financial Condition and Results of Operations 26 Quantitative and Qualitative Disclosures About Market Risk 35 Quantum Corporation Hard Disk Drive Group - Condensed Combined Financial Statements Condensed Combined Statements of Operations 36 Condensed Combined Balance Sheets 37 Condensed Combined Statements of Cash Flows 38 Notes to Condensed Combined Financial Statements 39 Management's Discussion and Analysis of Financial Condition and Results of Operations 45 Quantitative and Qualitative Disclosure About Market Risk 55 PART II - OTHER INFORMATION 56 SIGNATURE 57
PART I - FINANCIAL INFORMATION Item 1. Financial Statements QUANTUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited)
Three Months Ended July 2, June 27, 2000 1999 ---------- ---------- Revenue $1,225,053 $1,083,235 Cost of revenue 944,578 903,316 ---------- ---------- Gross profit 280,475 179,919 Operating expenses: Research and development 94,079 90,433 Sales and marketing 66,486 53,221 General and administrative 34,641 29,144 ---------- ---------- 195,206 172,798 Income from operations 85,269 7,121 Other income (expense): Interest income and other, net 14,402 12,447 Interest expense (6,776) (7,208) ---------- ---------- 7,626 5,239 Income before income taxes 92,895 12,360 Income tax provision 32,475 4,079 ---------- ---------- Net income $ 60,420 $ 8,281 ========== ========== Quantum common stock (1): Net income $ 8,281 ========== Net income per share: Basic $ 0.05 Diluted $ 0.05 Weighted-average common shares: Basic 166,661 Diluted 172,977 DLT & Storage Systems group (1): Net income $ 43,950 ========== Net income per share: Basic $ 0.29 Diluted $ 0.28 Weighted-average common shares: Basic 150,318 Diluted 154,631 Hard Disk Drive group (1): Net income $ 16,470 ========== Net income per share: Basic $ 0.20 Diluted $ 0.19 Weighted-average common shares: Basic 81,444 Diluted 88,535
(1) As discussed in Note 2 of the Notes to Condensed Consolidated Financial Statements, a recapitalization occurred on August 3, 1999. As a result, earnings per share for Quantum Corporation common stock reflect earnings through the recapitalization date, while earnings for DLT & Storage Systems group common stock and Hard Disk Drive group common stock reflect results subsequent to that date. See accompanying notes to condensed consolidated financial statements. 3 QUANTUM CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
July 2, March 31, 2000 2000 ---------- ---------- (unaudited) Assets - ------ Current assets: Cash and cash equivalents $ 818,301 $ 918,262 Marketable securities 30,373 32,080 Accounts receivable, net of allowance for doubtful accounts of $23,473 and $23,110 620,098 609,225 Inventories 259,841 223,825 Deferred taxes 133,252 133,382 Other current assets 98,155 96,780 ---------- ---------- Total current assets 1,960,020 2,013,554 Property and equipment, net of accumulated depreciation of $320,260 and $299,671 227,633 236,685 Intangible assets, net 246,699 250,203 Other assets 42,035 33,510 ---------- ---------- $2,476,387 $2,533,952 ========== ========== Liabilities and Stockholders' Equity - ------------------------------------ Current liabilities: Accounts payable $ 476,455 $ 470,210 Accrued warranty 105,105 99,560 Accrued compensation 81,299 90,452 Income taxes payable 45,538 44,284 Accrued special charges 36,856 43,363 Current portion of long-term debt 1,129 1,033 Other accrued liabilities 109,514 105,345 ---------- ---------- Total current liabilities 855,896 854,247 Deferred taxes 72,301 55,336 Long-term debt 37,561 37,838 Convertible subordinated debt 287,500 287,500 Stockholders' equity: Common stocks 699,132 737,020 Retained earnings 507,071 545,050 Accumulated other comprehensive income 16,926 16,961 ---------- ---------- Total stockholders' equity 1,223,129 1,299,031 ---------- ---------- $2,476,387 $2,533,952 ========== ==========
See accompanying notes to condensed consolidated financial statements. 4 QUANTUM CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Three Months Ended July 2, June 27, 2000 1999 --------- --------- Cash flows from operating activities: Net income $ 60,420 $ 8,281 Adjustments to reconcile net income to net cash provided by (used in) operations: Depreciation 24,754 23,711 Amortization 8,170 6,688 Deferred income taxes (447) (594) Compensation related to stock plans 5,161 960 Changes in assets and liabilities: Accounts receivable (10,873) 7,579 Inventories (36,016) 10,067 Accounts payable 6,245 (54,975) Income taxes payable 1,254 (8,079) Accrued warranty 5,545 2,940 Other assets and liabilities 1,287 (806) --------- --------- Net cash provided by (used in) operating activities 65,500 (4,228) --------- --------- Cash flows from investing activities: Investment in equity securities (7,500) - Purchases of marketable securities - (23,641) Maturities of marketable securities 2,032 14,641 Investment in property and equipment (18,364) (24,833) Proceeds from disposition of property and equipment - 60 --------- --------- Net cash used in investing activities (23,832) (33,773) --------- --------- Cash flows from financing activities: Purchase of treasury stock (146,294) (84,239) Principal payments on long-term credit facilities (181) (6,747) Proceeds from issuance of common stock 4,846 6,044 --------- --------- Net cash used in financing activities (141,629) (84,942) --------- --------- Decrease in cash and cash equivalents (99,961) (122,943) Cash and cash equivalents at beginning of period 918,262 772,368 --------- --------- Cash and cash equivalents at end of period $ 818,301 $ 649,425 ========= ========= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 2,558 $ 1,212 Income taxes, net of (refunds) $ (271) $ 14,914
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 include the accounts of Quantum Corporation ("Quantum" or the "Company") and its majority owned subsidiaries. All material intercompany balances and transactions have been eliminated. The interim financial statements reflect all adjustments, consisting only of normal recurring adjustments, that, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. The condensed consolidated balance sheet as of March 31, 2000 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying financial statements should be read in conjunction with the audited financial statements of Quantum Corporation for the fiscal year ended March 31, 2000 included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission. 2. Recapitalization On July 23, 1999, the Company's stockholders approved a tracking stock proposal. As a result, Quantum's Certificate of Incorporation was amended and restated, effective as of the close of business on August 3, 1999, designating two new classes of Quantum Corporation common stock, DLT & Storage Systems group ("DSSG") common stock, $.01 par value per share and Hard Disk Drive group ("HDDG") common stock, $.01 par value per share. On August 3, 1999, each authorized share of Quantum common stock, $.01 par value per share, was exchanged for one share of DSSG stock and one-half share of HDDG stock. These two securities are intended to track separately the performance of the DLT & Storage Systems group and the Hard Disk Drive group. 3. Inventories Inventories consisted of the following: (In thousands) July 2, March 31, 2000 2000 --------- --------- Materials and purchased parts $ 53,211 $ 49,206 Work in process 33,526 42,323 Finished goods 173,104 132,296 --------- --------- $ 259,841 $ 223,825 ========= ========= 6 4. Net income per share Net income per share was calculated on a consolidated basis until DSSG stock and HDDG stock were created as a result of the recapitalization on August 3, 1999. Subsequent to this date, net income per share was computed individually for DSSG and HDDG. The following table sets forth the computation of basic and diluted net income per share:
(In thousands, except per share data) Three Months Ended ---------------------------------------------------- July 2, 2000 June 27, 1999 --------------------------------- ----------------- DLT & Storage Hard Disk Quantum Systems Group Drive Group Corporation ------------------ ------------- ----------------- Numerator: Numerator for basic and diluted net income per share - income available to common stockholders $ 43,950 $ 16,470 $ 8,281 =============== ============== =============== Denominator: Denominator for basic net income per share - weighted average shares 150,318 81,444 166,661 Effect of dilutive securities: Outstanding options 4,313 7,091 6,316 --------------- ------------- --------------- Denominator for diluted net income per share - adjusted weighted average shares 154,631 88,535 172,977 =============== ============= =============== Basic net income per share $ 0.29 $ 0.20 $ 0.05 =============== ============= =============== Diluted net income per share $ 0.28 $ 0.19 $ 0.05 =============== ============= ===============
The computation of diluted net income per share for DSSG and HDDG for the three months ended July 2, 2000 excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 6,206,152 shares of DSSG common stock, or 21.587 shares per $1,000 note, and 3,103,076 shares of HDDG common stock, or 10.793 shares per $1,000 note, because the effect would have been antidilutive. The computation of diluted net income per share for Quantum for the three months ended June 27, 1999 excluded the effect of the 7% convertible subordinated notes issued in July 1997, which were convertible into 6,206,152 shares of Quantum common stock, or 21.587 shares per $1,000 note, because the effect would have been antidilutive. Options to purchase 20.9 million shares of DSSG common stock and 0.9 million shares of HDDG common stock were outstanding for the three months ended July 2, 2000, but were not included in the computation of diluted net income per share because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. Options to purchase 6.0 million shares of Quantum common stock were outstanding for the three months ended June 27, 1999, but were not included in the computation of diluted net income per 7 share because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 5. Common Stock Repurchase During fiscal year 2000, the Board of Directors authorized the Company to repurchase up to $700 million of the Company's common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock, while $100 million was authorized for repurchase of HDDG common stock. During the first quarter of fiscal year 2001, the Company repurchased 10.5 million shares of DSSG common stock and 3.2 million shares of HDDG common stock for a combined total of $146 million. As of July 2, 2000, the Company had repurchased 3.9 million shares of Quantum common stock, 26.2 million shares of DSSG common stock and 6.7 million shares of HDDG common stock for a combined total of approximately $471 million. 6. Credit Line In April 2000, the Company entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At the Company's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At July 2, 2000, there were no outstanding balances drawn on these lines. 7. Litigation On August 7, 1998, the Company was named as one of several defendants in a patent infringement lawsuit filed in the U.S. District Court for the Northern District of Illinois, Eastern Division. The plaintiff, Papst Licensing GmbH, owns at least 24 U.S. patents, which it asserts that the Company has infringed. The Company has studied many of these patents before and, of the patents it has studied, believes that defenses of patent invalidity and non-infringement can be asserted. However, the Company has not completed a full study of all the patents asserted by Papst and there can be no assurance that the Company has not infringed these or other patents owned by Papst. Recently, on Papst's motion, the case was transferred to a federal district court in New Orleans, Louisiana, where it has been joined with suits brought against Papst by Hewlett-Packard Company, Maxtor Corporation and Minebea Company, Ltd. for the purposes of coordinated discovery under multi-district litigation rules. Hewlett-Packard settled its dispute with Papst and has been withdrawn from the litigation. To date, discovery has not begun to any significant extent. Quantum does not believe that the transfer will affect the final disposition of this matter in a significant way. The final results of this litigation, as with any litigation, are uncertain. In addition, the costs of engaging in litigation with Papst will be substantial. The Company is also subject to other legal proceedings and claims that arise in the ordinary course of its business. For example, in fiscal year 2000, Discovision Associates brought patents they hold to the Company's attention. While management currently believes the amount of ultimate liability, if any, with respect to these actions will not materially affect the financial position, results of 8 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. 8. Special Charge Hard Disk Drive Group During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with the streamlining of HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in the customer service strategy and the consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to the streamlining of the global logistics model and changes in customer service strategy, $7.8 million in severance and benefits for terminated employees and approximately $12 million in other costs associated with the plan. The facilities costs noted above include lease payments on facilities to be vacated in and around Milpitas, California and Singapore, the write-off of related leasehold improvements, and other maintenance expenses associated with the vacated facilities. HDDG expects that the affected facilities will be vacated by the end of the second quarter of fiscal year 2001. In connection with the charge, HDDG currently expects a workforce reduction of approximately 600 employees. In addition, approximately 100 open job requisitions and budgeted positions have been eliminated. The reduction in force primarily affects employees at HDDG's drive configuration centers and warehouses in Milpitas, California and Dundalk, Ireland and employees within the desktop drive business. As of July 2, 2000, 499 of the 600 employees had been terminated. HDDG anticipates that the remaining employees will be terminated by the end of the second quarter of fiscal year 2001. Subsequent to the end of the second quarter of fiscal year 2000, HDDG revised its estimate of costs required to implement the restructuring plan. HDDG currently estimates that severance and benefits, inventory and other costs, which include the disposition of additional capital assets, will be more than previously estimated as a result of the planned changes in the customer service strategy. HDDG also estimates that costs associated with vacating leased facilities will be less than previously estimated as a result of vacating a major facility earlier than previously expected. Accordingly, HDDG has reallocated amounts between these categories. As of July 2, 2000, HDDG had incurred $9 million in cash expenditures associated with employee severance and benefits, facilities and other costs. HDDG expects to incur additional cash expenditures associated with the plan of approximately $15 million. 9 The following table summarizes activity related to the special charge at July 2, 2000.
