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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2007

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 1-13449

 


QUANTUM CORPORATION

(Exact name of Registrant as specified in its charter)

 


 

Delaware   94-2665054

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

1650 Technology Drive Suite 700, San Jose, California   95110
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (408) 944-4000

 


Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

  

Name of each exchange on which registered

QUANTUM CORPORATION-DLT & STORAGE SYSTEMS GROUP COMMON STOCK    NEW YORK STOCK EXCHANGE
RIGHTS TO PURCHASE SERIES B JUNIOR PARTICIPATING PREFERRED STOCK    NEW YORK STOCK EXCHANGE

Securities registered pursuant to Section 12(g) of the Act:

4.375% CONVERTIBLE SUBORDINATED NOTES DUE 2010

 


Indicate by check mark whether the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    YES  ¨    NO  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of Quantum Corporation’s common stock, $0.01 par value per share, held by nonaffiliates of the Registrant was approximately $218.0 million on September 30, 2006, the last day of the Registrant’s most recently completed second fiscal quarter, based on the closing sales price of the Registrant’s common stock on that date on the New York Stock Exchange. For purposes of this disclosure, shares of common stock held by persons who hold more than 5% of the outstanding shares of common stock and shares held by officers and directors of the Registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive.

As of the close of business on May 31, 2007, there were approximately 199.2 million shares of Quantum Corporation’s common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on August 17, 2007, which the Registrant will file with the Securities and Exchange Commission within 120 days after the end of the fiscal year covered by this report, is incorporated by reference in Part III of this Form 10-K to the extent stated herein.

 



Table of Contents

INDEX

 

          Page
Number

PART I

     

Item 1

   Business    1

Item 1A

   Risk Factors    12

Item 1B

   Unresolved Staff Comments    22

Item 2

   Properties    22

Item 3

   Legal Proceedings    22

Item 4

   Submission of Matters to a Vote of Security Holders    22

PART II

     

Item 5

   Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    23

Item 6

   Selected Financial Data    23

Item 7

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    25

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk    45

Item 8

   Financial Statements and Supplementary Data    46

Item 9

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    83

Item 9A

   Controls and Procedures    83

Item 9B

   Other information    84

PART III

     

Item 10

   Directors and Executive Officers of the Registrant    84

Item 11

   Executive Compensation    85

Item 12

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    85

Item 13

   Certain Relationships and Related Transactions    85

Item 14

   Principal Accountant Fees and Services    85

PART IV

     

Item 15

   Exhibits and Financial Statement Schedules    85

SIGNATURE

   90

POWER OF ATTORNEY

   91

 

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PART I

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 in this report usually contain the words “will,” “estimate,” “anticipate,” “expect”, “believe” or similar expressions and variations or negatives of these words. All such forward-looking statements including, but not limited to, (1) our expectation that we will continue to derive a substantial majority of our revenue from products based on our tape technology; (2) our expectations regarding the amounts and timing of any future restructuring charges, including cost savings resulting therefrom; (3) our belief that strong competition in the tape drive, tape media and tape automation systems markets will result in further price erosion; (4) our belief that we have sufficient resources to cover the remaining tax liability under the Tax Sharing and Indemnity Agreement with Maxtor; (5) our belief that our existing cash and capital resources will be sufficient to meet all currently planned expenditures and sustain our operations for the next 12 months; (6) our expectation that we will return to profitability; (7) our goals for our future operating performance, including our revenue growth, amount and mix, our expectations regarding revenue, gross margin and operating expenses for fiscal 2008 and our cash flows; (8) our belief that our ultimate liability in any infringement claims made by any third parties against us will not be material to us; (9) our belief that we may make additional acquisitions in the future; (10) our expectations about the timing and maximum amounts of our future contractual payment obligations; (11) our belief that our total foreign exchange rate exposure is not significant; (12) our expectations regarding the benefits of our acquisition of ADIC, including that the combined company will allow us to grow our business and improve our results of operations; (13) our expectations regarding the timing of recognized compensation costs related to our equity awards; (14) our expectations relating to our growth into disk, software and services markets , (15) our expectations regarding our ongoing efforts to reduce our cost structure, including facilities and workforce reductions, (16) our expectations relating to the Quantum Alliance Reseller Program, (17) our assessment of the debt market and our opportunity to refinance our debt at better terms and improved covenants; and (18) our business objectives, key focuses, opportunities and prospects are inherently uncertain as they are based on management’s expectations and assumptions concerning future events, and they are subject to numerous known and unknown risks and uncertainties. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. As a result, our actual results may differ materially from the forward-looking statements contained herein. Factors that could cause actual results to differ materially from those described herein include, but are not limited to, (1) the amount of orders received in future periods; (2) our ability to timely ship our products; (3) uncertainty regarding IT spending and the corresponding uncertainty in the demand for tape drives and tape automation products; (4) our ability to realize anticipated benefits from the ADIC acquisition; (5) our ability to achieve anticipated pricing, cost and gross margin levels, particularly on tape drives, given lower volumes and continuing price and cost pressures; (6) the successful execution of our strategy to expand our businesses into new directions; (7) our ability to successfully introduce new products; (8) our ability to achieve and capitalize on changes in market demand; (9) our ability to pay down the principal and interest on our indebtedness; (10) our ability to maintain supplier relationships; and (11) those factors discussed under “Risk Factors” in Item 1A. in this Annual Report on Form 10-K. Our forward-looking statements are not guarantees of future performance. We disclaim any obligation to update information in any forward-looking statement.

 

ITEM 1. Business

Business Description

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”) (NYSE:QTM) founded in 1980, is a leading global storage company specializing in backup, recovery and archive. Combining focused expertise, customer-driven innovation, and platform independence, we provide a comprehensive, integrated range of disk, tape and software solutions supported by our sales and service organization. We work closely with a broad network of value-added resellers (“VARs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection needs. Our stock is traded on the New York Stock Exchange.

In August 2006, we acquired Advanced Digital Information Corporation (“ADIC”). The combined company offers a broad range of solutions in the data storage market, providing performance and value to organizations of all sizes, from Global 2000 enterprises to small businesses and satellite offices. We have a broad portfolio of disk-based backup solutions and are a leading provider of tape libraries and autoloaders, as well as a top supplier of tape drives and media. Our data management software provides technology for shared workflow applications and multi-tiered archiving in high-performance, large-scale storage environments. In addition, our service plan includes a broad range of coverage options to provide the level of support for the widest possible range of IT environments, with service available in 180 countries.

In previous years, we reported two data storage business segments: Tape Drive and Storage Systems. Beginning with the first quarter of fiscal 2007, we began reporting one business segment as a result of organizational changes. These changes include the integration of marketing, sales and research and development functions to enhance product positioning and to lower the cost platforms within our business. As a result of these integration efforts, discrete financial information for these former segments is no longer tracked below the gross margin level, and management no longer measures operating performance nor makes resource allocation decisions on a segmented basis.

 

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While continuing to develop and introduce new products in the storage market, we have also continued to take steps to reduce costs in order to return to profitability and rationalize our operations following various acquisitions. Since 2001, our business has experienced increased competition from other data storage and computer equipment manufacturers and a continuously challenging operating environment as evidenced by both operating and net losses. In recent years, the difficult market conditions often created pressures that resulted in generally lower unit prices, lower unit sales, or both. We have taken numerous cost reduction actions and have acquired companies with complementary technologies to increase our market share, improve our competitive position and offset the impact of recent financial trends. These steps are aimed at returning us to profitability.

Strategy Update

In fiscal 2006, we implemented a number of actions to improve our future performance and establish a strong foundation for us to compete in the storage solutions market with a focus on backup, recovery and archive. In fiscal 2007, we continued to implement actions to improve our future performance and competitive position in the market. One of our more notable actions was our acquisition of ADIC. In acquiring ADIC, we defined three primary objectives: (1) to expand market access, mainly by building a stronger branded business; (2) to create a stronger growth platform, particularly by expanding our disk-based backup systems and software businesses; and (3) to improve our financial position, taking advantage of cost reduction actions and enhanced revenue and profit opportunities. With this acquisition, we have expanded our market access, increased our product offerings, integrated technology from both companies into existing and new products and created opportunities for growth. Additionally, in fiscal 2007, we continued to streamline our operations to control costs while introducing new products and gaining market acceptance on our newer products.

Customers’ backup, recovery and archive challenges are complex and rapidly evolving, and the need for a category expert is essential to success. We believe that our global scale and vertical integration in tape products, along with our growing branded business strength and decreasing cost structure, position us to build a strong, profitable storage systems business and improve our results of operations. In both the disk-based backup and software areas, we recently announced new products that leverage the combined technology of both companies and represent the first steps in executing on our integrated roadmap.

Our priorities are focused on two key strategies. First, we want to create a growth platform beyond tape with solutions that include disk, software and services that are optimized for tiered storage environments. We will remain vigilant in identifying opportunities that will provide for gross margin and overall cost structure improvements. In addition, we want to build on our independent tape business by capitalizing on our unique position as an independent developer of tape drives, tape media and automation systems.

We have a common customer base in the enterprise and larger midrange business segment whose storage needs are met by our tape automation and disk-based data protection solutions. Our strategy is to grow this market segment with our current product and service offerings to meet these customers’ growing needs. Further, we expect to grow in targeted vertical markets as our expanded sales force and channel partners create increased growth opportunities.

Another strategic tenet is to grow revenue in the small and medium business segments. We have a strong portfolio of products to meet the varied needs of this customer base and will leverage our sales and marketing and channel efforts to provide tape drives, tape media and low-end tape automation product solutions. Further, we have introduced new products, such as GoVault™, and will continue to provide new technology solutions to meet the various needs within this market segment.

We also intend to enhance media and technology license opportunities by maintaining our current royalty revenue stream with increased Linear Tape Open (“LTO” ®) royalties to offset declining Digital Linear Tape (“DLT”®) royalties. To augment our royalty revenue stream, we continue to build upon our strong intellectual property portfolio and pursue beneficial licensing opportunities.

We have aligned our internal structure to implement these strategic actions as we continue to reduce costs from our various internal actions, expand our market access and introduce new products and technologies that meet the ever-growing needs in the backup, archive and recovery storage market. We continue our focus on expanding our disk-based data protection solutions including de-duplication and replication technologies and interface flexibility. In the tape automation area, we continue to expand our service offerings, strategic partnerships and value-add features.

We also see opportunity as several key competitors struggle with the impact of industry consolidation and product transitions. This enables us to capitalize on our strengths to increase our market share in more mature markets and grow our position in newly emerging markets. There are numerous risks to the successful execution of our business plans. For a discussion of some of the risks and uncertainties that impact our business, see “Risk Factors” in Item 1A of Part I of this Form 10-K.

 

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Industry Background

Information technology departments in businesses and government offices face an expanding set of problems with storing their data. Digitization has become nearly universal, with a variety of information now relying on digital format as its primary form. This phenomenon applies to business-critical records of all kinds, including documents, images and communications, as well as to the actual products of entire industries, including rich media production services and television broadcasting. Intensifying the impact of this data wave is the rise of broadband communications and the ease of copying and moving records among users and sites. With a single mouse click, multiple copies of the same file—a picture, a presentation, a video clip, a spreadsheet—are sent to servers around the world, and copied over and over again.

The net effect is a rapid increase in the total amount of data being stored and managed, an increase that may outpace any change in fundamental business activity. The data storage requirements of virtually every company increase year after year, whether or not the business is growing.

Adding to the complexity of the data-management task are regulatory and economic issues. Virtually every company has regulatory requirements from different organizations that recognize the critical value of this data and that mandate both its long-term preservation and rapid access. Different industries are affected by different regulations, and the interpretation of requirements is not always straightforward; however, organizations of all types recognize the significance of storing and protecting their data over time. At the same time, IT organizations find themselves under pressure to increase operational efficiencies by doing more with the same, or reduced, staff levels. IT departments have come to expect that every year they will face the problem of how to manage more data, in more places.

This situation makes it very difficult for many companies to continue to operate in the ways they had in the past, and it drives a rapidly increasing need for value-add solutions aimed to solve storage problems.

Part of the solution can be found in new technologies associated with storage and with information management:

 

   

Flexible, lower cost, open system client-server platforms using UNIX, Linux and Windows operating systems are replacing mainframe environments.

 

   

Storage media, both fixed and removable, have been developed to provide more capacity and different kinds of capacity at lower cost.

 

   

Data transmission transports, including Fibre Channel and Internet Protocol, have been applied to storage solutions.

 

   

New networking techniques designed specifically for storage have developed, including Storage Area Networks (“SAN”) and Network Attached Storage (“NAS”).

Each of these technologies, however, can also have the effect of creating additional adoption and integration tasks for IT departments under pressure to keep up with the growth of data and the requirements to manage it. Technologies alone, especially in their early phases, cannot provide the operating leverage that is achieved with a comprehensive data management solution.

Products

As a leading global specialist in backup, recovery and archive, we provide a comprehensive range of disk, tape and software solutions supported by an outstanding sales and service organization. Our solutions are all designed to provide IT departments in a wide variety of organizations with innovative and dependable tools for protecting, retaining and accessing their digital assets. We sell our products via our branded channels and through OEMs such as Dell, Inc. (“Dell”), Hewlett-Packard Company (“HP”), International Business Machines Corporation (“IBM”) and Sun Microsystems, Inc. (“Sun”). We divide our products into three broad categories, (1) tape automation systems, (2) data management software and disk-based backup systems and (3) devices and media. The systems category is comprised of tape automation products, disk-based backup systems and data management software. The devices and media category includes removable disk drives, standalone tape drives and media products.

Tape Automation Systems

According to IDC’s Worldwide Branded Tape 2006 Vendor Analysis report, we are the world’s largest supplier of automated tape systems, in terms of both revenue and unit shipments. Our tape automation portfolio includes autoloaders and entry-level, midrange and enterprise libraries. These products integrate tape drives into a system with automation technology, advanced connectivity and sophisticated management tools. Today, the preferred tape drive format for automation environments is LTO.