(In thousands) Severance And Facilities Other Benefits Costs Inventory Costs Total -------- ----- --------- ----- ----- Special charge provision $ 7,833 $ 26,359 $ 13,214 $ 12,000 $ 59,406 Cash Payments (5,584) (1,519) - (1,810) (8,913) Non-cash charges - (8,274) (15,588) (8,800) (32,662) Adjustments 1,166 (7,852) 2,374 4,312 - -------- -------- -------- -------- -------- Balance at July 2, 2000 $ 3,415 $ 8,714 $ - $ 5,702 $ 17,831 ======== ======== ======== ======== ========
DLT & Storage Systems Group During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed assets to be written off, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. The facilities costs noted above include lease payments for vacant space in a facility in Colorado Springs, Colorado, the write-off of related leasehold improvements and manufacturing equipment, as well as the write-off of certain leasehold improvements at Quantum's facility in Penang, Malaysia, as this space is converted to DSSG manufacturing. DSSG expects that the Colorado facility will be vacated by the end of fiscal year 2001. The write-off of investments reflects DSSG's decision to end its research on certain optical based storage solutions. As a result, DSSG has written off an equity investment and technology licenses related to optical technology. DSSG currently expects a workforce reduction of approximately 900 employees. The reduction in force primarily affects employees at DSSG's manufacturing operations in Colorado Springs, Colorado, as well as administrative employees within the DLTtape Division. As of July 2, 2000, 286 employees had been terminated. DSSG anticipates that the remaining employees will be terminated by the end of the fourth quarter of fiscal year 2001. As of July 2, 2000, DSSG had incurred cash expenditures of $4 million associated with employee severance and benefits, facilities and other costs. DSSG expects to incur additional cash expenditures associated with the plan of approximately $14 million, which will be funded out of operations. 10 The following table summarizes activity related to the special charge at July 2, 2000: (In thousands)
Severance And Facilities Fixed Other Benefits Costs Investments Assets Costs Total -------- ----- ----------- ------ ----- ----- Special charge provision $ 7,646 $ 13,500 $ 13,908 $ 3,163 $ 1,866 $ 40,083 Cash payments (2,816) (33) -- -- (1,138) (3,987) Non-cash charges -- -- (13,908) (3,163) -- (17,071) ------- -------- ---------- ------- --------- -------- Balance at July 2, 2000 $ 4,830 $ 13,467 $ -- $ -- $ 728 $ 19,025 ======= ======== ========== ======= ========= ========
9. Comprehensive Income Accumulated other comprehensive income on the condensed consolidated balance sheets consists of unrealized gains on available for sale investments and foreign currency translation adjustments. Total comprehensive income for the three months ended July 2, 2000 and June 27, 1999, is presented in the following table: (In thousands) Three Months Ended July 2, June 27, 2000 1999 --------- --------- Net income $ 60,420 $ 8,281 Other comprehensive income - Change in unrealized gain on investments, net 195 -- Foreign currency translation adjustments (230) (920) --------- ------- Comprehensive income $ 60,385 $ 7,361 ========= ======= 10. Business Segment Information Quantum Corporation's reportable segments are its two business groups, the Hard Disk Drive group and the DLT & Storage Systems group, as further described in their separate financial statements. The Hard Disk Drive group consists of desktop and high-end hard disk drives. The DLT & Storage Systems group consists of DLTtape(TM) drives and media, autoloaders and libraries, network attached storage appliances and solid state storage systems. The Company markets its products to computer manufacturers and through a broad range of distributors, resellers, systems integrators and end-users. 11 The Company evaluates segment performance based on net profit or loss not including non-recurring gains or losses. Segment assets include those items that can be specifically identified with or reasonably allocated to a particular segment. Results for the Company's reportable segments for the three months ended July 2, 2000 and June 27, 1999 are presented in the following table: (In millions)
Three Months Ended --------------------------------------------------------------------- July 2, 2000 June 27, 1999 -------------------------------- ----------------------------- HDDG DSSG Total HDDG DSSG Total ---- ---- ----- ---- ---- ----- Revenues from external customers $ 859 $ 366 $ 1,225 $ 752 $ 331 $ 1,083 Intersegment revenues 5 - 5 - - - Segment profit (loss) 16 44 60 (43) 51 8
12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Quantum Corporation This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements usually are phrased in the future tense or contain the words "estimate," "anticipate," "expect," or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties. These uncertainties could cause actual results to differ materially from those expected for the reasons set forth under Trends and Uncertainties relating to the DLT & Storage Systems group and Trends and Uncertainties relating to the Hard Disk Drive group. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Business Description Quantum operates its business through two separate business groups: the DLT & Storage Systems group ("DSSG") and the Hard Disk Drive group ("HDDG") as described in their respective sections of this report. Results of Operations Revenue. Revenue in the three months ended July 2, 2000 was $1.225 billion, compared to $1.083 billion in the three months ended June 27, 1999, an increase of 13%. The increase reflected increased sales of DLTtape libraries and Snap servers, increased DLTtape media royalties, and increased revenue from sales of desktop and high-end hard disk drives. The increased sales of Snap server network attached storage appliances reflected the acquisition of Meridian Data, Inc. ("Meridian") in September 1999. The increase in DLTtape media royalties reflected an increase in the sales of DLTtape media cartridges at licensed media manufactures for which DSSG earns a royalty fee. The decrease in DLTtape drive revenue reflected an increase in shipments, offset by a decline in average unit prices due to competitive pricing. Sales of high-end hard disk drives reached a record high in the current quarter, increasing 64% compared to the first quarter of fiscal year 2000. High-end hard disk drive shipments reached a record high, reflecting strong demand from computer equipment manufacturers and distribution channel customers. Sales of desktop hard disk drives increased 6% compared to the prior year quarter, reflecting a 20% increase in shipments, partially offset by lower average unit prices due to competitive pricing pressure. Sales to our top five customers in the three months ended July 2, 2000 represented 47% of revenue, compared to 42% of revenue in the three months ended June 27, 1999. These amounts reflected a retroactive combination of the sales to Ingram Micro and Electronic Resources Limited as a result of their merger in July 1999. Sales to Compaq Computer Corporation were 12% of revenue in the three months ended July 2, 2000, and June 27, 1999. Sales to Dell 13 Computer Corporation were 10% of revenue in the three months ended July 2, 2000, compared to less than 10% of revenue in the three months ended June 27, 1999. Sales to Hewlett-Packard Company were less than 10% of revenue in the three months ended July 2, 2000, compared to 14% of revenue in the three months ended June 27, 1999. Sales to computer equipment manufacturers and distribution channel customers were 63% and 31% of revenue, respectively, in the three months ended July 2, 2000, compared to 59% and 35% of revenue, respectively, in the three months ended June 27, 1999. The remaining revenue in the three months ended July 2, 2000, and June 27, 1999, represented media royalty revenue, sales to value added resellers and direct sales. Gross Margin Rate. The gross margin rate in the three months ended July 2, 2000, increased to 22.9% from 16.6% in the three months ended June 27, 1999. The percentage increase reflected increased revenue from storage systems and DLTtape media royalties, which have significantly higher margins than Quantum's hard disk drive products. The increase also reflected higher margins earned on desktop and high-end hard disk drives. Gross margins earned on DLTtape drives and DLTtape media cartridges declined, reflecting lower average unit pricing. Thegross margin rate for desktop products of HDDG is expected to decline substantially in the second quarter of fiscal year 2001 because of accelerated average unit price declines and slower declines in bill-of-material costs. Research and Development Expenses. In the three months ended July 2, 2000, research and development expenses were $94 million, or 7.7% of revenue, compared to $90 million, or 8.3% of revenue, in the three months ended June 27, 1999. The increase in research and development expenses reflected the inclusion of Server Appliances (formerly Meridian) expenses, which were not included in the prior year periods as the acquisition occurred on September 10, 1999, and higher research and development expenses related to new tape drive products and other new information storage products and technologies, including Super DLTtape(TM) technology. HDDG had lower research and development costs as a result of expense reductions resulting from modifications to the hard disk drive business associated with the special charge recorded in the second quarter of fiscal year 2000. Sales and Marketing Expenses. Sales and marketing expenses in the three months ended July 2, 2000, were $66 million, or 5.4% of revenue, compared to $53 million, or 4.9% of revenue, in the three months ended June 27, 1999. The increase in sales and marketing expenses reflected the inclusion of Server Appliances expenses and an increase in costs associated with the expansion of ATL's infrastructure. Spending increased as DSSG continued to build both category awareness for network attached storage (NAS) appliances and brand awareness for the Snap! Server(TM) line. General and Administrative Expenses. General and administrative expenses in the three months ended July 2, 2000, were $35 million, or 2.8% of revenue, compared to $29 million, or 2.7% of revenue, in the three months ended June 27, 1999. The increase in general and administrative expenses reflected the inclusion of Server Appliances expenses, expansion of ATL's infrastructure and an increase in human resource spending within HDDG in support of change management, process reengineering and retention. 14 Special Charge - HDDG. During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with the streamlining of HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in the customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to the streamlining of the global logistics model and changes in the customer service strategy, $7.8 million in severance and benefits for terminated employees and approximately $12 million in other costs associated with the plan. HDDG is proceeding according to plan and expects to realize more than $100 million in cost savings per year, beginning in fiscal year 2001. The majority of the savings are expected in cost of revenue as a result of a more efficient distribution system and reduced customer service costs, with the remaining savings in research and development, as a result of the consolidation of product development programs. As compared to fiscal year 2000, HDDG expects operating expenses to be relatively flat in fiscal year 2001, with increased investments in disk drive and other storage products, primarily reflected in research and development, offsetting the cost savings resulting from the special charge. These expectations are forward-looking statements and actual results may differ. Special Charge - DSSG. During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed assets to be written-off, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. DSSG is proceeding according to plan and expects to realize annual cost savings from the plan of approximately $40 million beginning upon full implementation of the plan at the end of fiscal year 2001. Approximately $30 million of the savings are expected in cost of revenue as a result of reduced manufacturing costs with the remaining amount in operating expenses, primarily research and development, as a result of ending research on certain optical-based storage solutions. As compared to fiscal year 2000, DSSG expects operating expenses to increase because of increased investments in storage systems products and marketing in fiscal year 2001 and as a result of including the Server Appliances' operations for a full year following the acquisition of Meridian in September 1999. These expectations are forward-looking statements and actual results may differ. 15 Interest and Other Income/Expense. Net interest and other income for the three months ended July 2, 2000 was $7.6 million, compared to net interest and other income of $5.2 million for the three months ended June 27, 1999. The increase reflected increased interest income as a result of a higher average cash balance. Income Taxes. The Company's effective tax rate for the three months ended July 2, 2000 and June 27, 1999 was 35% and 33%, respectively. The lower fiscal year 2000 effective tax rate compared to the fiscal year 2001 tax rate reflects tax benefits resulting from HDDG losses in fiscal year 2000 compared to DSSG income in fiscal year 2001. Liquidity and Capital Resources. Cash, cash equivalents and marketable securities were $849 million at July 2, 2000 compared to $950 million at March 31, 2000. The Company used cash during the quarter to purchase $146 million of treasury stock, as discussed below. Other uses of cash included $18 million for investments in property and equipment. The Company generated approximately $66 million of cash from operations, primarily net income and non-cash expenses, partially offset by increases in inventories and accounts receivable. During fiscal year 2000, the Board of Directors authorized the Company to repurchase up to $700 million of the Company's common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock, while $100 million was authorized for repurchase of HDDG common stock. During the first quarter of fiscal year 2001, the Company repurchased 10.5 million shares of DSSG common stock and 3.2 million shares of HDDG common stock for a combined total of $146 million. As of July 2, 2000, the Company had repurchased 3.9 million shares of Quantum common stock, 26.2 million shares of DSSG common stock and 6.7 million shares of HDDG common stock for a combined total of approximately $471 million. In April 2000, the Company entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At the Company's option, borrowings under the revolving credit lines bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At July 2, 2000, there were no outstanding balances drawn on these lines. The Company expects to spend approximately $115 million in fiscal year 2001 for capital equipment and leasehold improvements. These capital expenditures will support the disk drive, tape drive and storage solutions businesses, research and development, and general corporate operations. The Company believes that its existing capital resources, including the credit facilities and any cash generated from operations, will be sufficient to meet all currently planned expenditures and sustain operations for the next 12 months. However, this belief assumes that operating results and cash flow from operations will meet our expectations. These expectations are forward-looking statements and actual results may be affected by the factors discussed in "Trends and Uncertainties Relating to the DLT & Storage Systems Group and Hard Disk Drive Group" in this report. In the future, the Company may seek to raise cash through the issuance of debt or equity securities. There can be no assurance that such financing would be available on terms favorable to the Company, if at all. 16 Euro Impact The Company believes that the adoption of a single currency, the Euro, by eleven European countries has not and will not materially affect our business, information systems or consolidated financial position, operating results or cash flows. 17 Item 3. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Company's Annual Report on Form 10-K for the year ended March 31, 2000. The Company is exposed to equity price risk on its investment in TiVo, Inc. common stock. The Company does not attempt to reduce or eliminate its market exposure on this security. The Company entered into a strategic alliance with TiVo in fiscal year 1999 to supply hard disk drives utilizing Quantum's QuickView technology for integration into TiVo's Personal Video Recorder. At July 2, 2000, the fair market value of the Company's investment was approximately $30 million. As TiVo is a relatively new company and has recently introduced a new product in the consumer electronics market, the Company does not believe it is possible to reasonably estimate any future price movement of TiVo common stock. 18 Item 1. Financial Statements QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP CONDENSED COMBINED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited)
Three Months Ended July 2, June 27, 2000 1999 ----------- ----------- Product revenue $ 313,223 $ 291,307 Royalty revenue 52,961 39,437 ----------- ----------- Total revenue 366,184 330,744 Cost of revenue 206,349 179,094 ----------- ----------- Gross profit 159,835 151,650 Operating expenses: Research and development 35,829 27,725 Sales and marketing 38,770 25,390 General and administrative 18,365 14,399 ----------- ------ 92,964 67,514 Income from operations 66,871 84,136 Other income (expense): Interest income and other, net 6,349 6,483 Interest expense (4,546) (4,844) ----------- ------------ 1,803 1,639 Income before income taxes 68,674 85,775 Income tax provision 24,724 34,310 ----------- ----------- Net income $ 43,950 $ 51,465 =========== =========== Net income per share (1): Basic $ 0.29 $ 0.31 Diluted $ 0.28 $ 0.30 Weighted-average common shares (1): Basic 150,318 166,661 Diluted 154,631 172,977
(1) Basic and diluted income per share and weighted average common shares for the period ended June 27, 1999 are pro forma and assume the recapitalization occurred at the beginning of fiscal year 2000. See accompanying notes to condensed combined financial statements. 19 QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP CONDENSED COMBINED BALANCE SHEETS (In thousands)
July 2, March 31, 2000 2000 ------------- ------------- (unaudited) Assets - ------ Current assets: Cash and cash equivalents $ 263,547 $ 336,720 Marketable securities - 2,032 Accounts receivable, net of allowance for doubtful accounts of $3,597 and $3,492 232,051 214,107 Inventories 100,346 101,478 Due from the Hard Disk Drive group 13,989 - Deferred taxes 54,668 54,669 Other current assets 45,643 38,424 ------------- ------------- Total current assets 710,244 747,430 Property and equipment, net of accumulated depreciation of $92,378 and $80,997 80,896 78,137 Intangible assets, net 245,605 248,288 Other assets 16,277 12,149 ------------- ------------- $ 1,053,022 $ 1,086,004 ============= ============= Liabilities and Group Equity - ---------------------------- Current liabilities: Accounts payable $ 106,430 $ 94,596 Accrued warranty 54,362 52,593 Accrued compensation 40,237 36,379 Income taxes payable 24,723 - Accrued special charge 19,025 20,954 Current portion of long-term debt 753 689 Due to the Hard Disk Drive group - 30,100 Other accrued liabilities 29,174 27,749 ------------- ------------- Total current liabilities 274,704 263,060 Deferred taxes 30,992 13,578 Long-term debt 25,041 25,225 Convertible subordinated debt 191,667 191,667 Group equity 530,618 592,474 ------------- ------------- $ 1,053,022 $ 1,086,004 ============= =============
See accompanying notes to condensed combined financial statements. 20 QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP CONDENSED COMBINED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Three Months Ended July 2, June 27, 2000 1999 -------------- -------------- Cash flows from operating activities: Net income $ 43,950 $ 51,465 Adjustments to reconcile net income to net cash provided by operations: Depreciation 9,825 7,486 Amortization 7,193 5,710 Deferred income taxes 2 - Compensation related to stock plans 3,547 640 Changes in assets and liabilities: Accounts receivable (17,944) 9,041 Inventories 1,132 (13,620) Accounts payable 11,834 27,161 Income taxes payable 24,723 - Accrued warranty 1,769 5,457 Other assets and liabilities (36,436) (3,554) ------------- ------------ Net cash provided by operating activities 49,595 89,786 ------------- ------------ Cash flows from investing activities: Investment in equity securities (3,750) - Maturities of marketable securities 2,032 - Investment in property and equipment (11,577) (10,691) ----------- --------------- Net cash used in investing activities (13,295) (10,691) ----------- --------------- Cash flows from financing activities: Purchases of treasury stock (111,331) (84,239) Principal payments on long-term credit facilities (120) (4,498) Proceeds from issuance of common stock 1,978 4,029 ------------ ------------- Net cash used in financing activities (109,473) (84,708) ------------ ------------- Decrease in cash and cash equivalents (73,173) (5,613) Cash and cash equivalents at beginning of period 336,720 272,643 ------------ ------------ Cash and cash equivalents at end of period $ 263,547 $ 267,030 ============ ============ Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 1,705 $ 808 Income taxes $ 3,419 $ 1,500
See accompanying notes to condensed combined financial statements. 21 QUANTUM CORPORATION DLT & STORAGE SYSTEMS GROUP NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (unaudited) 1. Basis of presentation The accompanying unaudited condensed combined financial statements of the DLT & Storage Systems group ("DSSG"), together with the condensed combined financial statements of the Hard Disk Drive group ("HDDG"), include all of the accounts in the condensed consolidated financial statements of Quantum. The separate group condensed combined financial statements give effect to the accounting policies applicable with the implementation of the tracking stock proposal. The separate DSSG and HDDG financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (i) the historical balance sheets, results of operations, and cash flows of businesses that comprise each of the groups, with all significant intragroup transactions and balances eliminated, (ii) in the case of DSSG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with DSSG, including allocated portions of Quantum's debt and selling, general and administrative costs, and (iii) in the case of HDDG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with HDDG, including allocated portions of Quantum's debt and selling, general and administrative costs. Intergroup transactions and balances are not eliminated in the separate financial statements of DSSG or HDDG. The condensed combined financial statements of the DLT & Storage Systems Group provide DSSG stockholders with financial information about the DLT & Storage Systems group operations. Holders of DSSG stock and HDDG stock are Quantum stockholders and are subject to all of the risks of an investment in Quantum and all of Quantum's businesses, assets and liabilities. Quantum retains ownership and control of all of the assets and operations of each group. Financial effects arising from one group that affect Quantum's consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the other group's stock. Any net losses of DSSG or HDDG, and dividends or distributions on, or repurchases of HDDG stock, or repurchases of preferred stock at a price per share greater than par value, will reduce the funds of Quantum legally available for payment of dividends on DSSG stock. As a result, DSSG's condensed combined financial statements should be read in conjunction with Quantum's condensed consolidated financial statements and HDDG's condensed combined financial statements. The condensed combined balance sheet as of March 31, 2000 has been derived from the audited financial statements of Quantum Corporation included in its Annual Report on Form 10-K filed with the Securities and Exchange Commission, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim financial statements reflect all adjustments, consisting only of normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. Certain prior period amounts have been reclassified to conform to the current period's presentation. 22 2. Inventories Inventories consisted of the following: (In thousands)
July 2, March 31, 2000 2000 --------- --------- Materials and purchased parts $ 46,336 $ 41,819 Work in process 29,989 37,024 Finished goods 24,021 22,635 -------- -------- $100,346 $101,478 ======== ========
3. Net income per share As a result of the recapitalization, net income per share for DSSG has been calculated based on the group's net income subsequent to August 3, 1999. It was not calculated on a group basis for periods prior to the recapitalization because DSSG stock was not part of Quantum's capital structure at that time. The following table sets forth the computation of basic and diluted net income per share for DSSG after the recapitalization date: (In thousands, except per share data) Three Months Ended July 2, 2000 -------------- Numerator: Numerator for basic and diluted net income per share - income available to common stockholders $ 43,950 ============ Denominator: Denominator for basic net income per share - weighted average shares 150,318 Effect of dilutive securities: Outstanding options 4,313 ------------ Denominator for diluted net income per share - adjusted weighted average shares 154,631 ============ Basic net income per share $ 0.29 ============ Diluted net income per share $ 0.28 ============ The computation of diluted net income per share for DSSG for the three months ended July 2, 2000 excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 6,206,152 shares of DSSG common stock, or 21.587 shares per $1,000 note, because the effect would have been antidilutive. Options to purchase 20.9 million shares of common stock were outstanding for the three months ended July 2, 2000, but were not included in the computation of diluted net income per share 23 because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 4. Common Stock Repurchase During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of Quantum's common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock, while $100 million was authorized for repurchase of HDDG common stock. During the first quarter of fiscal year 2001, Quantum repurchased 10.5 million shares of DSSG common stock and 3.2 million shares of HDDG common stock for a combined total of $146 million. As of July 2, 2000, Quantum had repurchased 3.9 million shares of Quantum common stock, 26.2 million shares of DSSG common stock and 6.7 million shares of HDDG common stock for a combined total of approximately $471 million. 5. Credit Line In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines will bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At July 2, 2000, there were no outstanding balances drawn on these lines. 6. Special Charge During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed assets to be written off, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. The facilities costs noted above include lease payments for vacant space in a facility in Colorado Springs, Colorado, the write-off of related leasehold improvements and manufacturing equipment, as well as the write-off of certain leasehold improvements at Quantum's facility in Penang, Malaysia, as this space is converted to DSSG manufacturing. DSSG expects that the Colorado facility will be vacated by the end of fiscal year 2001. 24 The write-off of investments reflects DSSG's decision to end its research on certain optical based storage solutions. As a result, DSSG has written off an equity investment and technology licenses related to optical technology. DSSG currently expects a workforce reduction of approximately 900 employees. The reduction in force primarily affects employees at DSSG's manufacturing operations in Colorado Springs, Colorado, as well as administrative employees within the DLTtape Division. As of July 2, 2000, 286 employees had been terminated. DSSG anticipates that the remaining employees will be terminated by the end of the fourth quarter of fiscal year 2001. As of July 2, 2000, DSSG had incurred cash expenditures of $4 million associated with employee severance and benefits, facilities and other costs. DSSG expects to incur additional cash expenditures associated with the plan of approximately $14 million, which will be funded out of operations. The following table summarizes activity related to the special charge at July 2, 2000:
(In thousands) Severance And Facilities Fixed Other Benefits Costs Investments Assets Costs Total -------- ----- ----------- ------ ----- ----- Special charge provision $7,646 $13,500 $ 13,908 $3,163 $ 1,866 $ 40,083 Cash payments (2,816) (33) -- -- (1,138) (3,987) Non-cash charges -- -- (13,908) (3,163) -- (17,071) ------- -------- -------- ------ ------- -------- Balance at July 2, 2000 $4,830 $13,467 $ -- $ -- $ 728 $ 19,025 ======= ======== ======== ====== ======= ========
25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - DLT & Storage Systems Group This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements usually are phrased in the future tense or contain the words "estimate," "anticipate," "expect," or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties. These uncertainties could cause actual results to differ materially from those expected for the reasons set forth under Trends and Uncertainties relating to the DLT & Storage Systems group. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Business Overview The DLT & Storage Systems group designs, develops, manufactures, licenses and markets DLTtape(TM) drives, DLTtape media cartridges and storage solutions. DSSG's storage solutions consist of DLTtape libraries, network attached storage appliances, solid state storage systems and service. DLTtape products are used to back up large amounts of data stored on network servers. Digital Linear Tape, or DLTtape, is DSSG's half-inch tape technology that is the de facto industry standard for data back up in the mid-range network server market. According to International Data Corporation, DSSG was the worldwide revenue leader for tape drives used for data storage and back up in calendar year 1999. DLTtape drives accounted for 30% of total tape drive market revenue in calendar year 1999, up from 24% in calendar year 1998 and 2% in calendar year 1994. The DLT & Storage Systems group is also a leader in the tape library market for mid-range network servers. DLTtape library products represented an estimated 46% of total tape automation revenue in calendar year 1999, up from 38% in calendar year 1998 and 29% in calendar year 1997. DSSG's tape libraries serve the entire tape library data storage market from desktop computers to enterprise class computers. DSSG is a leader in the rapidly emerging market for network attached storage appliances with products which incorporate hard disk drives and an operating system designed to meet the requirements of entry and workgroup level computing environments, where multiple computer users access shared data files over a local area network. DLTtape drives store data on DLTtape media cartridges. Historical use of DLTtape drives has shown that drives use many media cartridges per year. Growth in the installed base of DLTtape drives is expected to result in increasing demand for DLTtape media cartridges. DSSG's DLTtape media cartridges are manufactured and sold by licensed third party manufacturers. DSSG receives a royalty fee on DLTtape media cartridges sold by its licensees which, while resulting in lower revenue than DLTtape media sold directly by DSSG, generates comparable income from operations. DSSG prefers to sell a substantial portion of DLTtape media cartridge 26 through its license model because this minimizes DSSG's operational risks and expenses and provides an efficient distribution channel. Currently, approximately 85% of media sales occur through this license model. Products The DLT & Storage Systems group's products include: DLT: ---- . Super DLTtape(TM)drives. DSSG recently introduced a new family of tape drive products based on Super DLTtape technology, targeted to serve workgroup, mid-range and enterprise business needs. For workgroup and departmental servers, the Super DLTtape drive will deliver a native capacity of 80 gigabytes ("GB") (160GB compressed) and a sustained transfer rate of 8 megabytes ("MB") per second (16MB compressed). The mid-range market including large corporate departments and mid-size automated libraries will see a drive with a native capacity of 110GB (220GB compressed) and a sustained transfer rate of 11MB per second (22MB compressed). In response to high performance enterprise needs, DSSG will also offer a Super DLTtape drive with a sustained transfer rate of greater than 16MB per second (32MB compressed). Super DLTtape drives are expected to begin volume shipment in the second half of calendar year 2000. . DLTtape drives. DSSG currently offers three tape drive products--the DLT8000, the DLT7000 and the DLT4000. The DLT8000 provides a combination of 40GB of native capacity (80GB compressed) and a sustained data transfer rate of 6MB per second (12MB compressed). The DLT7000 provides a combination of 35GB of native capacity (70GB compressed) and a sustained data transfer rate of 5MB per second (10MB compressed). The DLT4000 provides a combination of 20GB of native capacity (40GB compressed) and a sustained data transfer rate of 1.5MB per second (3MB compressed). . DLTtape media cartridges. The DLTtape family of half-inch tape media cartridges is designed and formulated specifically for use with DLTtape drives. The capacity of a DLTtape media cartridge is up to 40GB (80GB compressed). DSSG's half-inch tape cartridges take advantage of shorter wavelength recording schemes to ensure read compatibility with future generations of DLTtape drives. The tape itself features a special high- grade metal particle formula that reduces tape and head wear. The result is tape that delivers a proven one million passes with a negligible impact on soft error rates and a 30-year archival life. Storage Solutions: ------------------ . Tape libraries. DSSG offers a broad line of automated DLTtape libraries that support a wide range of back-up and archival needs from workgroup servers to enterprise-class servers. DSSG's tape libraries range from its tape autoloaders which accommodate a single DLTtape drive and up to 280GB of storage capacity to the P6000 series library which features Prism Library Architecture(TM) and can be configured in multiple units to scale up to 22.8 terabytes of storage capacity. In addition, DSSG offers WebAdmin(TM), the industry's first Internet browser-based tape library management system, allowing system administrators to monitor widely distributed storage systems at remote locations with point-and-click ease. 27 . Network attached storage systems. DSSG's Snap! Server(TM) family of network attached storage appliances offers options ranging from 15GB to 120GB of network storage. These products incorporate hard disk drives and an operating system, provide the ease of plug-and-play features and can be directly attached to workgroup-level networks, providing instant additional network storage capacity. No special configurations are needed for ordinary use and advanced configuration options enable added value features. . LANvault(TM) tape backup appliance. LANvault is a backup appliance with a DLTtape library, a central management console and a customer service Web portal. This product is intended to meet the requirements for remote site backup and is designed as a workgroup backup solution appliance preloaded with industry-standard backup software for ease of installation and use. . Solid state storage systems. DSSG offers two families of solid state storage systems--the Rushmore(TM)Ultra series and the Rushmore eSystem Accelerators. The Rushmore Ultra Solid State Disks are available in capacities ranging from 268MB to 3.2GB and have data access times of less than 50 microseconds, 100 to 200 times faster than magnetic hard disk drives. Solid state storage systems store data on memory chips which enable significantly faster data access times than magnetic disks used in standard hard disk drives. DSSG recently introduced the next generation solid state storage product, Rushmore eSystem Accelerator, a comprehensive set of hardware, tools, services and consulting bundled into one inclusive package. With breakthrough semiconductor and controller technology, the Rushmore eSystem Accelerator dramatically increases system performance in e-commerce infrastructures. With capacities ranging from 536MB to 3.2GB, the Rushmore eSystem Accelerator delivers data access times of less than 25 microseconds, more than 18,000 accesses to information per second for time-critical applications. Results of Operations Revenue. Revenue in the three months ended July 2, 2000 was $366 million, compared to $331 million in the three months ended June 27, 1999, an increase of 11%. The increase in revenue reflected increased sales of DLTtape libraries and Snap servers, and increased DLTtape media royalties. Sales of tape libraries reached a record high in the quarter. Sales of Snap server network attached storage appliances also reached a record high without comparable sales in the prior year period as DSSG's sales of Snap servers followed the acquisition of Meridian in September 1999. The increase in DLTtape media cartridges sold reflects sales of cartridges for use in both new DLTtape drives and to meet the ongoing new media needs of the installed base of DLTtape drives that remain in use. The increase in DLTtape media royalties reflected an increase in the sales of DLTtape media cartridges at licensed media manufacturers for which DSSG earns a royalty fee. Revenue from sales of DLTape drives declined. The decrease in DLTtape drive revenue reflected an increase in shipments, offset by a decline in average unit prices due to competitive pricing. 28 The table below summarizes the components of DSSG's revenue in the three months ended July 2, 2000 and June 27, 1999, respectively:
(in millions) Three Months Ended July 2, June 27, 2000 1999 ---- ---- DLTtape drives $212 $219 DLTtape media 28 27 DLT royalty 53 39 Storage Solutions 100 67 Intra-group elimination* (27) (22) ----- ------ Revenue $366 $331 ===== ======
*Represents intra-group sales of DLTtape drives for incorporation into DSSG's tape libraries. Sales to the top five customers in the three months ended July 2, 2000 represented 47% of total revenue, compared to 50% of total revenue in the three months ended June 27, 1999. The lower percentage reflected a higher proportion of royalty revenue from licensed media manufacturers in the current quarter. Sales to Compaq were 19% of revenue in the three months ended July 2, 2000 compared to 21% of revenue in the three months ended June 27, 1999. Sales to Hewlett-Packard were 11% of revenue in the three months ended July 2, 2000 compared to 13% of revenue in the three months ended June 27, 1999. Sales to computer equipment manufacturers and distribution channel customers were 64% and 14% of revenue, respectively, in the three months ended July 2, 2000, compared to 69% and 12% of revenue, respectively, in the three months ended June 27, 1999. The remaining revenue in the three months ended July 2, 2000 and in the three months ended June 27, 1999, represented media royalty revenue, sales to value-added resellers and direct sales. Gross Margin Rate. The gross margin rate in the three months ended July 2, 2000, was 43.6%, compared to 45.9% in the three months ended June 27, 1999. The percentage decrease reflected lower DLTtape drive margins as a result of price declines, partially offset by an increase in the proportion of overall revenue represented by DLTtape media royalty revenue. Research and Development Expenses. Research and development expenses in the three months ended July 2, 2000, were $36 million, or 9.8% of revenue, compared to $28 million, or 8.4% of revenue, in the three months ended June 27, 1999. The increase in research and development expenses reflected the inclusion of Server Appliances (formerly Meridian) expenses, which were not included in the prior year periods as the acquisition occurred on September 10, 1999. In addition, there were higher research and development expenses related to new tape drive products and other new information storage products and technologies, including Super DLTtape technology. Sales and Marketing Expenses. Sales and marketing expenses in the three months ended July 2, 2000, were $39 million, or 10.6% of revenue, compared to $25 million, or 7.7% of revenue in the three months ended June 27, 1999. The increase in sales and marketing expenses reflected the inclusion of Server Appliances expenses and an increase in sales and marketing costs associated 29 with the expansion of ATL's infrastructure. Spending increased as DSSG continued to build both category awareness for NAS appliances and brand awareness for the Snap! Server line. General and Administrative Expenses. General and administrative expenses in the three months ended July 2, 2000, were $18 million, or 5.0% of revenue, compared to $14 million, or 4.4% of revenue, in the three months ended June 27, 1999. The increase in general and administrative expenses reflected the inclusion of Server Appliances expenses and the expansion of ATL's infrastructure. Special Charge. During the fourth quarter of fiscal year 2000, DSSG recorded a special charge of $40.1 million. The charge was primarily