 

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Our tape libraries range in size from easy-to-use desk-top units suitable for a small office to storage networking solutions that can protect the largest data center. Our SuperLoader™ 3 autoloader has one tape drive and up to 16 cartridges, whereas our large enterprise-class libraries can hold up to hundreds of drives and thousands of cartridges. Our lead midrange and enterprise libraries—the Scalar® i500TM and Scalar i2000TM, respectively—leverage a common, integrated software management approach called iLayerTM, which provides monitoring, alerts and diagnostics, thereby reducing service calls, shortening issue resolution time and reducing the time users spend managing backup. The Scalar i500 and Scalar i2000 can also be easily scaled, allowing users to expand the capacity of their libraries as their data grows. In addition, these products include connectivity options to improve backup performance and reliability in SAN environments.

Disk-Based Backup Systems

We launched one of the first open systems virtual tape library (“VTL”) products and the first VTL to provide disk-to-tape migration in open systems environments. Today, we offer a broad range of disk solutions for backup and recovery. Our newest solutions, which we began shipping in the fourth quarter of fiscal 2007, are our DXi-Series disk-based backup appliances featuring data de-duplication and replication technologies: the DXi3500 and DXi5500. Data de-duplication is an enabling technology that is fundamentally changing the economics of disk storage and data transmission. By greatly increasing effective disk capacity, data de-duplication enables users to retain backup data on fast recovery disk much longer than possible with conventional disk and significantly reduces the bandwidth needed to move data between sites. We hold a key patent in one of the most common methods of data de-duplication, known as variable-length data de-duplication.

The DXi-Series appliances use this patented data de-duplication technology to expand the amount of backup data users can retain on redundant array independent disk (“RAID”) systems by 10 to 50 times. The result is a cost-effective means for IT departments to store backup data on disk for months instead of days, providing high speed restores, increasing available data recovery points and reducing media management. For disaster recovery in distributed environments, the DXi-Series appliances also make wide area network (“WAN”) replication practical because of the greatly reduced bandwidth required with data de-duplication. DXi-Series solutions are integrated appliances that are easy to install and use with all leading backup applications. DXi-Series solutions provide leading performance and flexible, easy-to-use interface options including NAS, VTL or mixed presentations, along with Fibre Channel or iSCSI connectivity.

Our new DXi-Series appliance family provides a combination of enhanced enterprise performance and advanced functionality. In addition to data de-duplication, the core set of advanced features of the DXi-Series includes a high performance embedded file system, support for high speed data compression, asynchronous replication and built-in monitoring and diagnostic tools. Our DXi-Series products also offer an extensible foundation for future intelligent backup and archive solutions that will improve data protection for a broad range of customer environments, from remote offices to large enterprise data centers.

In addition to the DXi-Series appliances, we also provide VTL systems for midrange enterprises, our DX3000 and DX5000 products, and high-performance, highly-scalable VTLs for enterprise environments with our DX30, DX100 and Pathlight VX products. These VTLs emulate tape libraries to allow them to more easily back up and restore data than conventional disk systems without requiring users to change backup policies or procedures.

Data Management Software

Our data management software helps businesses with large-scale data needs benefit from workflow efficiencies, storage consolidation and archive management. Designed for open system computing environments, our data management software products allow multiple applications to rapidly access a single data set, increasing productivity and maximizing storage utilization. They also transparently move data based on business value, reducing storage costs while providing embedded data protection. For more than six years, organizations within rich media production and broadcast, the federal government and science and engineering have utilized our data management software to derive more value from their data while controlling costs. Many of these customers now rely on our software as a key technology.

Designed for data-intensive SAN environments, our flagship software solution is StorNext®, data management software that reduces the time and total cost of managing data for end users with large data sets and challenging distributed environments. StorNext provides high-performance shared access to data across different operating systems and storage platforms, and based on user-defined policies, it automatically copies and migrates data between different tiers of storage. The result is a scalable, high-performance data management solution that is designed to optimize the use of SAN storage while ensuring the long-term safety and recoverability of data.

Devices and Media

Our device and media products include removable disk devices as well as a broad family of tape drives and media representing all major tape technology formats including LTO, DLT, DAT/DDS and Travan. We sell performance line and value line tape drive devices to meet the varied needs of our customers.

 

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Our GoVault drive is a removable and ruggedized disk-based backup device which combines attributes of disk and tape. GoVault utilizes a server-embedded dock with removable disk cartridges that can be stored in remote locations for data retention and disaster recovery. GoVault is designed to offer small businesses an alternative to other existing data protection technologies.

Since acquiring Certance Holdings (“Certance”) in early 2005, we have offered tape drives and media based on the LTO format, which has become the leading technology in the midrange and open systems enterprise market segment. In fiscal 2007, we launched the LTO-3 HH, a half-height drive that is a cost-effective device that balances price with increased capacity and performance. Our newest generation performance line DLT tape drive is the DLT-S4, and the latest value line DLT tape drive is the DLT-V4. DLT-S4 provides among the industry’s highest tape capacity and the lowest media cost per gigabyte (“GB”) of storage available today. DLT-V4 offers enterprise-class features with the lowest media cost per GB in its class. In addition, both DLT-S4 and DLT-V4 feature our DLTSage™ suite of intelligent data protection tools that include DLTSage WORM (Write Once, Read Many) and DLTSage Tape Security. Our DAT/DDS tape drives are intended to provide backup, recovery and archive for small businesses, while our Travan drives offer affordable data protection for workstations and entry-level servers.

We also sell a full range of storage media offerings to complement each tape drive technology and satisfy a variety of specific media requirements. Our media includes DLTtape®, LTO Ultrium™, DAT, DDS and Travan data cartridges. Our media is compatible with our drives, autoloaders and libraries as well as other industry products.

For more information about our products, please visit our website at www.quantum.com. The contents of our website are not incorporated by reference into this Form 10-K.

Global Services and Warranty

Our global services strategy is an integral component of our total customer solution. Service is typically a significant purchase factor for customers considering data management and storage solutions, and our ability to provide comprehensive service and support can provide us with a noteworthy competitive advantage. In addition, we believe that our ability to retain long-term customer relationships and secure repeat business is frequently tied directly to our service capabilities and performance.

Through the combined use of new technology and traditional service components, we believe we can most effectively meet the dynamic support needs of our customers. StorageCareTM is our comprehensive suite of services designed to best meet our customers’ requirements for product support. StorageCare services include StorageCareGuardianTM, our remote service feature; Customer Service Center, our web support capability; and Online Service Request, an enhanced online service request tool that includes access to an extensive knowledge base, allowing customers to perform basic troubleshooting themselves. We continue to provide conventional support capabilities such as technical support and on-site services.

Our extensive use of technology and innovative, built-in product intelligence allows us to scale our global services operations to meet the needs of our expanding installed base. We are currently able to provide service to customers in 180 countries, supported by 24-hour, multi-language technical support centers located in North America, Europe and Asia. We provide our customers with warranty coverage on our products. Customers with high availability requirements may also purchase additional service to extend the warranty period, obtain faster response times, or both on our tape automation and disk-based backup systems. We offer this additional support coverage at a variety of response levels up to 24-hours a day, seven-days-a-week, 365-days-a-year, for customers with stringent high-availability needs. Our services and other revenue category includes sales of hardware service contracts as well as repair, installation and professional services.

We generally warrant our products against defects for periods ranging from three to 36 months from the date of sale and provide warranty service on tape drives on a return-to-factory basis. We provide automation systems warranty service from our facilities in Colorado Springs, Colorado and Böehmenkirch, Germany. Jabil Global Service provides screen and repair services in Reynosa, Mexico for North America customers and in Szombathely, Hungary for Europe, Middle East and Africa (“EMEA”) customers. Benchmark Electronics, Inc. (“BEI”) also provides automation systems warranty service in Redmond, Washington and Huntsville, Alabama. In addition, we utilize various other third party service providers throughout the world to perform tape drive and automation systems services for us in order to reach additional geographic areas and industries in a quality and cost-effective manner.

 

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Research and Development

Our research and development teams have developed multiple generations of Quantum storage products, platforms and software. We continue to focus our research and development efforts on solving crucial issues in storage and data protection. These development efforts are focused on major investments in new disk-based backup devices, appliances and data protection software as well as expansion of our legacy tape drives and tape automation systems. In fiscal 2007, we developed new technology to deliver an enhanced data drive utilizing the material exchange format (MXF) format for rich media and broadcast applications as well as continued enhancements to our new disk-based storage device, the DXi-series products. Our tape device investments include new technology involving data encryption and encryption key management to meet growing data security needs.

Time and investment requirements for new product development tend to be significant in terms of hardware engineering, firmware engineering and the development of tooling for manufacturing. Wherever feasible, we work toward developing software and hardware components that can be used across multiple platforms such as our DXi Series where the hardware and software are common for all customer segments. We have developed a new common architecture that incorporates the StorNext file system with intelligent software platforms such as de-duplication software that we license to customers.

Going forward, we expect to focus on LTO technology to enhance an already solid position in this growing market. We also continue to invest in our enterprise, midrange and entry-level automation platforms resulting in innovative and differentiating technology, features and solutions. We have suspended further development in the DLT and SDLT technologies as we focus our investments in LTO technology as well as new technology for growing market segments of the data storage market. Our disk-based appliances and software development efforts target three major market segments of the data storage market that have led to a shift in the approach and techniques to data protection that are solving the need for ever-increasing data storage products:

 

   

Capacity Optimized Storage (COS) in two areas:

 

   

Capacity Optimized Virtual Tape Library (COVTL) and

 

   

Other Capacity Optimized Storage (OCOS);

 

   

Continuous Data Technologies (CDT) and

 

   

WideArea Data Services (WDS)

These products will include sophisticated intellectual property such as de-duplication, many to many (N-N) replication, clustered file system and other solutions. It is our strategy to expand our investment in the rapidly growing market segments that are also producing successful start-up companies. We are focusing our research and development investments in the following main areas:

Capacity Optimized Storage Market

The COS market has been growing at an exponential pace and has been the primary replacement chosen for prior tape based solutions. Within the COS market, COVTL solutions have been growing at a more rapid pace than OCOS solutions. Our research and development efforts are targeted to provide us with more solutions within these rapidly growing markets.

Continuous Data Technologies Market

The CDT market supports granular data capture, allowing administrators to create unlimited numbers of any point-in-time (“APIT”) images, which is changing the copy creation environment in enterprises. This technology addresses entire data protection landscapes including backup, recovery, replication, testing, development, archiving, migrations and disaster recovery. It is supplanting nearly all forms of snapshot or other APIT approaches because of improved efficiency and flexibility. Products integrating this technology are becoming mainstream for databases, email and companies’ mission-critical electronic information which require the highest high availability (HA) and service level agreements (SLAs).

WideArea Data Services Market

This rapidly growing market encompasses transition control protocol (TCP) optimization, data reduction for replication, email caching and a range of application protocol optimizations which complement COS products and technologies. WAD provides a true IT path to server-less, lean network-efficient branch offices, solving backup and restore problems in remote office, business office (ROBO) settings. WAD products centralize distributed infrastructure such as file and mail servers, NAS and remote office backup systems without affecting remote users. The technology enables world-wide remote file sharing and remote WAN backup and replication that meet backup windows that were previously unachievable.

Our efforts depend on the integration of multiple engineering disciplines to generate products that competitively meet or exceed market needs in a timely fashion. Our new product development is frequently stimulated by the availability of an enhanced or more cost-effective storage capacity device, the emergence of new storage protocols and evolving end user requirements as noted above. We are constantly evaluating alternative technologies that can be incorporated into our products and provide us a competitive advantage. We identify and define new products based on their ability to meet a perceived market need in a rapidly evolving field. Our sales, marketing, product development, engineering, supply chain and global services organizations all contribute to the process of identifying and implementing advances in technology.

 

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We maintain research and development facilities in Boulder, Colorado Springs and Englewood, Colorado; Costa Mesa, Santa Maria, Irvine and San Jose, California; Burnsville, Minnesota; Richardson, Texas and Adelaide, Australia as of March 31, 2007. While we remain committed to a distributed research and development model, we anticipate executing on selected consolidation opportunities which we expect to yield benefits in both innovation and efficiency in certain product development areas.

Sales and Marketing

Our sales and marketing employees are focused exclusively on backup, recovery and archive solutions for our customers. The expertise of our sales and marketing professionals enables us to provide tailored advice and targeted solutions for our end-user customers. Furthermore, since we offer many different ways of protecting data involving disk, tape and software, our recommendations can be broad and are based on what serves the customer best. We rely on an array of channel partners to reach end user customers, which range in size from small businesses to government agencies and large, multinational corporations. Our products are sold under both the Quantum brand name and the names of various OEM customers. Our sales operations are based in Redmond, Washington; San Jose and Irvine, California; Munich; Paris; Singapore and Shanghai, with regional and field offices throughout North America, Europe and Asia.

Quantum Branded Sales Channels

For Quantum-branded products, we utilize VARs, distributors and direct marketing resellers. We also maintain a reseller agreement with EMC Corporation (“EMC”), through which EMC sells Quantum-branded tape libraries to its customer base and through its own network of resellers. Additionally, we sell directly to a select number of large corporate entities and governmental agencies. We believe international markets represent an attractive growth opportunity, particularly for our branded business and continue to expand the scope of our international sales efforts by recruiting talented sales professionals and entering into additional international distributor and reseller relationships.

In January 2007, we implemented a new, integrated Quantum Alliance™ Reseller Program for the Americas. The program allows our channel partners the option to purchase products directly or through distribution and access to a more comprehensive product line. A key element of Quantum Alliance is an online sales assistance tool that simplifies the process of product selection and ordering which enables fast system selection, configuration and ordering of even the most sophisticated systems. The program is designed to provide additional benefits to our partners as they grow their business with us.