focused on DSSG's DLTtape Division and reflected DSSG's strategy to align its DLTtape drive operations with market conditions. These conditions include slower growth in the mid-range server market and increasing centralization of server backup through automation solutions, both of which have resulted in relatively flat DLTtape drive shipments. The special charge included a reduction of overhead expenses throughout the DLTape Division and an acceleration of DSSG's low cost manufacturing strategy, which includes moving volume production of DLTtape drives from Colorado Springs, Colorado to Penang, Malaysia. The special charge consisted of $13.5 million in facility related costs, $13.9 million for the write-off of investments in optical technology, $7.6 million for severance and benefits for terminated employees, $3.2 million for fixed assets to be written-off, primarily related to the transfer of manufacturing to Penang, Malaysia and $1.9 million in other costs associated with the plan. DSSG is proceeding according to plan and expects to realize annual cost savings from the plan of approximately $40 million beginning upon full implementation of the plan at the end of fiscal year 2001. Approximately $30 million of the savings are expected in cost of revenue as a result of reduced manufacturing costs with the remaining amount in operating expenses, primarily research and development, as a result of ending research on certain optical-based storage solutions. As compared to fiscal year 2000, DSSG expects operating expenses to increase because of increased investments in storage systems products and marketing in fiscal year 2001 and as a result of including the Server Appliances' operations for a full year following the acquisition of Meridian in September 1999. These expectations are forward-looking statements and actual results may differ. Interest and Other Income/Expense. Net interest and other income for the three months ended July 2, 2000 was $1.8 million, compared to net interest and other income of $1.6 million for the three months ended June 27, 1999. Income Taxes. The effective tax rate for DSSG for the three months ended July 2, 2000 and June 27, 1999 was 36% and 40%, respectively. The decrease in the fiscal 2001 effective tax rate reflects an increased percentage of foreign earnings that are taxed at less than the U.S. rate. 30 Liquidity and Capital Resources DSSG cash, cash equivalents and marketable securities were $264 million at July 2, 2000 compared to $339 million at March 31, 2000. DSSG used cash during the quarter to purchase $111 million of treasury stock, as discussed below. Other uses of cash included approximately $12 million for investments in property and equipment. DSSG generated cash from operations of $50 million, primarily reflecting net income, increases in income taxes payable and accounts payable, partially offset by increases in other assets and accounts receivable. During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of Quantum's common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock, while $100 million was authorized for repurchase of HDDG common stock. During the first quarter of fiscal year 2001, Quantum repurchased 10.5 million shares of DSSG common stock and 3.2 million shares of HDDG common stock for a combined total of $146 million. As of July 2, 2000, Quantum had repurchased 3.9 million shares of Quantum common stock, 26.2 million shares of DSSG common stock and 6.7 million shares of HDDG common stock for a combined total of approximately $471 million. In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines will bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At July 2, 2000, there were no outstanding balances drawn on these lines. DSSG expects to spend approximately $60 million in fiscal year 2001 for capital equipment and leasehold improvements. These capital expenditures will support the introduction and manufacturing of Super DLTtape products; manufacturing DLTtape drives in its new location, Penang, Malaysia; and DSSG's general infrastructure. DSSG believes that its existing capital resources, including the credit facilities and any cash generated from operations, will be sufficient to meet all currently planned expenditures and sustain operations for the next 12 months. However, this belief assumes that operating results and cash flow from operations will meet DSSG's expectations. In the future, Quantum may seek to raise cash through the issuance of debt or equity securities. There can be no assurance that such financing would be available on terms favorable to Quantum, if at all. Trends and Uncertainties Relating to the DLT & Storage Systems Group Holders of DSSG stock remain stockholders of Quantum Corporation, which includes common stock of HDDG, and therefore, financial effects on HDDG could adversely affect DSSG Holders of DSSG stock and HDDG stock are stockholders of a single company. DSSG and HDDG are not separate legal entities. As a result, stockholders will continue to be subject to all of the risks of an investment in Quantum and all of its businesses, assets and liabilities. The issuance 31 of DSSG stock and HDDG stock and the allocation of assets and liabilities and stockholders' equity between DSSG and HDDG did not result in a distribution or spin-off to stockholders of any Quantum assets or liabilities and did not affect ownership of our assets or responsibility for our liabilities or those of our subsidiaries. The assets we attribute to one group could be subject to the liabilities of the other group, whether such liabilities arise from lawsuits, contracts or indebtedness that we attribute to the other group. If we are unable to satisfy one group's liabilities out of the assets we attribute to it, we may be required to satisfy those liabilities with assets we attribute to the other group. Financial effects from one group that affect our consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the tracking stock relating to the other group. In addition, net losses of either group and dividends and distributions on, or repurchases of, either class of tracking stock or repurchases of preferred stock at a price per share greater than par value will reduce the funds we can pay on each class of tracking stock under Delaware law. For these reasons, you should read our consolidated financial information with the financial information we provide for each group. Competition may increase in the tape drive market as a result of large competitors introducing tape drive products based on new technology standards DSSG competes with companies that develop, manufacture, market and sell tape drive products. DSSG's principal competitors include Exabyte Corporation, Hewlett-Packard, Seagate Technology, Inc., Sony Corporation and Storage Technology Corporation. These competitors are aggressively trying to develop new tape drive technologies that compete more successfully with DLTtape technology. Hewlett-Packard, IBM Corporation and Seagate have formed a consortium to develop new linear tape drive products. DSSG expects products based on this developing technology standard to target the high-capacity data back-up market and to compete with DSSG's products based on Super DLTtape technology. Such competition could have a material adverse impact on DSSG's operating results. DSSG's operating results depend on new product introductions, which may not be successful To compete effectively, DSSG must improve existing products and introduce new products, such as products based on Super DLTtape technology and network attached storage appliances. DSSG cannot assure you that: . it will introduce any of these new products in the time frame DSSG currently forecasts; . it will not experience technical or other difficulties that could prevent or delay the introduction of these new products; . its new products will achieve market acceptance; . its new products will be successfully or timely qualified with DSSG's customers by meeting customer performance and quality specifications. A successful and timely customer qualification must occur before customers will place large product orders; or . it will achieve high volume production of these new products in a timely manner, if at all. 32 These risks are magnified because DSSG expects that technological changes, changes in customer requirements and increasing competition could result in declining sales and gross margins on its existing products. Reliance on a limited number of third-party suppliers could result in significantly increased costs and delays in the event these suppliers experience shortages or quality problems DSSG depends on a limited number of suppliers for components and sub-assemblies, including recording heads, media cartridges and integrated circuits, all of which are essential to the manufacture of DLTtape drives and tape libraries. DSSG currently purchases the DLTtape media cartridges it sells primarily from Fuji Photo Film Co., Ltd. and Hitachi Maxell, Ltd. DSSG cannot assure you that Fuji or Maxell will continue to supply an adequate number of high quality media cartridges in the future. If component shortages occur, or if DSSG experiences quality problems with component suppliers, shipments of products could be significantly delayed and/or costs significantly increased. In addition, DSSG qualifies only a single source for many components and sub-assemblies, which magnifies the risk of future shortages. DSSG's main supplier of tape heads is located in China and political instability, trade restrictions or currency fluctuations in China could have an adverse impact on DSSG's operating results DSSG's main supplier of tape heads is located in China and political instability, trade restrictions, changes in tariff or freight rates or currency fluctuations in China could result in increased costs, delays in shipment and could have an adverse impact on DSSG's operating results. DSSG's quarterly operating results could fluctuate significantly and past quarterly operating results should not be used to predict future performance DSSG's quarterly operating results have fluctuated significantly in the past and could fluctuate significantly in the future. Quarterly operating results could be adversely affected by: . an inadequate supply of DLTtape media cartridges; . customers canceling, deferring or rescheduling significant orders as a result of excess inventory levels or other factors; . declines in network server demand; . failure to complete shipments in the last month of a quarter during which a substantial portion of DSSG's products are typically shipped; or . increased competition. 33 A majority of sales come from a few customers and these customers have no minimum or long-term purchase commitments DSSG's sales are concentrated with a few customers. Customers are not obligated to purchase any minimum product volume and DSSG's relationships with its customers are terminable at will. The loss of, or a significant change in demand from, one or more key customers could materially adversely impact DSSG's operating results. Unpredictable end-user demand may cause excess inventories which could result in inventory write-downs or losses or insufficient inventories, which could have an adverse impact on DSSG's customer relationships Unpredictable end-user demand, combined with the computer equipment manufacturer trend toward carrying minimal inventory levels, increases the risk that DSSG will manufacture and custom configure too much or too little inventory for particular customers. Significant excess inventory could result in inventory write-downs and losses, while inventory shortages could adversely impact DSSG's relationship with its customers, either of which could adversely impact DSSG's operating results. DSSG does not control licensee pricing or licensee sales of DLTtape media cartridges and as a result DSSG's royalty revenue may decline DSSG receives a royalty fee based on sales of DLTtape media cartridges by Fuji and Maxell. Under DSSG's license agreements with Fuji and Maxell, each of the licensees determines the pricing and number of units of DLTtape media cartridges sold by it. In addition, other companies may begin to sell DLTtape media cartridges under license agreements. As a result, DSSG's royalty revenue will vary depending upon the level of sales and prices set by Fuji, Maxell and potentially other licensees. In addition, lower licensee pricing could require DSSG to lower its prices on direct sales of DLTtape media cartridges, which would adversely impact DSSG's margins for this product. Third party infringement claims could result in substantial liability and significant costs From time to time, third parties allege DSSG's infringement of and need for a license under their patented or other proprietary technology. Adverse resolution of any third party infringement claim could subject DSSG to substantial liabilities and require it to refrain from manufacturing and selling certain products. In addition, the costs incurred in intellectual property litigation can be substantial, regardless of the outcome. 34 Item 3. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in Quantum's Annual Report on Form 10-K for the year ended March 31, 2000. 35 Item 1. Financial Statements QUANTUM CORPORATION HARD DISK DRIVE GROUP CONDENSED COMBINED STATEMENTS OF OPERATIONS (In thousands, except per share data) (unaudited)
Three Months Ended July 2, June 27, 2000 1999 ----------- ----------- Revenue $ 863,693 $ 752,491 Cost of revenue 743,053 724,222 ----------- ----------- Gross profit 120,640 28,269 Operating expenses: Research and development 58,250 62,708 Sales and marketing 27,716 27,831 General and administrative 16,276 14,745 ----------- ----------- 102,242 105,284 Income (loss) from operations 18,398 (77,015) Other income (expense): Interest income and other, net 8,053 5,964 Interest expense (2,230) (2,364) ----------- ----------- 5,823 3,600 Income (loss) before income taxes 24,221 (73,415) Income tax provision (benefit) 7,751 (30,231) ----------- ----------- Net income (loss) $ 16,470 $ (43,184) =========== =========== Net income (loss) per share (1): Basic $ 0.20 $ (0.52) Diluted $ 0.19 $ (0.52) Weighted-average common shares (1): Basic 81,444 83,330 Diluted 88,535 83,330
(1) Basic and diluted income (loss) per share and weighted average common shares for the period ended June 27, 1999 are pro forma and assume the recapitalization occurred at the beginning of fiscal year 2000. See accompanying notes to condensed combined financial statements. 36 QUANTUM CORPORATION HARD DISK DRIVE GROUP CONDENSED COMBINED BALANCE SHEETS (In thousands)
July 2, March 31, 2000 2000 ------------ ---------- (unaudited) Assets - ------ Current assets: Cash and cash equivalents $ 554,754 $ 581,542 Marketable securities 30,373 30,048 Accounts receivable, net of allowance for doubtful accounts of $19,876 and $19,618 388,047 395,118 Inventories 159,495 122,347 Due from the DLT & Storage Systems group - 30,100 Deferred taxes 78,584 78,713 Other current assets 52,512 58,356 ----------- ----------- Total current assets 1,263,765 1,296,224 Property and equipment, net of accumulated depreciation of $227,882 and $218,674 146,737 158,548 Intangible assets, net 1,094 1,915 Other assets 25,758 21,361 ----------- ----------- $1,437,354 $1,478,048 =========== =========== Liabilities and Group Equity - ---------------------------- Current liabilities: Accounts payable $ 370,025 $ 375,614 Accrued warranty 50,743 46,967 Accrued compensation 41,062 54,073 Income taxes payable 20,815 44,284 Accrued special charge 17,831 22,409 Current portion of long-term debt 376 344 Due to the DLT & Storage Systems group 13,989 - Other accrued liabilities 80,340 77,596 ----------- ----------- Total current liabilities 595,181 621,287 Deferred taxes 41,309 41,758 Long-term debt 12,520 12,613 Convertible subordinated debt 95,833 95,833 Group equity 692,511 706,557 ----------- ----------- $1,437,354 $1,478,048 =========== ===========
See accompanying notes to condensed combined financial statements. 37 QUANTUM CORPORATION HARD DISK DRIVE GROUP CONDENSED COMBINED STATEMENTS OF CASH FLOWS (In thousands) (unaudited)
Three Months Ended July 2, June 27, 2000 1999 ---------- ---------- Cash flows from operating activities: Net income (loss) $ 16,470 $ (43,184) Adjustments to reconcile net loss to net cash provided by (used in) operations: Depreciation 14,929 16,225 Amortization 977 978 Deferred income taxes (449) (594) Compensation related to stock plans 1,614 320 Changes in assets and liabilities: Accounts receivable 7,071 (1,462) Inventories (37,148) 23,687 Accounts payable (5,589) (82,136) Income taxes payable (23,469) (8,079) Accrued warranty 3,776 (2,517) Other assets and liabilities 37,723 2,748 ---------- ---------- Net cash provided by (used in) operating activities 15,905 (94,014) ---------- ---------- Cash flows from investing activities: Investment in equity securities (3,750) - Purchases of marketable securities - (23,641) Maturities of marketable securities - 14,641 Investment in property and equipment (9,618) (14,142) Proceeds from disposition of property and equipment 2,831 60 ---------- ---------- Net cash used in investing activities (10,537) (23,082) ---------- ---------- Cash flows from financing activities: Purchases of treasury stock (34,963) - Principal payments on long-term credit facilities (61) (2,249) Proceeds from issuance of common stock 2,868 2,015 ---------- ---------- Net cash used in financing activities (32,156) (234) ---------- ---------- Decrease in cash and cash equivalents (26,788) (117,330) Cash and cash equivalents at beginning of period 581,542 499,725 ---------- ---------- Cash and cash equivalents at end of period $ 554,754 $ 382,395 ========== ========== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 853 $ 404 Income taxes, net of (refunds) $ (3,690) $ 13,414
See accompanying notes to condensed combined financial statements. 38 QUANTUM CORPORATION HARD DISK DRIVE GROUP NOTES TO CONDENSED COMBINED FINANCIAL STATEMENTS (unaudited) 1. Basis of presentation The accompanying unaudited condensed combined financial statements of the Hard Disk Drive group ("HDDG"), together with the condensed combined financial statements of the DLT & Storage Systems group ("DSSG"), include all of the accounts in the condensed consolidated financial statements of Quantum. The separate group condensed combined financial statements give effect to the accounting policies applicable with the implementation of the tracking stock proposal. The separate HDDG and DSSG financial statements have been prepared on a basis that management believes to be reasonable and appropriate and include (i) the historical balance sheets, results of operations, and cash flows of businesses that comprise each of the groups, with all significant intragroup transactions and balances eliminated, (ii) in the case of HDDG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with HDDG, including allocated portions of Quantum's debt and selling, general and administrative costs, and (iii) in the case of DSSG's financial statements, corporate assets and liabilities of Quantum and related transactions identified with DSSG, including allocated portions of Quantum's debt and selling, general and administrative costs. Intergroup transactions and balances are not eliminated in the separate financial statements of HDDG or DSSG. The condensed combined financial statements of the Hard Disk Drive group provide HDDG stockholders with financial information about the Hard Disk Drive group operations. Holders of HDDG stock and DSSG stock are Quantum stockholders and are subject to all of the risks of an investment in Quantum and all of Quantum's businesses, assets and liabilities. Quantum retains ownership and control of all of the assets and operations of each group. Financial effects arising from one group that affect Quantum's consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the other group's stock. Any net losses of HDDG or DSSG, and dividends or distributions on, or repurchases of DSSG stock, or repurchases of preferred stock at a price per share greater than par value, will reduce the funds of Quantum legally available for payment of dividends on HDDG stock. As a result, HDDG's condensed combined financial statements should be read in conjunction with Quantum's condensed consolidated financial statements and DSSG's condensed combined financial statements. The condensed combined balance sheet as of March 31, 2000 has been derived from the audited financial statements of Quantum Corporation included in the Annual Report on Form 10-K filed with the Securities and Exchange Commission, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim financial statements reflect all adjustments, consisting only of normal recurring adjustments which, in the opinion of management, are necessary for a fair presentation of the results for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full fiscal year. Certain prior period amounts have been reclassified to conform to the current period's presentation. 39 2. Inventories Inventories consisted of the following: (In thousands)
July 2, March 31, 2000 2000 -------- -------- Materials and purchased parts $ 6,875 $ 7,387 Work in process 3,537 5,299 Finished goods 149,083 109,661 -------- -------- $159,495 $122,347 ======== ========
3. Net income per share As a result of the recapitalization, net income per share for HDDG has been calculated based on the group's net income subsequent to August 3, 1999. It was not calculated on a group basis for periods prior to the recapitalization because HDDG stock was not part of Quantum's capital structure at that time. The following table sets forth the computation of basic and diluted net income per share for HDDG after the recapitalization date: (In thousands, except per share data) Three Months Ended July 2, 2000 ------------ Numerator: Numerator for basic and diluted net income per share - income available to common stockholders $ 16,470 ========== Denominator: Denominator for basic net income per share - weighted average shares 81,444 Effect of dilutive securities: Outstanding options 7,091 ---------- Denominator for diluted net income per share - adjusted weighted average shares 88,535 ========== Basic net income per share $ 0.20 ========== Diluted net income per share $ 0.19 ========== The computation of diluted net income per share for HDDG for the three months ended July 2, 2000 excluded the effect of the 7% convertible subordinated notes issued in July 1997, which are convertible into 3,103,076 shares of HDDG common stock, or 10.793 shares per $1,000 note, because the effect would have been antidilutive. Options to purchase 0.9 million shares of common stock were outstanding for the three months ended July 2, 2000, but were not included in the computation of diluted net income per share 40 because the options' exercise price was greater than the average market price of the common stock and, therefore, the effect would have been antidilutive. 4. Common Stock Repurchase During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of its common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock, while $100 million was authorized for repurchase of HDDG common stock. During the first quarter of fiscal year 2001, Quantum repurchased 10.5 million shares of DSSG common stock and 3.2 million shares of HDDG common stock for a combined total of $146 million. As of July 2, 2000, Quantum had repurchased 3.9 million shares of Quantum common stock, 26.2 million shares of DSSG common stock and 6.7 million shares of HDDG common stock for a combined total of approximately $471 million. 5. Credit Line In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines will bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At July 2, 2000, there were no outstanding balances drawn on these lines. 6. Litigation On August 7, 1998, Quantum was named as one of several defendants in a patent infringement lawsuit filed in the U.S. District Court for the Northern District of Illinois, Eastern Division. The plaintiff, Papst Licensing GmbH, owns at least 24 U.S. patents which it asserts that Quantum has infringed. Quantum has studied these patents and believes that defenses of patent invalidity and non- infringement can be asserted. However, Quantum has not completed a full study of all the patents asserted by Papst and there can be no assurance that Quantum has not infringed these or other patents owned by Papst. Recently, on Papst's motion, the case was transferred to a federal district court in New Orleans, Louisiana, where it has been joined with suits brought against Papst by Hewlett- Packard, Maxtor Corporation and Minebea Company, Ltd. for the purposes of coordinated discovery under multi-district litigation rules. Hewlett-Packard recently settled its dispute with Papst and has been withdrawn from the litigation. To date, discovery has not begun to any significant extent. Quantum does not believe that the transfer will affect the final disposition of this matter in a significant way. The final results of this litigation, as with any litigation, are uncertain. In addition, the costs of engaging in litigation with Papst will be substantial. Quantum is also subject to other legal proceedings and claims that arise in the ordinary course of its business. For example, in fiscal year 2000, Discovision Associates brought patents they hold to Quantum's attention. While management currently believes the amount of ultimate liability, if any, with respect to these actions will not materially affect the financial position, results of operations, or liquidity of Quantum, the ultimate outcome of any litigation is uncertain. Were an unfavorable outcome to occur, the impact could be material to Quantum. 41 7. Special Charge During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with the streamlining of HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in the customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to the streamlining of the global logistics model and change in customer service strategy, $7.8 million in severance and benefits for terminated employees, and approximately $12 million in other costs associated with the plan. The facilities costs noted above include lease payments on facilities to be vacated in and around Milpitas, California and Singapore, the write-off of related leasehold improvements, and other maintenance expenses associated with the vacated facilities. HDDG expects that the affected facilities will be vacated by the end of the second quarter of fiscal year 2001. In connection with the charge, HDDG currently expects a workforce reduction of approximately 600 employees. In addition, approximately 100 open job requisitions and budgeted positions have been eliminated. The reduction in force primarily affects employees at HDDG's drive configuration centers and warehouses in Milpitas, California and Dundalk, Ireland and employees within the desktop drive business. As of July 2, 2000, 499 of the 600 employees had been terminated. HDDG anticipates that the remaining employees will be terminated by the end of the second quarter of fiscal year 2001. Subsequent to the end of the second quarter fiscal year 2000, HDDG revised its estimate of costs required to implement the restructuring plan. HDDG currently estimates that severance and benefits, inventory and other costs, which include the disposition of additional capital assets, will be more than previously estimated as a result of the planned changes in the customer service strategy. HDDG also estimates that costs associated with vacating leased facilities will be less than previously estimated as a result of vacating a major facility earlier than previously expected. Accordingly, HDDG has reallocated amounts between these categories. As of July 2, 2000, HDDG had incurred $9 million in cash expenditures associated with employee severance and benefits, facilities and other costs. HDDG expects to incur additional cash expenditures associated with the plan of approximately $15 million. 42 The following table summarizes activity related to the special charge at July 2, 2000.