OEM Relationships

We sell our products to several OEM customers who generally resell our products under their own brand name and typically assume responsibility for product sales, end user service and support. These OEM relationships enable us to reach end users not served by our branded distribution channels or our direct sales force. They also allow us to sell to select geographic or vertical markets where specific OEMs have exceptional strength. We maintain ongoing discussions with numerous OEMs, including leading systems suppliers, regarding opportunities for our products. We primarily sell our entry-level products through our hardware OEMs.

Fulfillment models vary, but generally require maintaining an inventory of OEM product in third party logistics centers near the OEM’s manufacturing or distribution facility. In these relationships, we generally maintain title to products until those products leave the third party logistics location. Service support differs widely from one OEM to another. We provide support ranging from repair and replacement to 24-hour fast exchange to on-site service support for our mid-range and enterprise-class products.

Customers

Customers for our systems products, including tape automation and disk-based backup systems and data management software, include Bell Microproducts, Inc., Dell, EMC, HP, IBM and a variety of other resellers, distributors and OEMs to reach end user customers from small businesses to government agencies and large, multinational corporations. Software OEMs include Cray, Inc., HP and Grass Valley Group, Inc. Our devices and media have achieved broad market acceptance in the mid-range network server market with leading computer equipment manufacturers such as Dell, HP and Sun.

Because the leading computer equipment manufacturers have a dominant share of the computer systems market into which our products are incorporated, our sales are concentrated with several key customers. Greater emphasis on our branded business has reduced the portion of sales to our top five customers in fiscal 2007 and distributed our revenues across a larger number of customers. Our top five customers in fiscal 2007 represented 42% of revenue, compared to 49% of revenue in fiscal 2006 and 52% of revenue in fiscal 2005. Sales to Dell increased to 20% of revenue in fiscal 2007, compared to 18% of revenue in fiscal 2006 and 17% of revenue in fiscal 2005. Sales to HP decreased to 9% of revenue in fiscal 2007, compared to 18% of revenue in fiscal 2006 and 22% of revenue in fiscal 2005. These sales concentrations do not include revenues from sales of our media that were sold directly to our top five customers by our licensees, for which we earn royalty revenue, or revenues from sales of tape libraries sold to our top five customers by our other OEM tape drive customers. We anticipate further expansion of our customer base through our Quantum Alliance Reseller Program and implementing similar channel programs in EMEA and Asia, which would likely distribute our product revenues across a larger number of customers.

 

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Strategic Licensing Partners

Multiple recording tape media manufacturing companies are qualified and licensed to manufacture, use, offer for sale and sell one or more DLTtape and LTO Ultrium media products. License agreements with these companies allow them to independently sell tape media cartridges for which we receive royalty payments. These strategic license agreements expand the market for DLTtape and LTO Ultrium media products and provide customers with multiple channels for obtaining tape media cartridges.

We may enter into licensing agreements with respect to our data de-duplication technology, patents and similar intellectual property which also provides licensing revenues. In fiscal 2007, we licensed one of our patents in a cross-license agreement. In the near term we anticipate licensing to select licensing partners, then further expanding the licensing partner program based on market demand.

Competition

With the acquisition and integration of ADIC, we have significantly strengthened our position as a leading independent supplier of backup, recovery and archive solutions. However, all the markets in which we participate continue to be highly competitive, and in some cases, our competitors in one area are customers or suppliers in another. Several of our competitors have greater financial, technical, manufacturing, marketing and other resources than we do.

In the tape automation market, we primarily compete for midrange and enterprise reseller and end user business with IBM and Sun as well as HP through its OEM relationship with other tape automation suppliers. Competitors for entry-level and OEM tape automation business include BDT Products Inc. and several others that supply or manufacture similar products. In addition, disk-based backup products have emerged as a competitive alternative to tape products and solutions.

Our disk-based backup solutions compete with products sold by EMC, HP, IBM, Network Appliance, Inc. and Sun. A number of our competitors also license technology from competing start-up companies such as FalconStor Software, Inc. and Sepaton, Inc. There are also other start-up companies with which we compete directly such as Data Domain, Inc. Our StorNext software products face competition from Cray, IBM, Isilon Systems, Inc., Silicon Graphics, Inc. and Sun.

At the storage device level, our main competitors in the market for performance tape drives are HP and IBM. Both companies develop and sell their own LTO tape drives, which compete with our DLT-S and LTO offerings. Our value line tape drives, Travan, DAT/DDS and DLT-V, largely compete with those from HP and Tandberg Data. We also face competition from disk-based alternatives, including removable disk drives at the low-end of the market. Although we have our own removable disk drive in GoVault, several other companies sell removable disk drives, such as Imation Corporation, Iomega Corporation and ProStor Systems, Inc.

For a discussion of risks associated with competing technologies, see Part 1, Item 1A, Risk Factors, “We derive almost all of our revenue from products incorporating tape technology. If competition from alternative storage technologies continues or increases, our business, financial condition and operating results would be materially and adversely harmed.”

Manufacturing

We utilize contract manufacturers to produce certain of our products and manufacture others in our own facilities. We manufacture certain of our tape automation systems, all of our disk-based backup systems and complete final configuration for specified products in our Colorado Springs and Englewood, Colorado facilities. In fiscal 2007 and 2006, our manufacturing facilities also included our Costa Mesa, California location. Some of our tape automation systems and spare parts for use by our OEM customers are produced by our Penang, Malaysia facility and some by Mitsumi via a manufacturing partner relationship with Fotronics in Singapore. As a result of our acquisition of ADIC in August 2006, we acquired a tape automation system and disk-based back up manufacturing facility in Englewood, Colorado and a tape automation system manufacturing relationship with BEI in Huntsville, Alabama and Redmond, Washington.

We produce most of our tape drives and head assemblies for those drives in our Penang, Malaysia facility. Some of the head assemblies for our DLT drives are still produced by Lafe in China, and some of our drives are produced by PSEC in Japan and Indonesia and Mitsumi in the Philippines. The head assemblies for certain PSEC drives are produced in our Penang facility, while others are manufactured by Lafe in China.

Our tape media cartridges are manufactured by third parties. Although we have a small number of contract manufacturers, each manufacturer produces different products. As a result, we have a single source of supply for each product, except for some of our tape media cartridges. In addition, certain components and subassemblies included in our products are obtained from single source suppliers or a limited group of suppliers. Most of these suppliers and our contract manufacturers are located outside the U.S.

 

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We continue to evaluate our manufacturing operations strategy for efficient, cost-effective and quality manufacturing solutions, including our U.S., Asian and European manufacturing and configuration requirements. Implementing our manufacturing operations strategy, we have started consolidating our U.S. manufacturing and final configuration activity into our Colorado Springs, Colorado facility. We also continue strategic sourcing of certain tape automation systems from BEI. In fiscal 2008, we expect to continue consolidating our in-house manufacturing within the U.S. and continue to evaluate our Asian and European manufacturing operations.

Backlog

We manufacture our products based on forecasts of customer demand. We also place inventory in strategic locations in order to enable certain key customers to obtain products on demand. Orders are generally placed by customers on an as-needed basis. Product orders are confirmed and, in most cases, shipped to customers within one week. More complex systems and product configurations often have longer lead times and may include on-site integration and customer acceptance. Since we fill the majority of our orders as they are received, we do not believe our backlog levels are a meaningful indicator of future revenues or material to an understanding of our business.

Information Technology and Infrastructure

We are focused on continuous improvement of our internal business systems and global information technology infrastructure. With our acquisitions of Certance and ADIC over the past two years, we continue to integrate and improve our key business systems to bring the consolidated company onto a single platform designed to provide more streamlined and scalable processes and support of our global functions. We collaborate with several key business partners to integrate business-to-business communication platforms into our technology infrastructure that are designed to increase the efficiency of critical transactional processes.

Technology

We develop and protect our technology and know-how, principally in the field of data storage. We presently hold 449 U.S. patents and have 151 pending U.S. patent applications. In general, these patents have a 20-year term from the first effective filing date for each patent. We also hold a number of foreign patents and patent applications for certain of our products and technologies. Although we believe that our patents and applications have significant value, rapidly changing computer industry technology means that our future success will also depend heavily on the technical competence and creative skills of our employees.

From time to time, third parties have asserted that the manufacture and sale of our products and services have infringed on their patents. We conduct ongoing investigations into the assertions and presently believe that either licenses are not required or that any licenses ultimately determined to be required could be obtained on commercially reasonable terms. However, we cannot provide assurance that such licenses are presently obtainable, or if later determined to be required, could be obtained on commercially reasonable terms.

We have signed a patent cross-licensing agreement with IBM and have agreed to a time-limited, mutual patent, non-assertion agreement with Maxtor covering certain technologies and patents of each party. In fiscal 2006, we entered into a patent cross license agreement with Sun where each party received a license to certain of the other party’s patents on a nonexclusive, worldwide basis. In the fourth quarter of fiscal 2007, we signed a patent cross-license agreement with Data Domain covering data de-duplication and other non-tape storage technologies. We may enter into patent cross-licensing agreements with other third parties in the future as part of our normal business activities. These agreements, when and if entered into, would enable us to use certain patents owned by these third parties and to enable these third parties to use certain patents that we own.

Environmental Compliance

We are subject to federal, state, local and international environmental laws and regulations. Compliance with these laws and regulations has not had a material effect on our capital expenditures, earnings or competitive position.

During 2004, the European Union finalized the Waste Electrical and Electronic Equipment (WEEE) directive, which regulates the collection, recovery and recycling of waste from electrical and electronic products, and the Restrictions on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (RoHS) directive, which bans the use of certain hazardous materials including lead, mercury, cadmium, chromium and halogenated flame-retardants. During 2005 and 2006, member nations undertook legislation for the application of WEEE and RoHS within their borders. Most member countries have finalized their laws as of the end of 2006, and many countries that have finalized laws are just beginning to implement their processes. To comply with the WEEE directive, we are responsible for financing the collection, treatment, disposal and recycling of past and future covered products within those countries in which we operate. To comply with the RoHS directive, we identified alternatives for certain components used in our products and changed certain aspects of our product designs. Future years may bring additional implementation requirements, such as the expiration of current exemptions, and we may need to substantially alter product designs and locate alternate suppliers for critical components used in those products. We continue to evaluate the potential impact that compliance with WEEE and RoHS may have on our results of operations and financial and competitive position.

 

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Employees

We had approximately 2,900 employees worldwide as of March 31, 2007.

Available Information

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at www.quantum.com when such reports are available on the Securities and Exchange Commission website. The contents of our website are not incorporated into this Form 10-K.

New York Stock Exchange Certification

We submitted the certification of our Chief Executive Officer required by the New York Stock Exchange (“NYSE”) Listing Standards, Section 303A.12(a), relating to Quantum’s compliance with the NYSE Corporate Governance Listing Standards, to the NYSE on September 27, 2006 with no qualifications.

EXECUTIVE OFFICERS OF QUANTUM CORPORATION

Set forth below are the names, ages (as of June 1, 2007), positions and offices held by, and a brief account of the business experience of each executive officer of Quantum.

 

Name

   Age   

Position with Quantum

Barbara L. Barrett

   58    Vice President, Human Resources

Richard E. Belluzzo

   53    Chairman and Chief Executive Officer

William C. Britts

   48    Executive Vice President, Sales, Marketing and Service

Stephen P. Dalton

   48    Senior Vice President, Tiered Storage Systems Engineering

Jon W. Gacek

   45    Executive Vice President and Chief Financial Officer

Shawn D. Hall

   38    Vice President, General Counsel and Secretary

Ms. Barrett joined Quantum in 1999 and has been Vice President of Human Resources since July 2003. Prior to assuming her current role, Ms. Barrett held other human resources management positions within the Company, most recently Vice President, Human Resources of the DLTtape business. Before joining Quantum, Ms. Barrett held leadership positions at companies in the telecommunications and utilities industries in a variety of human resource functions, including compensation, training, consulting and organizational development.

Mr. Belluzzo has been Chief Executive Officer since joining the Company in September 2002 and Chairman of the Board since July 2003. Before joining Quantum, from September 1999 to May 2002, Mr. Belluzzo held senior management positions with Microsoft Corp., most recently as President and Chief Operating Officer. Prior to Microsoft, from January 1998 to September 1999, Mr. Belluzzo was Chief Executive Officer of Silicon Graphics Inc. Before his tenure at Silicon Graphics, from 1975 to January 1998, Mr. Belluzzo was with Hewlett-Packard, most recently as Executive Vice President of the computer organization. Currently Mr. Belluzzo is a member of the board of directors of PMC-Sierra, as well as JDS Uniphase, and is a member of the board of trustees for Golden Gate University.

Mr. Britts became Executive Vice President of Sales, Marketing and Service in August 2006, upon Quantum’s acquisition of ADIC. Before joining Quantum, Mr. Britts was the Co-Executive Vice President of Products, Sales and Service at ADIC. In his 12 years at ADIC, he held numerous leadership positions, including Executive Vice President of Worldwide Sales and Marketing, Vice President of Sales and Marketing and Director of Marketing. Prior to ADIC, Mr. Britts held a number of marketing and sales positions at Raychem Corp. and its subsidiary, Elo TouchSystems.

Mr. Dalton became Senior Vice President of Engineering for Quantum’s Tiered Storage Systems in October 2006. Prior to joining Quantum, Mr. Dalton was General Manager, SAN Business Unit, of Broadcom Corporation’s enterprise storage business where he started after the acquisition of Gadzoox Networks, Inc. in which he was President and CEO. He previously served as General Manager for Americas for Force Computers, Inc. (“Force”). Prior to Force, Mr. Dalton served in the Office of the President and Vice President Development at Auspex Systems, Inc. and was the President and Chief Operating Officer of Streamlogic Corporation after an acquisition of FWB Software where he was the Vice President of Engineering.

 

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Mr. Gacek joined Quantum as Executive Vice President and Chief Financial Officer in August 2006, upon Quantum’s acquisition of ADIC. Previously, he served as the Chief Financial Officer at ADIC from 1999 to 2006 and also led Operations during his last two years there. Prior to ADIC, Mr. Gacek was an audit partner at PricewaterhouseCoopers LLP and led the Technology Practice in the firm’s Seattle office. While at PricewaterhouseCoopers LLP, he assisted several private equity investment firms with a number of mergers, acquisitions, leveraged buyouts and other transactions. Mr. Gacek serves on the board of directors for Loud Technologies, Inc. and HouseValues, Inc.

Mr. Hall joined Quantum in 1999 as Corporate Counsel and assumed the role of Vice President, General Counsel and Secretary in 2001. Prior to Quantum, Mr. Hall worked at the law firms of Skadden, Arps and Willkie Farr & Gallagher, where he practiced in the areas of mergers and acquisitions and corporate finance, representing numerous public and private technology companies.

 

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ITEM 1A. Risk Factors

RISK FACTORS

THE READER SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, TOGETHER WITH ALL OF THE OTHER INFORMATION INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K, BEFORE MAKING AN INVESTMENT DECISION. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING QUANTUM. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT ARE CURRENTLY DEEMED IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS AND OPERATIONS. THIS ANNUAL REPORT ON FORM 10-K CONTAINS “FORWARD-LOOKING” STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. PLEASE SEE PAGE 3 OF THIS REPORT FOR ADDITIONAL DISCUSSION OF THESE FORWARD-LOOKING STATEMENTS.

A large percentage of our sales come from a few customers, and these customers have no minimum or long-term purchase commitments. The loss of, or a significant reduction in demand from, one or more key customers could materially and adversely affect our business, financial condition and operating results.

Our sales have been and continue to be concentrated among a few customers. Sales to our top five customers in fiscal 2007 represented 42% of total revenue. This sales concentration does not include revenues from sales of our media that our licensees sold to our top five customers, for which we earn royalty revenue. Furthermore, customers are not obligated to purchase any minimum product volume and our relationships with our customers are terminable at will. In fiscal 2007, sales to Dell contributed approximately 20% of our revenue. If we experience a significant decline in revenue from Dell, we could be materially and adversely affected.

In addition, many of our tape products are primarily incorporated into larger storage systems or solutions that are marketed and sold to end-users by our large OEM customers. Because of this, we have limited market access to these end-users, limiting our ability to reach and influence their purchasing decisions. These market conditions further our reliance on these large OEM customers. Thus if they were to significantly reduce, cancel or delay their orders with us, our results of operations could be materially adversely affected.

In connection with the acquisition of ADIC, we drew on our $500 million credit facility with Key Bank, substantially increasing our debt service obligations and constraining our ability to operate our business. Unless we are able to generate sufficient cash flows from operations to meet these debt obligations, our business financial condition and operating results will be materially and adversely affected.

In connection with our acquisition of ADIC, we borrowed $496.5 million under our credit facility with KeyBank, adding a significant amount of indebtedness and interest expense to our obligations. As of March 31, 2007, the total amount outstanding under the credit facility was $362.5 million. Our level of indebtedness presents significant risks to investors, both in terms of the constraints that it places on our ability to operate our business and because of the possibility that we may not generate sufficient cash to pay the principal of and interest on our indebtedness as it becomes due.

Our substantial debt could have important consequences, such as:

 

   

Making it more difficult or impossible for us to make payments on our convertible subordinated notes or any other indebtedness or obligations;

 

   

Requiring us to dedicate a significant portion of our cash flow from operations and other capital resources to debt service, thereby reducing our ability to fund working capital, capital expenditures, research and development and other cash requirements;

 

   

Increasing our vulnerability to adverse economic and industry conditions;

 

   

Limiting our flexibility in planning for, or reacting to, changes and opportunities in, the electronics manufacturing industry, which may place us at a competitive disadvantage; and

 

   

Limiting our ability to incur additional debt on acceptable terms, if at all.

In addition, there is a risk that we may not be able to repay our debt obligations as they become due. We have incurred significant losses since 2001. Our ability to meet our debt service obligations (and fund our working capital, capital expenditures, acquisitions, research and development and other general corporate needs) will depend upon our ability to generate sufficient cash flow from operations. We cannot provide assurance that we will generate sufficient cash flow from operations to service these debt obligations, or that future borrowings or equity financing will be available to us on commercially reasonable terms or at all, or available in an amount sufficient to enable us to pay our debt obligations or fund our other liquidity needs. Unless we are able to improve our cash flows from operations we may not generate sufficient cash flow to service our debt obligations, which would require that we reduce or delay capital expenditures and/or sell assets, thereby affecting our ability to remain competitive and materially and adversely affecting our business. Such a failure to repay our debt obligations when due would also result in our default under our loan agreements, which would give our lenders the right to seize all of our assets. Any such inability to meet our debt obligations would therefore have a material and adverse effect on our business, financial condition and results of operations.

 

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Our credit agreement contains various covenants that limit our discretion in the operation of our business, which could have an adverse effect on our business, financial condition and results of operations.

Our credit agreement contains numerous restrictive covenants that require us to comply with and maintain certain financial tests and ratios, thereby restricting our ability to:

 

   

Incur debt;

 

   

Incur liens;

 

   

Redeem or prepay subordinated debt;

 

   

Make acquisitions of businesses or entities or sell certain assets;

 

   

Make investments, including loans, guarantees and advances;

 

   

Make capital expenditures beyond a certain threshold;

 

   

Engage in transactions with affiliates;

 

   

Pay dividends or engage in stock repurchases; and

 

   

Enter into certain restrictive agreements.

Our ability to comply with covenants contained in our credit agreement may be affected by events beyond our control, including prevailing economic, financial and industry conditions. Even if we are able to comply with all covenants, the restrictions on our ability to operate our business could harm our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities. In addition, we may seek to refinance certain of our indebtedness in the future. We cannot assure you that additional financing will be available on terms favorable to us, or at all.

Our credit agreement is secured by a pledge of all of our assets. If we were to default under our credit agreement and were unable to obtain a waiver for such a default, the lenders would have a right to foreclose on our assets in order to satisfy our obligations under the credit agreement. Any such action on the part of the lenders against us could have a materially adverse impact on our business, financial condition and results of operations.

In prior year periods, we violated certain financial covenants under our credit agreement and received waivers or amendments for such violations. If in the future we violate financial covenants, it could materially and adversely impact our financial condition and liquidity.

If our operating results do not improve in the future and we violate any financial or reporting covenant in our credit agreement and receive a notice of default letter from our bank group, our credit line could become unavailable, and any amounts outstanding could become immediately due and payable.

Without the availability of the credit agreement, we would have to rely on operating cash flows and debt or equity arrangements other than the credit agreement, if such alternative funding arrangements are available to us at all, in order to maintain sufficient liquidity. If we were not able to obtain sufficient cash from our operations or from these alternative funding sources under such circumstances, our operations, financial condition and liquidity would be materially and adversely affected.

We derive almost all of our revenue from products incorporating tape technology. If competition from alternative storage technologies continues or increases, our business, financial condition and operating results would be materially and adversely harmed.

We derive almost all of our revenue from products that incorporate some form of tape technology and we expect to continue to derive a substantial majority of our revenue from these products for the foreseeable future. As a result, our future operating results depend on the continued market acceptance of products employing tape drive technology. Our tape products, including tape drives and automation systems, are increasingly challenged by products using hard disk drive technology, such as Virtual Tape Libraries (VTL), standard disk arrays and Network Attached Storage (NAS). Hard disk drives have experienced a trend toward lower prices while capacity and performance have increased. If disk-based backup products gain comparable or superior market acceptance, or their costs decline far more rapidly than tape drive and media costs, the competition resulting from these products would increase as customers migrate toward them. We are working to address this risk through our own targeted investment in disk-based products and other alternative technologies, but if we are not successful in our efforts, our business, financial condition and operating results would be materially and adversely affected.

 

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Competition has increased, and may increasingly intensify, in the tape drive and tape automation markets as a result of competitors introducing products based on new technology standards, which could materially and adversely affect our business, financial condition and results of operations.

We compete with companies that develop, manufacture, market and sell tape drive and tape automation products. The principal competitors for our tape drive products include Hewlett-Packard, IBM and Sony. These competitors are aggressively trying to advance and develop new technologies and products to compete against our technologies and products. For instance, LTO technology, which was developed by Certance, Hewlett-Packard and IBM, targets the high-capacity data backup market and competes directly with our products based on Super DLTtape technology. Hewlett-Packard and IBM thus compete not only with our Super DLTtape products but now compete with the LTO product offerings that we acquired through our acquisition of Certance. This competition has resulted in a trend, which is expected to continue, toward lower prices and lower margins earned on our DLTtape® and Super DLTtape drives and media. Additionally, over the last two years, our DLT and Super DLTtape drives have lost market share to LTO based products, and we cannot provide assurance that our tape technology based products will not continue to lose market share to LTO based products in the future. These factors, and additional factors, such as the possibility of industry consolidation, when combined with the current environment of intense competition, which has resulted in reduced shipments of our tape drive products, could result in a further reduction in our prices, volumes and margins, which could materially and adversely impact our business, financial condition and results of operations.

Our tape automation products compete with product offerings of Dell, EMC IBM and Sun, which offer tape automation systems incorporating DLTtape® and Super DLTtape technology as well as LTO technology. Increased competition has resulted in increased price competition. If this trend continues or worsens, if competition further intensifies, or if industry consolidation occurs, our sales and gross margins could decline, which could materially and adversely affect our business, financial condition and results of operations.

From time to time we make acquisitions, such as the recent acquisition of ADIC. The failure to successfully integrate recent or future acquisitions could harm our business, financial condition and operating results.

As a part of our business strategy, we have in the past and expect in the future to make acquisitions, or significant investments in, complementary companies, products or technologies, such as the recent acquisition of ADIC. If we fail to successfully integrate such acquisitions, it could harm our business, financial condition and operating results. Risks that we may face in our efforts to integrate any recent or future acquisitions include, among others:

 

   

Failure to realize anticipated savings and benefits from the acquisition;

 

   

Difficulties in assimilating and retaining employees;

 

   

Potential incompatibility of business cultures;

 

   

Coordinating geographically separate organizations;

 

   

Diversion of management’s attention from ongoing business concerns;

 

   

Coordinating infrastructure operations in a rapid and efficient manner;

 

   

The potential inability to maximize our financial and strategic position through the successful incorporation of acquired technology and rights into our products and services;

 

   

Insufficient revenues to offset increased expenses associated with the acquisition;

 

   

Costs and delays in implementing or integrating common systems and procedures;

 

   

Reduction or loss of customer orders due to the potential for market confusion, hesitation and delay;

 

   

Impairment of existing customer, supplier and strategic relationships of either company;

 

   

Insufficient cash flows from operations to fund the working capital and investment requirements;

 

   

Difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;

 

   

The possibility that we may not receive a favorable return on our investment, the original investment may become impaired, and/or we may incur losses from these investments;

 

   

Dissatisfaction or performance problems with the acquired company;

 

   

The assumption of risks of the acquired company that are difficult to quantify, such as litigation;

 

   

The cost associated with the acquisition; and

 

   

Assumption of unknown liabilities or other unanticipated adverse events or circumstances.

Acquisitions present many risks, and we may not realize the financial and strategic goals that were contemplated at the time of any transaction. We cannot provide assurance that we will be able to successfully integrate any business, products, technologies or personnel that we may acquire in the future, and our failure to do so could harm our business, financial condition and operating results.

 

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Our operating results depend on new product introductions, which may not be successful, in which case our business, financial condition and operating results may be materially and adversely affected.

To compete effectively, we must continually improve existing products and introduce new ones, such as our recently introduced DXi series products, PX500-Series libraries, the DLT S-4 and GoVault and enhanced Scalar i500 and Scalar i2000 products and next generation StorNext software. We have devoted and expect to continue to devote considerable management and financial resources to these efforts. We cannot provide assurance that:

 

   

We will introduce new products in the time frame we are forecasting;

 

   

We will not experience technical, quality, performance-related or other difficulties that could prevent or delay the introduction of, and market acceptance of, new products;

 

   

Our new products will achieve market acceptance and significant market share, or that the markets for these products will continue or grow as we have anticipated;

 

   

Our new products will be successfully or timely qualified with our customers by meeting customer performance and quality specifications because a successful and timely customer qualification must occur before customers will place large product orders; or

 

   

We will achieve high volume production of these new products in a timely manner, if at all.

If we are not successful in timely completion of our new product qualifications and then ramping sales to our key customers, our revenue and results of operations could be adversely impacted. In addition, if the quality of our products is not acceptable to our customers, this could result in customer dissatisfaction, lost revenue and increased warranty and repair costs.

We have taken considerable steps towards reducing our cost structure and may take further cost reduction actions. The steps we have taken and may take in the future may not reduce our cost structure to a level appropriate in relation to our future sales and therefore, these anticipated cost reductions may be insufficient to bring us back to profitability.

In the last four years, we have recorded significant restructuring charges and made cash payments in order to reduce our cost of sales and operating expenses to rationalize our operations following past acquisitions and in response to adverse economic, industry and competitive conditions. We may take future steps to further reduce our operating costs. These steps and additional future restructurings in response to rationalization of operations following future acquisitions, strategic decisions or adverse changes in our business and industry may require us to make cash payments that, if large enough, would materially and adversely affect our liquidity. We may be unable to reduce our cost of sales and operating expenses at a rate and to a level consistent with a future potential adverse sales environment, which may adversely affect our business, financial condition and operating results.

Our tape media and tape royalty business generates a relatively high gross margin rate, which significantly impacts the total company gross margin rate. If we were to experience a significant decline in the tape media or tape royalty gross margin rate, our business, financial condition, and operating results would be materially and adversely affected.