(In thousands) Severance And Facilities Other Benefits Costs Inventory Costs Total -------- ----- --------- ----- ----- Special charge provision $ 7,833 $ 26,359 $ 13,214 $ 12,000 $ 59,406 Cash Payments (5,584) (1,519) - (1,810) (8,913) Non-cash charges - (8,274) (15,588) (8,800) (32,662) Adjustments 1,166 (7,852) 2,374 4,312 - -------- -------- -------- -------- -------- Balance at July 2, 2000 $ 3,415 $ 8,714 $ - $ 5,702 $ 17,831 ======== ======== ======== ======== ========
8. Comprehensive Income (Loss) Accumulated other comprehensive income included in group equity on the condensed combined balance sheets of the Hard Disk Drive group consists of unrealized gains on available for sale investments and foreign currency translation adjustments. Total comprehensive income (loss) for the three months ended July 2, 2000 and June 27, 1999 is presented in the following table:
(In thousands) Three Months Ended July 2, June 27, 2000 1999 -------- --------- Net income (loss) $ 16,470 $(43,184) Other comprehensive income (loss)- Change in unrealized gain on investments, net 195 - Foreign currency translation adjustments (230) (920) -------- -------- Comprehensive income (loss) $ 16,435 $(44,104) ======== ========
9. Business Units The Hard Disk Drive group currently has two primary product lines, desktop hard disk drives and high-end hard disk drives. HDDG has two separate business units that support these two product lines. The desktop business unit designs, develops and markets desktop hard disk drives designed to meet the storage requirements of entry-level to high-end desktop personal computers in home and business environments. The high-end business unit designs, develops and markets high-end hard disk drives designed to meet the storage requirements of network servers, workstations and storage subsystems. In the future, the two HDDG business units may become a single business unit as their markets begin to converge and be reported on a combined basis. 43 Results for HDDG's business units for the three ended July 2, 2000 and June 27, 1999 are presented in the following table: (In millions) Three Months Ended July 2, June 27, 2000 1999 ---- ---- Business unit: Desktop Revenue $675 $637 Unit operating income (loss) 10 (62) High-end Revenue 189 115 Unit operating income (loss) 9 (15) (In millions) Three Months Ended July 2, June 27, 2000 1999 ---- ---- Income/Loss reconciliation: Total unit operating income (loss) $ 19 $ (77) Unallocated amounts: Interest and other income/(expense) 5 4 ---- ----- Income (loss) before income taxes $ 24 $ (73) ==== ===== 44 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Hard Disk Drive Group This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements usually are phrased in the future tense or contain the words "estimate," "anticipate," "expect," or similar expressions. All forward-looking statements are inherently uncertain as they are based on various expectations and assumptions concerning future events and they are subject to numerous known and unknown risks and uncertainties. These uncertainties could cause actual results to differ materially from those expected for the reasons set forth under Trends and Uncertainties relating to the Hard Disk Drive group. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Business Overview The Hard Disk Drive group designs, develops and markets a diversified product portfolio of hard disk drives featuring leading-edge technology. HDDG's hard disk drives are designed for the desktop market, which requires economy and reliability, and the high-end market, which requires faster and higher capacity disk drives--as well as the emerging market for hard disk drives specially designed for consumer electronics devices such as personal video recorders, personal audio recorders, cable and set-top boxes, Internet appliances and digital video editing. HDDG has been the leading volume supplier of hard disk drives for the desktop market for each of the past seven years. According to Dataquest, HDDG's market share in the desktop market has grown from 3% in calendar year 1990 to an industry leading 22% in calendar year 1999. HDDG designs desktop hard disk drives to meet the storage requirements of entry- level to high-performance desktop PCs in home and business environments. HDDG also designs high-end hard disk drives to store data on large computing systems such as network servers. These high-end hard disk drives are generally used for: . dedicated sites that store large volumes of data; . network servers such as those used for Internet and intranet services, online transaction processing and enterprise wide applications; . high-speed computers used for specialized engineering design software; and . computer systems incorporating a large number of shared hard disk drives. HDDG also pioneered hard disk drive applications for the developing consumer electronics market. These hard disk drive applications utilize Quantum QuickView(TM)--HDDG's hard disk drive technology designed especially for consumer electronics. Quantum QuickView technology makes it possible to simultaneously record and play back audio and video content and to instantly and inexpensively access large amounts of audio and video content--capabilities that are not as well suited to competing technologies such as video tape and optical media. 45 Products Desktop products. HDDG offers two families of desktop hard disk drives--the Quantum Fireball(TM) and Quantum Fireball Plus. The Quantum Fireball family offers 3.5-inch hard disk drives for consumer and commercial PCs, as well as entry-level workstations and network servers. Fireball Plus offers superior performance for power users. HDDG offers the Shock Protection System(TM), Shock Protection System II and Data Protection System(TM) with its desktop products. These features substantially reduce failure rates and provide increased reliability and performance. Shock Protection System II provides enhanced protection against both operating and non-operating shock. Along with providing enhanced protection against shock during handling and integration, Shock Protection System II guards against kicks and jolts while the PC is running to reduce field failures. HDDG has also incorporated feature enhancements of the Quiet Drive Technology into recently introduced Quantum desktop drives. This technology has been pioneered through a combination of proprietary design innovations and unique drive features that enable Quantum to develop drives that emit dramatically reduced levels of noise. It was first introduced over a year ago in Quantum QuickView drives targeted for the noise-sensitive consumer electronics market and has continued to be refined with technology and feature enhancements. High-end products. HDDG also offers a broad line of high-end 3.5-inch hard disk drives--the Quantum Atlas(TM) and Quantum Atlas 10K families. The Quantum Atlas families offer high-capacity hard disk drives for high performance storage- intensive applications such as enterprise servers and storage subsystems. HDDG also offers the Shock Protection System, Shock Protection System II and Data Protection System with its high-end products, and has incorporated the Quiet Drive Technology into its recently introduced Atlas 10K II. 46 The table below sets forth key performance characteristics for HDDG's current products:
Capacity Product Rotational per Disk Capacity Speed Products (GB) (GB) (RPM) Platform - -------- ---- ---- ----- -------- Fireball lct 10 10.3 5.1 to 30.0 5,400 Desktop PCs--Value, with Ultra ATA/66 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Fireball lct 15 15.0 7.5 to 30.0 4,400 Desktop PCs--Value, with Ultra ATA/66 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Fireball lct 20 20.4 10.0 to 40.0 4,500 Desktop PCs--Value, with Ultra ATA/100 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Fireball Plus LM 10.3 10.2 to 30.0 7,200 Desktop PCs--Performance, with Ultra ATA/66 interface, Shock Protection System and Data Protection System Fireball Plus AS 20.0 10.2 to 60.0 7,200 Desktop PCs--Performance, with Ultra ATA/100 interface, Shock Protection System II, Data Protection System and Quiet Drive Technology Atlas IV 4.5 9.1 to 36.4 7,200 Servers, Workstations and Storage Subsystems, with Ultra 160 SCSI interface, Shock Protection System Atlas V 9.1 9.1 to 36.7 7,200 Servers, Workstations and Storage Subsystems, with Ultra 160 SCSI interface, Shock Protection System II and Data Protection System Atlas 10K 3.0 9.1 to 36.4 10,000 Enterprise Servers, Workstations and Storage Subsystems, with Ultra 160 SCSI interface, Shock Protection System II and Data Protection System Atlas 10K II 7.3 9.2 to 73.4 10,000 Enterprise Servers, Workstations and Storage Subsystems, with Ultra 160 SCSI interface, Shock Protection System II, Data Protection System and Quiet Drive Technology
Results of Operations Revenue. Revenue in the three months ended July 2, 2000 was $864 million, compared to $752 million in the three months ended June 27, 1999, an increase of 15%. The increase in revenue reflected increased revenue from sales of both desktop and high-end hard disk drives. Desktop hard disk drive revenue in the three months ended July 2, 2000 was $675 million, compared to $637 million in the three months ended June 27, 1999, an increase of 6%. The increase reflected a 20% increase in shipments, partially offset by lower average unit prices due to competitive pricing pressure. 47 High-end hard disk drive revenue in the three months ended July 2, 2000 was $189 million, compared to $115 million in the three months ended June 27, 1999, an increase of 64%. High-end hard disk drive shipments reached a record high, refecting strong demand from computer equipment manufacturers and distribution channel customers. Sales to the top five customers in the three months ended July 2, 2000 represented 48% of revenue, compared to 49% of revenue in the three months ended June 27, 1999. These amounts reflected a retroactive combination of the sales to Ingram Micro and Electronic Resources as a result of their merger in July 1999. Sales to Dell Computer were 13% of revenue in the three months ended July 2, 2000, compared to less than 10% of revenue in the three months ended June 27,1999. Sales to Ingram Micro were 11% of revenue in the three months ended July 2, 2000, compared to 14% of revenue in the three months ended June 27, 1999, including sales to Electronic Resources. Sales to Hewlett-Packard were less than 10% of revenue in the three months ended July 2, 2000 compared to 15% of revenue in the three months ended June 27, 1999. Sales to computer equipment manufacturers and distribution channel customers were 63% and 37% of revenue, respectively, in the three months ended July 2, 2000, compared to 55% and 45% of revenue, respectively, in the three months ended June 27, 1999. Gross Margin Rate. The gross margin rate increased to 14.0% in the three months ended July 2, 2000 from 3.8% in the three months ended June 27, 1999. The desktop gross margin rate was 11.3% in the three months ended July 2, 2000, compared to 1.4% in the three months ended June 27, 1999. The increase reflected the transition to new lower cost, higher margin products, partially offset by a decrease in average unit prices due to competitive pricing pressures. The high-end gross margin rate was 23.6% in the three months ended July 2, 2000, compared to 16.6% in the three months ended June 27, 1999. The 7% increase reflected higher sales volumes and the transition to new, higher margin products. The gross margin rate for desktop products is expected to decline substantially in the second quarter of fiscal year 2001 because of accelerated average unit price declines and slower declines in component costs. Research and Development Expenses. Research and development expenses in the three months ended July 2, 2000, were $58 million, or 6.7% of revenue, compared to $63 million, or 8.3% of revenue, in the three months ended June 27, 1999. The decrease in research and development expenses reflected expense reductions resulting from modifications to the hard disk drive business associated with the special charge recorded in the second quarter of fiscal year 2000. Sales and Marketing Expenses. Sales and marketing expenses in the three months ended July 2, 2000, were $28 million, or 3.2% of revenue, compared to $28 million, or 3.7% of revenue in the three months ended June 27, 1999. 48 General and Administrative Expenses. General and administrative expenses in the three months ended July 2, 2000, were $16 million, or 1.9% of revenue, compared to $15 million, or 2.0% of revenue, in the three months ended June 27, 1999. The increase in general and administrative expenses reflected an increase in human resource spending in support of change management, process reengineering and retention. Special Charge. During the second quarter of fiscal year 2000, HDDG recorded a special charge of $59.4 million. The charge reflected HDDG's strategy to modify the hard disk drive business to more closely align product development and the business' operating model with the requirements of the rapidly growing low-cost PC market. The special charge was associated primarily with the streamlining of HDDG's logistics model in order to create a faster and more flexible fulfillment system, changes in the customer service strategy and consolidation of certain product development programs. The special charge consisted of $26.4 million related to facilities costs, $13.2 million in asset write-offs related to the streamlining of the global logistics model and change in customer service strategy, $7.8 million in severance and benefits for terminated employees, and approximately $12 million in other costs associated with the plan. HDDG is proceeding according to plan and expects to realize more than $100 million in cost savings per year, beginning in fiscal year 2001. The majority of the savings are expected in cost of revenue as a result of a more efficient distribution system and reduced customer service costs, with the remaining savings in research and development, as a result of the consolidation of product development programs. As compared to fiscal year 2000, HDDG expects operating expenses to be relatively flat in fiscal year 2001, with increased investments in disk drive and other storage products, primarily reflected in research and development, offsetting the cost savings resulting from the special charge. These expectations are forward-looking statements and actual results may differ. Interest and Other Income/Expense. Net interest and other income for the three months ended July 2, 2000 was $5.8 million, compared to net interest and other income of $3.6 million for the three months ended June 27, 1999. The increase reflected increased interest income as a result of a higher average cash balance. Income Taxes. HDDG recorded a tax provision of $8 million and a tax benefit of $30 million for effective tax and benefit rates of 32% and 41%, respectively, for the three months ended July 2, 2000 and June 27, 1999, respectively. The fiscal 2001 rate reflects increased research and development credits and lower state taxes. Liquidity and Capital Resources Cash, cash equivalents and marketable securities were $585 million at July 2, 2000 compared to $612 million at March 31, 2000. HDDG used cash during the quarter to purchase $35 million of treasury stock, as discussed below. Other uses of cash included approximately $9 million for investments in property and equipment. HDDG generated cash from operations of $16 million, primarily reflecting net income and an increase in other liabilities, partially offset by an increase in inventories and a decrease in income taxes payable. 