Our tape royalty and media gross margin rates and revenues are dependent on many factors, including the following factors:

 

   

The pricing actions of other media suppliers;

 

   

The size of the installed base of tape drives that use our tape cartridges;

 

   

The performance of our strategic licensing partners, which sell our tape media cartridges;

 

   

The relative growth in units of our newer tape drive products, since the associated media cartridges typically sell at higher prices than the media cartridges associated with older tape drive products;

 

   

The relative mix of media purchased directly from us as compared to our licensees;

 

   

The media consumption habits and rates of end users;

 

   

The pattern of tape drive retirements; and

 

   

The level of channel inventories.

Competition from other tape technologies has had a significant negative impact on our income from media as well as on our sales of tape drives. Similarly, competition among media suppliers has periodically resulted in intense, price-based competition for media sales, which also affects media income. If either of these competitive factors continues or intensifies, it would further erode tape drive unit sales, tape drive installed base, media units and media pricing. To the extent that our Quantum branded media revenue and media royalties depend upon media pricing and the quantity of media consumed by the installed base of our tape drives, reduced media prices, or a reduced installed tape drive base, would result in further reductions in our Quantum branded media and media royalty revenue and gross margin rates. This would materially and adversely affect our business, financial condition, and results of operations.

 

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Third party intellectual property infringement claims could result in substantial liability and significant costs, and, as a result, our business, financial condition, and operating results may be materially and adversely affected.

From time to time, third parties allege our infringement of and need for a license under their patented or other proprietary technology. While we currently believe the amount of ultimate liability, if any, with respect to any such actions will not materially affect our financial position, results of operations, or liquidity, the ultimate outcome of any license discussion or litigation is uncertain. Adverse resolution of any third party infringement claim could subject us to substantial liabilities and require us to refrain from manufacturing and selling certain products. In addition, the costs incurred in intellectual property litigation can be substantial, regardless of the outcome. As a result, our business, financial condition, and operating results could be materially and adversely affected.

In addition, certain products or technologies acquired or developed by us may include so-called “open source” software. Open source software is typically licensed for use at no initial charge. Certain open source software licenses, however, require users of the open source software to license to others any software that is based on, incorporates or interacts with, the open source software under the terms of the open source license. Although we endeavor to comply fully with such requirements, third parties could claim that we are required to license larger portions of our software than we believe we are required to license under open source software licenses. If such claims were successful, they could adversely impact our competitive position and financial results by providing our competitors with access to sensitive information that may help them develop competitive products. In addition, our use of open source software may harm our business and subject us to intellectual property claims, litigation or proceedings in the future because:

 

   

Open source license terms may be ambiguous and may subject us to unanticipated obligations regarding our products, technologies and intellectual property;

 

   

Open source software generally cannot be protected under trade secret law; and

 

   

It may be difficult for us to accurately determine the origin of the open source code and whether the open source software infringes, misappropriates or violates third party intellectual property or other rights.

As a result of our global manufacturing and sales operations, we are subject to a variety of risks that are unique to businesses with international operations of a similar scope, any of which could, individually or in the aggregate have a material adverse effect on our business:

A significant portion of our manufacturing and sales operations and supply chain occurs in countries other than the United States. We also have sales outside the United States. In addition, a significant number of our products are manufactured in Malaysia. Similarly, one of the suppliers of recording heads for our products is located in China. Because of these operations, we are subject to a number of risks including:

 

   

Import and export duties and value-added taxes;

 

   

Import and export regulation changes that could erode our profit margins or restrict our exports;

 

   

Political risks and natural disasters, including earthquakes, especially in emerging or developing economies;

 

   

Potential restrictions on the transfer of funds between countries;

 

   

Natural disasters, including earthquakes, typhoons and tsunamis;

 

   

Inflexible employee contracts and employment laws that may make it difficult to terminate employees in some foreign countries in the event of business downturns;

 

   

Adverse movement of foreign currencies against the U.S. dollar (the currency in which our results are reported);

 

   

Shortages in component parts and raw materials; and

 

   

The burden and cost of complying with foreign laws.

Any or all of these risks could have a material adverse effect on our business.

We rely on indirect sales channels to market and sell our branded products. Therefore, the loss of or deterioration in our relationship with one or more of our resellers or distributors could negatively affect our operating results.

We sell the majority of our branded products to value-added resellers, or VARs, and to direct marketing resellers such as CDW Corporation, who in turn sell our products to end users, and to distributors such as Ingram Micro, Tech Data and others. We also have a growing relationship with EMC through which we make available our branded products that complement EMC’s product offerings. The success of these sales channels is hard to predict, particularly over time, and we have no purchase commitments or long-term orders from them that assure us of any baseline sales through these channels. Several of our resellers carry competing product lines that they may promote over our products. A reseller might not continue to purchase our products or market them effectively, and each reseller determines the type and amount of our products that it will purchase from us and the pricing of the products that it sells to end user customers. Certain of our contracts with our distributors contain “most favored nation” pricing provisions mandating that we offer our products to these customers at the lowest price offered to other similarly situated customers. In addition, sales of our enterprise-class libraries, and the revenue associated with the on-site service of those libraries, are somewhat concentrated in specific customers, including government agencies and government-related companies. Our operating results could be adversely affected by any number of factors including:

 

   

A change in competitive strategy that adversely affects a reseller’s willingness or ability to distribute our products;

 

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The reduction, delay or cancellation of orders or the return of a significant amount of products;

 

   

The loss of one or more of such resellers; or

 

   

Any financial difficulties of such resellers that result in their inability to pay amounts owed to us.

Our quarterly operating results could fluctuate significantly, and past quarterly operating results should not be used to predict future performance.

Our quarterly operating results have fluctuated significantly in the past and could fluctuate significantly in the future. As a result, our past quarterly operating results should not be used to predict future performance. Quarterly operating results could be materially and adversely affected by a number of factors, including, but not limited to:

 

   

An inadequate supply of tape media cartridges;

 

   

Reduced demand from our OEM customers;

 

   

Customers canceling, reducing, deferring or rescheduling significant orders as a result of excess inventory levels, weak economic conditions or other factors;

 

   

Declines in network server demand;

 

   

Product ramp cycles;

 

   

Failure to complete shipments in the last month of a quarter during which a substantial portion of our products are typically shipped; or

 

   

Increased competition.

If we fail to meet our projected quarterly results, our business, financial condition, and results of operations may be materially and adversely harmed.

If we do not successfully manage the changes that we have made and may continue to make to our infrastructure and management, our business could be disrupted, and that could adversely impact our results of operations and financial condition.

Managing change is an important focus for us. Following the acquisitions of Certance and ADIC, one of our important initiatives involves combining and integrating the information technology infrastructures of the companies, including our enterprise resource planning systems, and adapting our business processes and software to the requirements of the new organization. We are also managing several significant initiatives involving our operations, including efforts to reduce the number of contract manufacturers and suppliers we use, the outsourcing of our repair capabilities and the related closing of our facility in Dundalk, Ireland. In addition, we continue to reduce headcount to streamline and consolidate our supporting functions as appropriate following past acquisitions and in response to market or competitive conditions. If we are unable to successfully manage the changes that we implement, and detect and address issues as they arise, it could disrupt our business and adversely impact our results of operations and financial condition.

If we fail to protect our intellectual property or if others use our proprietary technology without authorization, our competitive position may suffer.

Our future success and ability to compete depends in part on our proprietary technology. We rely on a combination of copyright, patent, trademark, and trade secrets laws and nondisclosure agreements to establish and protect our proprietary technology. We currently hold 449 United States patents and have 151 United States patent applications pending. However, we cannot provide assurance that patents will be issued with respect to pending or future patent applications that we have filed or plan to file or that our patents will be upheld as valid or will prevent the development of competitive products or that any actions we have taken will adequately protect our intellectual property rights. We generally enter into confidentiality agreements with our employees, consultants, customers, potential customers, and others as required, in which we strictly limit access to, and distribution of, our software, and further limit the disclosure and use of our proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain or use our products or technology. Our competitors may also independently develop technologies that are substantially equivalent or superior to our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States.

 

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Because we may order components from suppliers in advance of receipt of customer orders for our products which include these components, we could face a material inventory risk.

Historically, we have relied primarily on third parties to manufacture our products. However, we have begun to manufacture more of our products ourselves and anticipate that we will continue to increase the proportion of our products that we manufacture ourselves. Managing such a build-up of our in-house manufacturing capabilities presents a number of risks that could materially and adversely affect our financial condition. For instance, as part of our component planning, we place orders with or pay certain suppliers for components in advance of receipt of customer orders. We occasionally enter into negotiated orders with vendors early in the manufacturing process of our storage products to ensure that we have sufficient components for our new products to meet anticipated customer demand. Because the design and manufacturing process for these components is complicated, it is possible that we could experience a design or manufacturing flaw that could delay or even prevent the production of the components for which we previously committed to pay. We also face the risk of ordering too many components, or conversely, not enough components, since supply orders are generally based on forecasts of customer orders rather than actual customer orders. In addition, in some cases, we make non-cancelable order commitments to our suppliers for work-in-progress, supplier’s finished goods, custom sub-assemblies, discontinued (end-of-life) components and Quantum-unique raw materials that are necessary to meet our lead times for finished goods. If we cannot change or be released from supply orders, we could incur costs from the purchase of unusable components, either due to a delay in the production of the components or other supplies or as a result of inaccurately predicting supply orders in advance of customer orders. Our business and operating results could be materially and adversely affected as a result of these increased costs.

Some of our manufacturing, and our service repair, is outsourced to third party contract manufacturers. If we cannot obtain our products and parts from these third parties in a cost effective and timely manner that meets our customers’ expectations, this could materially and adversely impact our business, financial condition, and results of operations.

Some of our tape drive and tape automation products are manufactured for us by contract manufactures. We face a number of risks as a result of this outsourced manufacturing, including, among others:

 

   

Sole source of product supply

In each case, our contract manufacturer is our sole source of supply for the tape drive and/or tape automation products they manufacture for us. Because we are relying on one supplier, we are at greater risk of experiencing component shortages or other delays in customer deliveries that could result in customer dissatisfaction and lost sales, which could materially damage customer relationships and result in lost revenue.

 

   

Cost and purchase commitments

We may not be able to control the costs we would be required to pay our contract manufacturers for the products they manufacture for us. They procure inventory to build our products based upon a forecast of customer demand that we provide. We would be responsible for the financial impact on the contract manufacturer of any reduction or product mix shift in the forecast relative to materials that they had already purchased under a prior forecast. Such a variance in forecasted demand could require us to pay them for finished goods in excess of current customer demand or for excess or obsolete inventory and generally incur higher costs. As a result, we could experience reduced gross margins and larger operating losses based on these purchase commitments.

 

   

Quality

We will have limited control over the quality of products produced by our contract manufacturers. Therefore, the quality of the products may not be acceptable to our customers and could result in customer dissatisfaction, lost revenue, and increased warranty costs.

Any or all of these risks could have a material adverse effect on our business.

We do not control licensee pricing or licensee sales of tape media cartridges. To the extent that our royalty revenue is dependent on the prices of cartridges sold by our licensees, should these licensees significantly lower prices on the media products that they sell, such reduced pricing would lower our royalty revenue, which would materially and adversely affect our business, financial condition, and operating results.

We receive a royalty fee based on sales of our tape media cartridges by Fuji, Maxell, Imation and Sony. Under our license agreements with these companies, each of the licensees determines the pricing and number of units of tape media cartridges that it sells. To the extent that our royalty revenue is based on the prices of cartridges sold by our licensees, our royalty revenue will vary depending on the level of sales and prices set by the licensees. In addition, lower prices set by licensees could require us to lower our prices on direct sales of tape media cartridges, which would reduce our revenue and margins on these products. As a result, lower prices on our tape media cartridges would reduce media revenue, which could materially and adversely affect our business, financial condition, and operating results.

 

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Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees, and recent changes in accounting for equity compensation are adversely affecting earnings.

Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) Share-Based Payment (“SFAS No. 123R”), which we implemented at the beginning of fiscal 2007. We are required to recognize compensation expense in our statement of operations for the fair value of unvested employee stock options at the date of adoption and new stock options granted to our employees after the adoption date over the related vesting periods of the stock options. The requirement to expense stock options granted to employees reduces their attractiveness to Quantum because the expense associated with these grants typically results in future compensation charges. In addition, the expenses recorded may not accurately reflect the value of our stock options because the option pricing models used to estimate fair value were not developed for use in valuing employee stock options and are based on highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. Alternative compensation arrangements that can replace stock option programs may also negatively impact profitability. Stock options remain an important employee recruitment and retention tool, and we may not be able to attract and retain key personnel if we reduce the scope of our employee stock option program following the adoption of SFAS No. 123R. Our employees are critical to our ability to develop and design systems that advance our productivity and technology goals, increase our sales goals and provide support to customers. Accordingly, as a result of the requirement under SFAS No. 123R to recognize the fair value of stock options as compensation expense, beginning in the first quarter of fiscal 2007, our future results of operations will be adversely impacted. See also Note 4 “Stock Incentive Plans and Share-based Compensation” to the Consolidated Financial Statements.

Our stock price could become more volatile if certain institutional investors were to increase or decrease the number of shares they own. In addition, there are other factors and events that could affect the trading prices of our common stock.

Five institutional investors own approximately 48% of our common stock. If any or all of these investors were to decide to purchase additional shares or to sell some or all of the common shares they currently own, that may cause our stock price to be more volatile. For example, there have been instances in the past where a shareholder with a significant equity position begins selling shares, putting downward pressure on our stock price for the duration of their selling activity. In these situations, selling pressure outweighs buying demand and our stock price declined.