49 During fiscal year 2000, the Board of Directors authorized Quantum to repurchase up to $700 million of its common stocks in open market or private transactions. Of the total repurchase authorization, $600 million was authorized for repurchase of either Quantum, DSSG or HDDG common stock, while $100 million was authorized for repurchase of HDDG common stock. During the first quarter of fiscal year 2001, Quantum repurchased 10.5 million shares of DSSG common stock and 3.2 million shares of HDDG common stock for a combined total of $146 million. As of July 2, 2000, Quantum had repurchased 3.9 million shares of Quantum common stock, 26.2 million shares of DSSG common stock and 6.7 million shares of HDDG common stock for a combined total of approximately $471 million. In April 2000, Quantum entered into two new unsecured senior credit facilities, each providing a $187.5 million revolving credit line and expiring in April 2001 and April 2003, respectively. At Quantum's option, borrowings under the revolving credit lines will bear interest at either the London interbank offered rate or a base rate, plus a margin determined by a leverage ratio with option periods of one to six months. At July 2, 2000, there were no outstanding balances drawn on these lines. HDDG expects to spend approximately $55 million in fiscal year 2001 for capital equipment and leasehold improvements. These capital expenditures will support the development and introduction of new disk drive products. HDDG believes that its existing capital resources, including the credit facilities and any cash generated from operations, will be sufficient to meet all currently planned expenditures and sustain operations for the next 12 months. However, this belief assumes that operating results and cash flow from operations will meet HDDG's expectations. In the future, Quantum may seek to raise cash through the issuance of debt or equity securities. There can be no assurance that such financing would be available on terms favorable to Quantum, if at all. Trends and Uncertainties Relating to the Hard Disk Drive Group Holders of HDDG stock remain stockholders of Quantum Corporation, which includes common stock of DSSG, and, therefore, financial effects on DSSG could adversely affect HDDG Holders of HDDG stock and DSSG stock are stockholders of a single company. HDDG and DSSG are not separate legal entities. As a result, stockholders will continue to be subject to all of the risks of an investment in Quantum and all of its businesses, assets and liabilities. The issuance of the HDDG stock and the DSSG stock and the allocation of assets and liabilities and stockholders' equity between HDDG and DSSG did not result in a distribution or spin-off to stockholders of any Quantum assets or liabilities and did not affect ownership of our assets or responsibility for our liabilities or those of our subsidiaries. The assets we attribute to one group could be subject to the liabilities of the other group, whether such liabilities arise from lawsuits, contracts or indebtedness that we attribute to the other group. If we are unable to satisfy one group's liabilities out of the assets we attribute to it, we may be required to satisfy those liabilities with assets we attribute to the other group. 50 Financial effects from one group that affect our consolidated results of operations or financial condition could, if significant, affect the results of operations or financial condition of the other group and the market price of the tracking stock relating to the other group. In addition, net losses of either group and dividends and distributions on, or repurchases of, either class of tracking stock or repurchases of preferred stock at a price per share greater than par value will reduce the funds we can pay on each class of tracking stock under Delaware law. For these reasons, you should read our consolidated financial information with the financial information we provide for each group. HDDG's operating results depend on new product introductions, which may not be successful To compete effectively, HDDG must frequently introduce new hard disk drives. HDDG cannot assure you that: . it will successfully or timely develop or market any new hard disk drives in response to technological changes or evolving industry standards; . it will not experience technical or other difficulties that could delay or prevent the successful development, introduction or marketing of new hard disk drives; . it will successfully qualify new hard disk drives, particularly high-end disk drives, with HDDG's customers by meeting customer performance and quality specifications. A successful and timely customer qualification must occur before customers will place large product orders; . it will quickly achieve high volume production of new hard disk drives; or . its new products will achieve market acceptance. These risks are magnified because HDDG expects technological changes, short product life cycles and intense competitive pressures to result in declining sales and gross margins on its current generation products. HDDG's quarterly operating results could fluctuate significantly and past quarterly operating results should not be used to predict future performance HDDG's quarterly operating results have fluctuated significantly in the past and may fluctuate significantly in the future. As a result, you should not use HDDG's past quarterly operating results to predict future performance. Quarterly operating results could be adversely affected by: . the ability of MKE, HDDG's exclusive manufacturer, to quickly achieve high volume production of HDDG's hard disk drives; . customers canceling, deferring or rescheduling significant orders; . returns by customers of unsold hard disk drives for credit; . decline in PC demand; or 51 . failure to complete shipments in the last month of a quarter during which a substantial portion of HDDG's products are typically shipped. HDDG's prices and margins are subject to declines due to unpredictable end-user demand and oversupply of hard disk drives End-user demand for the computer systems that contain HDDG's hard disk drives has historically been subject to rapid and unpredictable fluctuations. As a result, the hard disk drive market tends to experience periods of excess capacity, which typically lead to intense price competition. If intense price competition occurs, HDDG may be forced to lower prices sooner and more than expected and transition to new products sooner than expected. For example, in fiscal year 1999 and the second half of fiscal year 1998, as a result of excess inventory in the desktop hard disk drive market, aggressive pricing and corresponding margin reductions materially adversely impacted HDDG's operating results. HDDG experienced similar conditions in the high-end hard disk drive market during most of fiscal years 1998 and 1999. Growth of the lower priced PC markets is putting downward pressure on HDDG's desktop hard disk drive prices The growth of the lower priced PC market has led to a shift toward lower priced desktop hard disk drives. HDDG expects the trend toward lower prices on hard disk drives to continue. If HDDG is unable to lower the cost of its desktop hard disk drives accordingly, operating results could be materially adversely affected. Intense competition in the desktop and high-end hard disk drive market could adversely impact HDDG's operating results In the desktop hard disk drive market, HDDG's primary competitors are Fujitsu Limited, IBM, Maxtor Corporation, Samsung Electronics Co., Ltd., Seagate and Western Digital Corporation. The desktop hard disk drive market is characterized by more competitiveness than that seen in the computer industry in general. HDDG's operating results and competitive position could be negatively impacted by the introduction of competitive products with higher performance, higher reliability and/or lower cost than HDDG's products. For example, in the first half of fiscal year 2000, certain competitors reduced prices for their products significantly. As a result, HDDG's operating results were materially adversely affected. In the high-end hard disk drive market, HDDG's primary competitors are Fujitsu, Hitachi, IBM and Seagate. Currently, Seagate and IBM have the largest market share for high-end hard disk drives. A majority of sales come from a few customers that have no minimum or long-term purchase commitments HDDG's sales are concentrated with a few customers. Customers are not obligated to purchase any minimum product volume and HDDG's customer relationships are terminable at will. The loss of, or a significant change in demand from, one or more key HDDG customers could have a material adverse impact on HDDG's operating results. 52 Because HDDG depends on MKE for the manufacture of all hard disk drives, adverse material developments in this critical manufacturing relationship would adversely affect HDDG's operating results HDDG's relationship with MKE is critical to the Hard Disk Drive group's operating results and overall business performance. HDDG's dependence on MKE includes the following principal risks: . Quality and Delivery. HDDG relies on MKE to quickly achieve volume production of new hard disk drives at a competitive cost, to meet HDDG's stringent quality requirements and to respond quickly to changing product delivery schedules. Failure of MKE to satisfy these requirements could have a material adverse impact on HDDG's operating results. . Purchase Forecasts. MKE's production schedule is based on HDDG's forecasts of its purchase requirements, and HDDG has limited rights to modify short-term purchase orders. The failure of HDDG to accurately forecast its requirements or successfully adjust MKE's production schedule could lead to inventory shortages or surpluses. . Pricing. HDDG negotiates pricing arrangements with MKE on a quarterly basis. Any failure to reach competitive pricing arrangements would have a material adverse impact on HDDG's operating results. . Capital Commitment. HDDG's future growth will require that MKE continue to devote substantial financial resources to property, plant and equipment to support the manufacture of HDDG's products. . Manufacturing Capacity. If MKE is unable or unwilling to meet HDDG's manufacturing requirements, an alternative manufacturing source may not be available in the near term. MKE depends on a limited number of component and sub-assembly suppliers and component shortages and quality problems or delays from these suppliers could result in increased costs and reduced sales MKE depends on a limited number of qualified suppliers for components and sub-assemblies, including recording heads, media and integrated circuits, all of which are essential to the manufacture of HDDG's hard disk drives. MKE may qualify only a single source for certain components and sub-assemblies, which can magnify the risk of component shortages. Component shortages have constrained HDDG's sales growth in the past, and HDDG believes that it will periodically experience component shortages. If MKE experiences quality problems with its component suppliers, HDDG's hard disk drive shipments could be significantly delayed or costs could be significantly increased. Unexpected warranty costs could have a material adverse impact on operating results HDDG warrants its products against defects for a period of one to five years. Actual warranty costs could have a material adverse impact on HDDG's operating results if the actual unit failure rate or unit repair costs are greater than those for which HDDG established a warranty accrual. 53 Third party infringement claims could result in substantial liability and significant costs From time to time, third parties allege HDDG's infringement of and need for a license under their patented or other proprietary technology. For example, in August 1998, Quantum was named as one of several defendants in a patent infringement lawsuit. The plaintiff, Papst Licensing GmbH, owns at least 24 U.S. patents, which it asserts that HDDG has infringed. In fiscal year 2000, Discovision Associates brought patents to HDDG's attention. Adverse resolution of the Papst or any other third party infringement claim could subject HDDG to substantial liabilities and require it to refrain from manufacturing and selling certain products. HDDG cannot assure you that licenses to any technology owned by Papst or any other third party alleging infringement could be obtained on commercially reasonable terms, or at all. In addition, the costs of litigation could be substantial, regardless of the outcome. HDDG's foreign manufacturing costs could be adversely impacted by fluctuations in currency exchange rates MKE generally purchases manufacturing components at prices denominated in U.S. dollars. However, significant increases in currency exchange rates against the U.S. dollar could increase MKE's manufacturing costs and could result in higher product prices and/or declining margins for HDDG's products. 54 Item 3. Quantitative and Qualitative Disclosures About Market Risk Market Risk Disclosures For financial market risks related to changes in interest rates and foreign currency exchange rates, reference is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk, in the Quantum's Annual Report on Form 10-K for the year ended March 31, 2000. HDDG is exposed to equity price risk on its investment in TiVo, Inc. common stock. HDDG does not attempt to reduce or eliminate its market exposure on this security. HDDG entered into a strategic alliance with TiVo in fiscal year 1999 to supply hard disk drives utilizing Quantum's QuickView technology for integration into TiVo's Personal Video Recorder. At July 2, 2000, the fair market value of HDDG's investment was approximately $30 million. As TiVo is a relatively new company and has recently introduced a new product in the consumer electronics market, HDDG does not believe it is possible to reasonably estimate any future price movement of TiVo common stock. 55 QUANTUM CORPORATION PART II - OTHER INFORMATION Item 1. Legal proceedings The information contained in Note 7 of the Notes to Condensed Consolidated Financial Statements and Note 6 of the Notes to Condensed Combined Financial Statements of the Hard Disk Drive group is incorporated into this Part II, Item 1 by reference. Item 2. Changes in securities - Not Applicable Item 3. Defaults upon senior securities - Not Applicable Item 4. Submission of matters to a vote of security holders - 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 56 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: August 8, 2000 By: /s/ Richard L. Clemmer --------------------------------- Richard L. Clemmer Executive Vice President, Finance and Chief Financial Officer 57 QUANTUM CORPORATION INDEX TO EXHIBITS Exhibit Number Exhibit 10.1 CREDIT AGREEMENT, dated April 19, 2000, among Registrant, certain financial institutions (collectively, the "Banks"), Banc of America Securities LLC as Sole Arranger and Sole Book Manager for the Banks, Bank of America, N.A., as Administrative Agent for the Banks, Fleet National Bank as Syndication Agent for the Banks and The Bank of Nova Scotia as Documentation Agent for the Banks 10.2 CREDIT AGREEMENT, dated April 19, 2000, among Registrant, certain financial institutions (collectively, the "Banks"), Banc of America Securities LLC as Sole Arranger and Sole Book Manager for the Banks, Bank of America, N.A., as Administrative Agent for the Banks, Fleet National Bank as Syndication Agent for the Banks and The Bank of Nova Scotia as Documentation Agent for the Banks 27.1 Financial Data Schedule