Trading prices of our common stock may fluctuate in response to a number of other events and factors, such as:

 

   

General economic conditions;

 

   

Changes in interest rates;

 

   

Fluctuations in the stock market in general and market prices for high technology companies in particular;

 

   

Quarterly variations in our operating results;

 

   

New products, services, innovations and strategic developments by our competitors or us, or business combinations and investments by our competitors or us;

 

   

Changes in financial estimates by us or securities analysts and recommendations by securities analysts;

 

   

Changes in our capital structure, including issuance of additional debt or equity to the public; and

 

   

Strategic acquisitions.

Any of these events and factors may cause our stock price to rise or fall and may adversely affect our business and financing opportunities.

Some of our production processes and materials are environmentally sensitive, and new environmental regulation could lead to increased costs, or otherwise adversely affect our business, financial condition, and results of operations.

We are subject to a variety of laws and regulations relating to, among other things, the use, storage, discharge and disposal of chemicals, gases and other hazardous substances used in our manufacturing processes, air emissions, waste discharges, waste disposal, the investigation and remediation of soil and ground water contamination, as well as requirements for the design of and materials used in our products. A recent directive in the European Union imposes a “take back” obligation on manufacturers for the financing of the collection, recovery and disposal of electrical and electronic equipment. Additional European legislation has banned the use of some heavy metals including lead and some flame retardants in electronic components beginning in July 2006. We have implemented procedures to comply with this new legislation. However, this legislation may adversely affect our manufacturing costs or product sales by requiring us to acquire costly equipment or materials, or to incur other significant expenses in adapting our manufacturing processes or waste and emission disposal processes. Furthermore, environmental claims or our failure to comply with present or future regulations could result in the assessment of damages or imposition of fines against us, or the suspension of affected operations, which could have an adverse effect on our business, financial condition, and results of operations.

 

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We may be sued by our customers as a result of failures in our data storage products.

We face potential liability for performance problems of our products because our end users employ our storage technologies for the storage and backup of important data and to satisfy regulatory requirements. Although we maintain technology errors and omissions insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could harm our business.

In addition, we could potentially face claims for product liability from our customers if our products cause property damage or bodily injury. Although we maintain general liability insurance, our insurance may not cover potential claims of this type or may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could harm our business.

We must maintain appropriate levels of service inventories. If we have too little service inventory, we may experience increased levels of customer dissatisfaction. If we have too much service inventory, we may incur financial losses.

We maintain levels of service inventories to satisfy future warranty obligations and also to earn service revenue to repair products for which the warranty has expired. We estimate the required amount of service inventories based on historical usage and forecasts of future warranty requirements, including estimates of failure rates and costs to repair, and out of warranty revenue. Given the significant levels of judgment inherently involved in the process, we cannot provide assurance that we will be able to maintain appropriate levels of service inventories to satisfy customer needs and to avoid financial losses from excess inventory charges. If we are unable to maintain appropriate levels of service inventories, our business, financial condition, and results of operations may be materially and adversely impacted.

Because we rely heavily on distributors and other resellers to market and sell our products, if one or more distributors were to experience a significant deterioration in its financial condition or its relationship with us, this could disrupt the distribution of our products and reduce our revenue, which could materially and adversely affect our business, financial condition, and operating results.

In certain product and geographic segments we heavily utilize distributors and value added resellers to perform the functions necessary to market and sell our products. To fulfill this role, the distributor must maintain an acceptable level of financial stability, creditworthiness and the ability to successfully manage business relationships with the customers it serves directly. Under our distributor agreements with these companies, each of the distributors determines the type and amount of our products that it will purchase from us and the pricing of the products that it sells to its customers. If the distributor is unable to perform in an acceptable manner, we may be required to reduce the amount of sales of our product to the distributor or terminate the relationship. We may also incur financial losses for product returns from distributors or for the failure or refusal of distributors to pay obligations owed to us. Either scenario could result in fewer of our products being available to the affected market segments, reduced levels of customer satisfaction and/or increased expenses, which could in turn have a material and adverse impact on our business, results of operations, and financial condition.

If the future outcomes related to the estimates used in recording tax liabilities to various taxing authorities result in higher tax liabilities than estimated, then we would have to record tax charges, which could be material.

We have provided amounts and recorded liabilities for probable and estimable tax adjustments that may be proposed by various taxing authorities in the U.S. and foreign jurisdictions. If events occur that indicate payments of these amounts will be less than estimated, then reversals of these liabilities would create tax benefits being recognized in the periods when we determine the liabilities have reduced. Conversely, if events occur which indicate that payments of these amounts will be greater than estimated, then tax charges and additional liabilities would be recorded. In particular, various foreign jurisdictions could challenge the characterization or transfer pricing of certain intercompany transactions. In the event of an unfavorable outcome of such challenge, there exists the possibility of a material tax charge and adverse impact on the results of operations in the period in which the matter is resolved or an unfavorable outcome becomes probable and estimable.

Maxtor’s failure to perform under its agreements with Quantum could harm our business, financial condition, and operating results.

We may have contingent liabilities for some obligations assumed by Maxtor in connection with the disposition of the Hard Disk Drive group, including liabilities for taxes, real estate and litigation, and Maxtor’s failure to perform under these obligations could result in significant costs to us that could have a materially adverse impact on our business, financial condition, and operating results. In May 2006, Maxtor was acquired by Seagate, which assumed Maxtor’s defense and indemnification obligations.

 

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The disposition of the Hard Disk Drive group may be determined not to be tax-free, which would result in us or our stockholders, or both, incurring a substantial tax liability, which could materially and adversely affect our business, financial condition, and results of operations.

Maxtor and Quantum have agreed not to request a ruling from the Internal Revenue Service, or any state tax authority confirming that the structure of the combination of Maxtor with the Hard Disk Drive group will not result in any federal income tax or state income or franchise tax to Quantum or the previous holders of the Hard Disk Drive common stock. Instead, Maxtor and Quantum have agreed to effect the disposition and the merger on the basis of an opinion from our tax advisor, and a tax opinion insurance policy issued by a syndicate of major insurance companies to us covering up to $340 million of tax loss caused by the disposition and merger.

If the disposition of the Hard Disk Drive group is determined not to be tax-free and the tax opinion insurance policy does not fully cover the resulting tax liability, we or our stockholders or both could incur substantial tax liability, which could materially and adversely affect our business, financial condition, and results of operations. In May 2006, Maxtor was acquired by Seagate, which assumed Maxtor’s defense and indemnification obligations.

The tax opinion insurance policy issued in conjunction with the disposition of the Hard Disk Drive group does not cover all circumstances under which the disposition could become taxable to us, and as a result, we could incur an uninsured tax liability, which could materially and adversely affect our business, financial condition, and results of operations.

In addition to customary exclusions from its coverage, the tax opinion insurance policy does not cover any federal or state tax payable by us if the disposition becomes taxable to us as a result of a change in relevant tax law. We could incur uninsured tax liability, which could materially and adversely affect our business, financial condition, and results of operations.

If we incur an uninsured tax liability as a result of the disposition of the Hard Disk Drive group, our financial condition and operating results could be negatively affected.

If the disposition of the Hard Disk Drive group were determined to be taxable to Quantum, we would not be able to recover an amount to cover the tax liability either from Maxtor or under the insurance policy in the following circumstances:

 

   

If the tax loss were not covered by the policy because it fell under one of the exclusions from coverage under the tax opinion insurance policy described above, insurance proceeds would not be available to cover the loss;

 

   

If the tax loss were caused by our own acts or those of a third party that made the disposition taxable (for instance, an acquisition of control of Quantum which began during the one-year period before and nine-month period following the closing), Maxtor would not be obligated to indemnify us for the amount of the tax liability; or

 

   

If Maxtor were required to reimburse us for the amount of the tax liability according to its indemnification obligations under the Hard Disk Drive group disposition, but was not able to pay the reimbursement in full, we would nevertheless be obligated, as the taxpayer, to pay the tax.

In any of these circumstances, the tax payments due from us could be substantial. In order to pay the tax, we would have to either deplete our existing cash resources or borrow cash to cover our tax obligation. Our payment of a significant tax prior to payment from Maxtor under Maxtor’s indemnification obligations, or in circumstances where Maxtor has no payment obligation, could harm our business, financial condition, and operating results. In May 2006, Maxtor was acquired by Seagate, which assumed Maxtor’s defense and indemnification obligations.

We are exposed to fluctuations in foreign currency exchange rates, and an adverse change in foreign currency exchange rates relative to our position in such currencies could have a materially adverse impact on our business, financial condition, and results of operations.

We do not use derivative financial instruments for hedge or speculative purposes. To minimize foreign currency exposure, we use foreign currency obligations to match and offset net currency exposures associated with certain assets and liabilities denominated in non-functional currencies. Corresponding gains and losses on the underlying transaction generally offset the gains and losses on these foreign currency obligations. We have used in the past, and may use in the future, foreign currency forward contracts to hedge our exposure to foreign currency exchange rates. To the extent that we have assets or liabilities denominated in a foreign currency that are inadequately hedged or not hedged at all, we may be subject to foreign currency losses, which could be significant.

Our international operations can act as a natural hedge when both operating expenses and sales are denominated in local currencies. In these instances, although an unfavorable change in the exchange rate of a foreign currency against the U.S. dollar would result in lower sales when translated to U.S. dollars, operating expenses would also be lower in these circumstances. Also, since an insignificant amount of our current sales are denominated in currencies other than the U.S. dollar, we do not believe that our total foreign exchange rate exposure is significant. Nevertheless, an increase in the rate at which a foreign currency is exchanged for U.S. dollars would require more of that particular foreign currency to equal a specified amount of U.S. dollars than before such rate increase. In such cases, and if we were to price our products and services in that particular foreign currency, we would receive fewer U.S. dollars than we would have received prior to such rate increase for the foreign currency. Likewise, if we were to price our products and services in U.S. dollars while competitors priced their products in a local currency, an increase in the relative strength of the U.S. dollar would result in our prices being uncompetitive in those markets. Such fluctuations in currency exchange rates could materially and adversely affect our business, financial condition, and results of operations.

 

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ITEM 1B. Unresolved Staff Comments

We received comments from the Securities and Exchange Commission (“SEC”) in regard to our Form 10-K for the fiscal year ended March 31, 2006. We responded to these comments on May 11, 2007. Subsequently, we were orally informed by the SEC that we would be receiving an additional comment regarding the fiscal 2006 Form 10-K, but as of our filing date for this Form 10-K for the year ended March 31, 2007, we have not yet received the comment and do not know the nature of the comment.

 

ITEM 2. Properties

Our headquarters are located in San Jose, California. We own or lease facilities in North America, Europe and Asia. The following is a summary of the significant locations and primary functions of those facilities as of March 31, 2007:

 

Location

  

Function

    

North America

     
San Jose, CA    Corporate headquarters, research and development    A
Costa Mesa, CA    Research and development, logistics, manufacturing    A
Irvine, CA    Administration, configuration, service, research and development    A
Santa Maria, CA    Research and development   
Colorado Springs, CO    Operations, research and development, administration    A
Boulder, CO    Research and development    A
Englewood, CO    Research and development, service and operations   
Redmond, WA    Sales, service and administrative offices   
Other North America    Sales offices, research and development   
Europe      
Paris, France    Sales   
Binder, Germany    Operations   
Munich, Germany    Sales, service and administrative offices   
Böehmenkirch, Germany    Service and operations   
Irvine, Scotland    Logistics   
Berkshire, UK    Sales, service and administrative offices   
Wokingham, UK    Warehouse    A
Zurich, Switzerland    Operations and administration   
Other Europe    Sales, service and administrative offices    A
Asia      
Tokyo, Japan    Sales office and media procurement center   
Singapore City, Singapore    Sales and distribution   
Penang, Malaysia    Tape drive and heads manufacturing and customer service    B
Other Asia    Sales offices   

A indicates that a facility is vacant, partially vacant, or sublet.

B indicates ownership of the facility

We believe that our existing facilities are adequate to meet our business needs through the next 12 months. However, there can be no assurance that we will be able to obtain additional space to accommodate future needs or dispose of excess space as required on reasonable terms.

 

ITEM 3. Legal Proceedings

For information regarding legal proceedings, refer to Note 17 “Litigation” to the Consolidated Financial Statements.

 

ITEM 4. Submission of Matters to a Vote of Security Holders

We did not submit any matters to a vote of security holders during the fourth quarter of fiscal 2007.

 

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PART II

 

ITEM 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded on the New York Stock Exchange under the symbol “QTM”. Prior to November 15, 2006, our stock traded under the symbol “DSS”. As of June 1, 2007, the closing price of our common stock was $3.02 per share. The prices per share reflected in the following table represent the range of high and low closing prices for the quarters indicated.

 

Fiscal 2007

   High    Low

First quarter ended June 30, 2006

   $ 3.76    $ 2.59

Second quarter ended September 30, 2006

   $ 2.66    $ 1.94

Third quarter ended December 31, 2006

   $ 2.50    $ 1.98

Fourth quarter ended March 31, 2007

   $ 2.72    $ 2.24

Fiscal 2006

   High    Low

First quarter ended June 27, 2005

   $ 2.96    $ 2.29

Second quarter ended September 26, 2005

   $ 3.17    $ 2.66

Third quarter ended December 26, 2005

   $ 3.19    $ 2.81

Fourth quarter ended March 31, 2006

   $ 3.95    $ 3.02

Historically, we have not paid cash dividends on our common stock and do not intend to pay dividends in the foreseeable future. Our ability to pay dividends is restricted by the covenants in our credit facility.

As of June 1, 2007, there were 1,738 Quantum stockholders of record including the Depository Trust Company, which holds shares of Quantum common stock on behalf of an indeterminate number of beneficial owners.

The information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in our proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of our fiscal year ended March 31, 2007.

On July 30, 2003, we issued an aggregate of $160 million 4.375% convertible subordinated notes due 2010 in a private placement transaction pursuant to Rule 144A under the Securities Act of 1933, as amended. Lehman Brothers, Morgan Stanley and McDonald Investments, Inc. were the initial purchasers of the notes. In connection with the transaction, we paid the initial purchasers an aggregate fee of $4 million. The notes are convertible into common stock of Quantum at any time prior to maturity of the notes at the conversion rate of 229.8851 shares per $1,000 principal amount of the notes. For further discussion of the issuance, see Note 10 “Convertible Subordinated Debt, Short-Term Debt and Long-Term Debt” to the Consolidated Financial Statements of Quantum under Item 8 of this Annual Report on Form 10-K.

 

ITEM 6. Selected Financial Data

This summary of selected consolidated financial information of Quantum for fiscal 2003 to 2007 should be read along with our Consolidated Financial Statements contained in this Annual Report on Form 10-K. On August 22, 2006, we completed the acquisition of Advanced Digital Information Corporation (“ADIC”) and on January 5, 2005, we completed the acquisition of Certance Holdings (“Certance”). On February 4, 2003, we completed the acquisition of SANlight, Inc. (“SANlight”) and on November 13, 2002, we completed the acquisition of Benchmark Storage Innovations, Inc. (“Benchmark”). The selected information below includes the results of operations of our acquisitions from their respective acquisition dates (refer to Note 5 “Acquisitions” to the Consolidated Financial Statements). As a result of the disposition of the network attached storage (“NAS”) business on October 28, 2002, the selected financial information below presents results of the NAS business as discontinued operations. Other items affecting the comparability of selected financial information are described below:

 

   

The results of continuing operations for fiscal 2007 and 2003 included $14.7 million and $7.8 million, respectively, of purchased in-process research and development in connection with the acquisitions of ADIC and SANlight, respectively.

 

   

The results of continuing operations for fiscal 2006 included loss on settlement charges from a legal settlement and cross license agreement of $18.6 million.

 

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The results of continuing operations for fiscal 2003 included a cumulative effect of an accounting change of $94.3 million related to the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets and $58.7 million for a write-off of goodwill related to the Storage Systems business.

 

(In thousands, except per-share data)

   For the year ended March 31,  
     2007     2006     2005     2004     2003  
Statement of Operations Data:           

Product revenue

   $ 902,256     $ 705,606     $ 670,194     $ 677,259     $ 684,156  

Royalty revenue

     113,918       128,681       123,974       131,125       186,653  
                                        

Total revenue

     1,016,174       834,287       794,168       808,384       870,809  

Cost of revenue

     721,889       601,847       558,689       556,725       603,646  

Restructuring charges related to cost of revenue

     900       512       —         —         —    
                                        

Total cost of revenue

     722,789       602,359       558,689       556,725       603,646  
                                        

Gross margin

     293,385       231,928       235,479       251,659       267,163  

Research and development expenses

     115,220       107,407       96,680       103,471       111,926  

Sales and marketing, general and administrative expenses

     178,711       127,367       136,813       152,668       171,720  

Goodwill impairment

     —         —         —         —         58,689  

Restructuring charges

     11,908       18,118       11,521       15,212       24,200  

In-process research and development

     14,700       —         —         —         7,802  
                                        

Loss from operations

     (27,154 )     (20,964 )     (9,535 )     (19,692 )     (107,174 )

Loss from continuing operations

     (64,094 )     (41,479 )     (3,496 )     (63,715 )     (132,088 )

Income (loss) from discontinued operations

     —         —         —         1,693       (37,909 )

Cumulative effect of an accounting change

     —         —         —         —         (94,298 )

Net loss

   $ (64,094 )   $ (41,479 )   $ (3,496 )   $ (62,022 )   $ (264,295 )

Basic and diluted loss per share from continuing operations

   $ (0.33 )   $ (0.23 )   $ (0.02 )   $ (0.36 )   $ (0.81 )

Basic and diluted net loss per share

   $ (0.33 )   $ (0.23 )   $ (0.02 )   $ (0.35 )   $ (1.63 )
     As of March 31,  
     2007     2006     2005     2004     2003  
Balance Sheet Data:           

Property and equipment, net

   $ 50,241     $ 38,748     $ 42,716     $ 40,377     $ 59,092  

Total assets

   $ 1,125,829     $ 663,344     $ 724,614     $ 705,558     $ 921,729  

Short-term debt

   $ 25,000     $ —       $ —       $ 537     $ —    

Long-term debt

   $ 497,500     $ 160,000     $ 160,000     $ 160,000     $ 287,500  

 

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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”) founded in 1980, is a leading global storage company specializing in backup, recovery and archive. Combining focused expertise, customer-driven innovation, and platform independence, we provide a comprehensive, integrated range of disk, tape and software solutions supported by our sales and service organization. We work closely with a broad network of value-added resellers (“VARs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection needs. Our stock is traded on the New York Stock Exchange.

We earn our revenue from the sale of products, systems and services through an array of channel partners to reach end user customers, which range in size from small businesses to government agencies and large, multinational corporations. Our products are sold under both the Quantum brand name and under the names of various OEM customers. We face a variety of challenges and opportunities in responding to the competitive dynamics of the technology market which is characterized by rapid change, evolving customer demands and intense competition, including competition with several companies who are also significant customers.

In August 2006, we acquired Advanced Digital Information Corporation (“ADIC”). The combined company offers a broad range of solutions in this market, providing performance and value to organizations of all sizes, from Global 2000 enterprises to small businesses and satellite offices. We have a broad portfolio of disk-based backup solutions and are a leading provider of tape libraries and autoloaders, as well as a top supplier of tape drives and media. Our data management software provides technology for shared workflow applications and multi-tiered archiving in high-performance, large-scale storage environments. In addition, our service plan includes a broad range of coverage options to provide the level of support for the widest possible range of IT environments, with service available in 180 countries.

In acquiring ADIC, we defined three primary objectives: (1) to expand market access, mainly by building a stronger branded business; (2) to create a stronger growth platform, particularly by expanding our disk-based backup systems and software businesses; and (3) to improve our financial position, taking advantage of the resulting cost synergies and enhanced revenue and profit opportunities.

In measuring our progress toward these objectives, we focused on four areas: (1) growing our branded business to 60 percent of revenue; (2) maintaining our media royalty quarterly revenue in the high $20 million range; (3) driving growth in both disk-based backup systems and in software solutions to deliver $30 million to $40 million in quarterly revenue by the end of fiscal 2008; and (4) generating cash and repaying our debt.

We have been operating as a combined company since late August 2006, and we face many challenges, including intense competition, declining revenue in our legacy tape drive business, continued integration of ADIC and Quantum and significantly increased indebtedness and related interest expense. However, we continue to make progress towards our objectives and are looking forward to the opportunities ahead. Customers’ backup, recovery and archive challenges are complex and rapidly evolving, and the need for a category expert is essential to success. We believe that our global scale and vertical integration in tape products, along with our growing branded strength and decreasing cost structure, position us to build a strong, profitable storage solutions business and improve our results of operations. In both the disk-based backup and software areas, we recently announced new products that leverage the combined technology of both companies and represent execution on our integrated roadmap.

We also see opportunity as several key competitors struggle with the impact of industry consolidation and product transitions. This enables us to capitalize on the strength of the Quantum-ADIC combination to increase our market share in more mature segments of the data storage market and expand our position in growing segments of this market. In general we expect to execute on fewer product programs which are more focused on market segments where we believe there is both growth and expanded margin potential for our business. However, there are numerous risks to the successful execution of our business plans. For a discussion of some of the risks and uncertainties that impact our business, see “Risk Factors” in Item 1A of Part I of this Form 10-K.

In fiscal 2007, we had total net revenues of $1.02 billion. This represented a 22% increase from fiscal 2006 net revenues of $834 million, primarily due to our acquisition of ADIC. Our focus on our branded business during the year, combined with our acquisition of ADIC, is reflected in the greater proportion of branded product revenues throughout fiscal 2007, from 47% of total product revenue in the first quarter, to 52% in the second quarter, to 54% in the third quarter and 57% in the fourth quarter. Overall, revenues from branded products in fiscal 2007 comprised 53% of product revenue compared to 44% of product revenue in the prior year.

 

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Our gross margin percentage increased 110 basis points from 27.8% in fiscal 2006 to 28.9% in fiscal 2007, primarily due to the increase in the percentage of our product sales through branded channels. Sales of branded products typically generate higher gross margins than sales to our OEM customers. Our gross margin on products sold through both branded and OEM channels increased compared to the prior year.

During fiscal 2007, our research and development efforts brought the release of the DXi series products, our first product that integrates and combines key technologies from ADIC and Quantum. The DXi series products encompass Quantum’s patented data de-duplication technology and other improved functionality to enhance our disk-based backup solutions. Other new product offerings during the fiscal year resulting from our research and development efforts included upgrades to our LTO tape platform, new releases of StorNext software, integration of DLT-S4 tape drives into our Scalar libraries and introduction of the SuperLoader 3A professional video audioloader. These efforts were completed while integrating ADIC, reducing overall research and development headcount from the prior year end and limiting research and development expenses to $115.2 million, a 7% increase over the prior year. Going forward, we expect to reduce our overall research and development spending while focusing on product development in growing markets.

Our investment in sales and marketing increased in fiscal 2007 as we integrated ADIC, expanded our sales team and further developed sales channels to support our technologically evolving product lines. General and administrative expenses increased in fiscal 2007, primarily due to additional facilities acquired with ADIC as well as share-based compensation. Our restructuring charges in fiscal 2007 were primarily related to our global integration of ADIC and strategic roadmap decisions. We also had $14.7 million of in-process research and development expense related to the ADIC acquisition. Our operating expenses rose to 31.5% of revenues in fiscal 2007 from 30.3% in fiscal 2006, primarily due to our increased sales and marketing expenditures. Included in our total operating expenses were $15.4 million of intangible amortization and $7.8 million in share-based compensation expense, a $10.0 million and $7.0 million increase from the prior year, respectively.

Interest expense increased in fiscal 2007 as we borrowed $496.5 million for our acquisition of ADIC. We made principal payments of $120.0 million on our revolving credit line in the fourth quarter of fiscal 2007 and $6.2 million in both the third and fourth quarters of fiscal 2007 on our long-term loan. Our revolving credit facility and term debt balance was $362.5 million at March 31, 2007. On April 2, 2007, we borrowed $50 million on the revolving credit line.

In fiscal 2008, we plan to continue to reduce our on-going cost structure by consolidating facilities, reducing workforce and taking other discretionary expense reduction measures. We anticipate seeing additional cost savings from measures taken in fiscal 2007 and from additional implementation of integration savings plans during fiscal 2008.

During fiscal 2007 our operating activities generated positive cash flows of approximately $63.8 million. Our focus on cash management remains a top priority and we reduced our outstanding debt with the cash generated by operations. We continue to emphasize our cash conversion cycle, the duration between the purchase of inventories and services, and the collection of the cash for the sale of our products and services. As of March 31, 2007, we had total cash, cash equivalents and marketable debt securities of approximately $95.6 million, down from the prior fiscal year ending balance of $223.3 million, primarily reflecting the $489.5 million used in investing activities, partially offset by cash provided by financing activities and cash generated from operations. In fiscal 2008, focus on cash management will continue to be a top priority in order to allow us to invest in specified strategic research and development efforts, maintain our sales and service organization and reduce our outstanding debt.

Acquisition of ADIC

On August 22, 2006 (the “Acquisition Date”), we completed our acquisition of ADIC, a publicly traded provider of storage solutions for the open systems marketplace, pursuant to the terms of the Agreement and Plan of Merger (“Merger Agreement”), dated May 2, 2006. ADIC’s results of operations are included in our Consolidated Statements of Operations and Cash Flows from the Acquisition Date. We acquired ADIC to expand our global sales force, market access and product offerings into the enterprise and data management software space.

Pursuant to the Merger Agreement, each outstanding share of ADIC common stock was converted into the right to receive either (a) $12.25 in cash or (b) a number of shares of Quantum common stock equal to the number of ADIC shares of common stock multiplied by 3.461, with ADIC stockholders given the choice to elect to receive cash, stock or a combination of the two. Substantially all stockholders elected to receive cash and we paid $545.4 million in cash, net of cash acquired. We also issued 1.9 million shares of Quantum common stock to those electing shares.

As of August 22, 2006, ADIC had approximately 2.5 million stock options outstanding. Based on the exchange ratio of 5.9756 calculated in accordance with the formula in the Merger Agreement, we assumed the outstanding options of ADIC, which are exercisable for an aggregate of 14.7 million shares of Quantum common stock. The fair value of options assumed was calculated using a Black-Scholes-Merton valuation model. See Notes 4 and 5 to the Consolidated Financial Statements for additional details.

 

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The total purchase price was allocated to ADIC’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill. Goodwill related to this acquisition and the appropriate associated liability are subject to change with regard to completion of the ADIC integration plan and finalizing restructuring costs through the allocation period of up to 12 months from the acquisition date.

The following discussion of our financial condition and results of operations is intended to provide information that will assist in understanding our financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our financial statements.

RESULTS OF OPERATIONS FOR FISCAL 2007, 2006 AND 2005

In previous years, we reported two data storage business segments: Tape Drive and Storage Systems. Beginning with the first quarter of fiscal 2007, we began reporting one business segment as a result of organizational changes. These changes include the integration of marketing, sales and research and development functions to enhance product positioning and to lower the cost platforms within our business. As a result of these integration efforts, discrete financial information for these former segments is no longer tracked below the gross margin level, and management no longer measures operating performance nor makes resource allocation decisions on a segmented basis.

 

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RESULTS OF OPERATIONS

 

(In thousands)

   For the year ended March 31,     Change  
     2007     2006     2005     2007 vs 2006     2006 vs 2005  
           % of
revenue
          % of
revenue
          % of
revenue
          %           %  

Product revenue

   $ 902,256     88.8 %   $ 705,606     84.6 %   $ 670,194     84.4 %   $ 196,650     27.9 %   $ 35,412     5.3 %

Royalty revenue

     113,918     11.2 %     128,681     15.4 %     123,974     15.6 %     (14,763 )   (11.5 )%     4,707     3.8 %
                                                                      

Total revenue

     1,016,174     100.0 %     834,287     100.0 %     794,168     100.0 %     181,887     21.8 %     40,119     5.1 %

Cost of revenue

     721,889     71.0 %     601,847     72.1 %     558,689     70.3 %     120,042     19.9 %     43,158     7.7 %

Restructuring charges related to cost of revenue

     900     0.1 %     512     0.1 %     —       —         388     75.8 %     512     100 %
                                                                      

Total cost of revenue

     722,789     71.1 %     602,359     72.2 %     558,689     70.3 %     120,430     20.0 %     43,670     7.8 %
                                                                      

Gross margin

     293,385         231,928         235,479         61,457     26.5 %     (3,551 )   (1.5 )%

Gross margin rate

     28.9 %       27.8 %       29.7 %          

Operating expenses:

                    

Research and development

     115,220     11.3 %     107,407     12.9 %     96,680     12.2 %     7,813     7.3 %     10,727     11.1 %

Sales and marketing

     126,840     12.5 %     85,388     10.2 %     87,029     11.0 %     41,452     48.5 %     (1,641 )   (1.9 )%

General and administrative

     51,871     5.1 %     41,979     5.0 %     49,784     6.3 %     9,892     23.6 %     (7,805 )   (15.7 )%

Restructuring charges

     11,908     1.2 %     18,118     2.2 %     11,521     1.5 %     (6,210 )   (34.3 )%     6,597     57.3 %

In-process research and development

     14,700     1.4 %     —       —         —       —         14,700     100.0 %     —       —    
                                                                      
     320,539     31.5 %     252,892     30.3 %     245,014     30.9 %     67,647     26.7 %     7,878     3.2 %
                                                                      

Loss from operations

     (27,154 )   (2.7 )%     (20,964 )   (2.5 )%     (9,535 )   (1.2 )%     (6,190 )   29.5 %     (11,429 )   119.9 %

Interest income and other, net

     8,746     0.9 %     11,376     1.4 %     8,612     1.1 %     (2,630 )   (23.1 )%     2,764     32.1 %

Loss on litigation settlement

     —       —         (20,517 )   (2.5 )%     —       —         20,517     100.0 %     (20,517 )   (100.0 )%

Interest expense

     (40,748 )   (4.0 )%     (9,976 )   (1.2 )%     (11,212 )   (1.4 )%     (30,772 )   308.5 %     1,236     (11.0 )%
                                                                      

Loss before income taxes

     (59,156 )   (5.8 )%     (40,081 )   (4.8 )%     (12,135 )   (1.5 )%     (19,075 )   47.6 %     (27,946 )   230.3 %

Income tax provision (benefit)

     4,938     0.5 %     1,398     0.2 %     (8,639 )   (1.1 )%     3,540     253.2 %     10,037     (116.2 )%
                                                                      

Net loss

   $ (64,094 )   (6.3 )%   $ (41,479 )   (5.0 )%   $ (3,496 )   (0.4 )%   $ (22,615 )   54.5 %   $ (37,983 )   N/M  
                                                                      

Percentage columns may not add due to rounding.

 

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Revenue

Fiscal 2007 Compared to Fiscal 2006

Our product revenue, which includes sales of our hardware and software products and services sold through both our Quantum branded and OEM channels, increased in fiscal 2007 compared to fiscal 2006. The revenue increase was primarily due to increased revenue for tape automation systems and to a lesser extent, increased revenues from disk-based backup systems and software compared to the prior year. We also had an increase in our services and other revenues which typically correlate with increases in our installed product base. Offsetting these increases in part were declines in devices and non-royalty media revenue compared to fiscal 2006.

Tape automation system sales increased in fiscal 2007 compared to fiscal 2006 largely due to our acquisition of ADIC. Our midrange tape automation line, including the Scalar i500, was one of the strongest contributors to total systems revenue in fiscal 2007, with sales to both branded and OEM customers. In addition, we had revenue increases from sales of our branded enterprise tape automation products, such as the Scalar i2000 and the PX720.

Revenues from software and disk-based backup systems increased in fiscal 2007 compared to fiscal 2006 primarily due to our acquisition of ADIC. Our StorNext software contributed to increased software revenues while our enterprise class DX-Series products and the PVX were the products primarily contributing to increased disk-based backup system revenues during fiscal 2007.

Product revenue from devices, which includes tape drives and removable hard drives, and non-royalty media sales declined in fiscal 2007 compared to fiscal 2006 due to the continuing retirement of older tape drives, especially our older, entry-level drives sold by OEMs. We also de-emphasized sales of non-royalty media compared to the prior year due to pricing dynamics in the market that would have resulted in lower margins on the non-royalty media products.

Tape media royalties decreased in fiscal 2007 compared to fiscal 2006 due to lower media unit sales sold through our OEM customers. Royalties related to our newer LTO products have been increasing, but at a slower rate than declines in royalties from our maturing DLT products, where we experienced a net reduction in the installed base of DLTtape drives. We expect LTO royalties will continue to increase as the installed base grows and DLT royalties will further decline over time as our installed base continues to decrease.

In the fourth quarter of fiscal 2007, we recorded $3.3 million in royalty revenue in connection with licensing certain of our patents related to our de-duplication technology in a cross-license agreement. We anticipate licensing to select licensing partners in the near term and expanding the licensing partner program based on market demand.

Fiscal 2006 Compared to Fiscal 2005

Product revenue increased in fiscal 2006 compared to fiscal 2005 as a result of higher product revenue from devices offset by lower systems revenue.

Systems revenue declined in fiscal 2006 compared to fiscal 2005 primarily due to decreases in average unit prices and unit sales across most product lines, particularly in the OEM channel. There was a significant decline in revenue from some of our larger OEM customers for some of our older products. This decrease was partially offset by unit sales of the SuperLoader 3 and PX500 series, our storage systems products that started shipping during the second quarter of fiscal 2006. Sales of products introduced in fiscal 2006 and late fiscal 2005 did not gain enough traction to completely offset the decline in the sales of older products.

Product revenue from devices increased in fiscal 2006 compared to fiscal 2005 primarily driven by sales of tape drives acquired through the Certance acquisition, partially offset by decreases in unit shipments across most product lines. Unit sales of the replacement products introduced in fiscal 2006 did not offset the decline in unit sales of older products, such as the VS80 and SDLT 320.

The increase in tape media royalties in fiscal 2006 compared to fiscal 2005 was substantially driven by a significant increase in the media royalty revenue associated with the Certance acquisition, partially offset by lower media unit sales sold through our licensees.

 

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Looking Forward

We anticipate annual revenues of approximately $1.1 billion to $1.2 billion in fiscal 2008. To achieve these increased revenues, we expect our product revenues to increase and our royalty revenue to remain relatively flat. Within our product revenues, we plan to increase our branded product sales in both absolute dollars and as a percentage of product sales. We expect to increase revenues across the majority of our branded product categories; however, we are focusing on the data storage market segments with growth opportunities. Products from our software solutions and our disk-based backup systems are targeted to meet the needs of customers within these growing market segments. In addition to the products that contributed to growth of our software solutions and our disk-based backup systems in fiscal 2007, we anticipate our newer product offerings, such as the DXi-series products, will contribute to revenue increases in the coming fiscal year. Our near term goal is to achieve 60% of product revenues in branded product sales.

Gross Margin

Fiscal 2007 Compared to Fiscal 2006

The increase in gross margin percentage in fiscal 2007 compared to fiscal 2006 was largely due to the acquisition of ADIC, which helped increase the percentage of our product sales through branded channels. Revenues from branded products in fiscal 2007 comprised 53% of product revenue compared to 44% of product revenue in the prior year. Sales of branded products typically generate higher gross margins than sales to our OEM customers. Our overall gross margin percentage increased 110 basis points from 27.8% in fiscal 2006 to 28.9% in fiscal 2007 primarily due to the increase in the percentage of our product sales through branded channels.

Our gross margin on products sold through both branded and OEM channels increased compared to the same periods of the prior year. This improvement in gross margin was partially offset by increases in non-cash expenses such as amortization of intangible assets of $26.6 million as well as increased share-based compensation and amortization of service parts.

Fiscal 2006 Compared to Fiscal 2005

The decrease in gross margin percentage in fiscal 2006 compared to fiscal 2005 reflected a decline in the average unit prices for several of our products, partially offset by sales of higher margin products introduced in fiscal 2006. In particular, average unit prices of our highest volume but older products, such as the ValueLoader and SuperLoader, continued to experience price erosion, causing a deterioration of our gross margins and gross margin rates for those products. This was partially offset by an increase in tape drive sales as a result of the Certance acquisition, partially offset by lower average unit prices for most other products. Average unit prices and sales decreased for our older products, including the VS80 and SDLT 320, while sales of the higher margin products introduced in fiscal 2006 had not gained enough traction to completely offset the decline in sales of these older products. This occurrence, as well as a revenue contribution mix from media royalties to branded tape media due to more media product offerings, contributed to the decrease in the gross margin rate in fiscal 2006 as compared to the previous fiscal year.

Looking Forward

In fiscal 2008, we anticipate improved gross margins as we continue increasing the percentage of sales of our branded products as well as maintaining our efforts to limit costs. Sales of branded products typically generate higher gross margins than sales to our OEM customers. We also expect our gross margins will improve as a result of activities to align our operations infrastructure to support our strategy of focusing on market segments with growth opportunities and reduce investments in areas that have less growth and profit potential.

Research and Development Expenses

Fiscal 2007 Compared to Fiscal 2006

Research and development expenses increased during fiscal 2007 compared to fiscal 2006 primarily due to the acquisition of ADIC. Increases were also attributable to share-based compensation and amortization of intangibles. The increased expenses were partially offset by decreases from cost reduction actions, primarily reduced headcount as we integrated the ADIC acquisition and decreased expenses from product launches completed in the prior fiscal year.

Fiscal 2006 Compared to Fiscal 2005

The increase in research and development expenses in fiscal 2006 compared to fiscal 2005 primarily reflected additional headcount and expenses associated with our Certance acquisition, partially offset by cost reduction actions, including reduced headcount as we integrated Certance and, to a lesser extent, completed new product launches.

 

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Looking Forward

We expect our research and development expenses will decrease slightly in fiscal 2008 as we align our research and development spending with our strategy of growing our business in the growing segments of the data storage solutions market. We intend to emphasize new product development in our software and our disk-based backup systems solutions. We also plan to focus on LTO technology to enhance an already solid position in this growing market and also continue to invest in our enterprise, midrange and entry-level tape automation platforms, resulting in innovative and differentiating technology, features and solutions.

Sales and Marketing Expenses

Fiscal 2007 Compared to Fiscal 2006

The increase in sales and marketing expenses during fiscal 2007 compared to fiscal 2006 was primarily due to the acquisition of ADIC. Increased salaries, benefits and commissions from increased headcount and increased sales costs, especially for our branded products, were the majority of the increase. Sales through branded channels typically have higher selling costs than sales to OEM customers. In addition, amortization of intangibles comprised $9.9 million of the increase for fiscal 2007.

Fiscal 2006 Compared to Fiscal 2005

The decrease in sales and marketing expenses in fiscal 2006 compared to fiscal 2005 reflected a reduction of demo units and the impact of cost reduction actions, including reduced headcount. This was partially offset by increased headcount from the Certance acquisition and increased spending on marketing and consulting programs.

Looking Forward

In fiscal 2008, we expect our sales and marketing expenses will increase commensurate with growth of our branded business as we maintain and expand our customer-facing sales resources.

General and Administrative Expenses

Fiscal 2007 Compared to Fiscal 2006

The increase in general and administrative expenses during fiscal 2007 compared to fiscal 2006 was primarily due to the acquisition of ADIC. Increases were largely due to additional facilities acquired with ADIC as well as share-based compensation. These increases were partially offset by decreased spending on outside services.

Fiscal 2006 Compared to Fiscal 2005

The decrease in general and administrative expenses in fiscal 2006 compared to fiscal 2005 reflected decreased spending for Sarbanes-Oxley related consulting expenses, general cost reduction actions and lower legal costs partially offset by increased headcount from the Certance acquisition.

In-Process Research and Development

During fiscal 2007, we expensed $14.7 million of in-process research and development (“IPR&D”) expense as a result of our acquisition of ADIC in August 2006. The following table summarizes the relevant factors used to determine the amount of in-process research and development (in thousands, except for percentage of completion and discount rate):

 

Fair value of IPR&D

   $  14,700  

Estimated cost to complete technology at time of acquisition

   $ 1,008  

Percentage of completion at time of acquisition

     92 %

Discount rate

     18 %

IPR&D relates to projects associated with the ADIC Scalar i2000 and Scalar i500 products that had not yet reached technological feasibility as of the date of acquisition and have no alternative future use. At the time of acquisition, these projects were expected to be completed within a year. Technological feasibility is established when an enterprise has completed all planning, designing, coding and testing activities that are necessary to establish that a product can be produced to meet its design specifications including functions, features and technical performance requirements.

 

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In accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), all identifiable assets acquired were analyzed to determine their fair value. The value assigned to IPR&D of $14.7 million was determined by considering the importance of each project to our overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows using a discount rate of 18% to their present value based on the percentage of completion of the IPR&D projects.

Interest Income and Other, Net

The decrease in interest income and other, net in fiscal 2007 compared to fiscal 2006 as well as the increase in fiscal 2006 compared to fiscal 2005 were mainly due to a $1.3 million payment received from a funded benefit trust and a $0.7 million refund received from the IRS for FICA withholding during fiscal 2006. Fiscal 2007 had lower interest income due to lower interest earning investments during the year than the prior year. In fiscal 2006 compared to fiscal 2005, there was also an $0.8 million increase in interest income earned from higher yielding investments.

Loss on Litigation Settlement

The loss on settlement in fiscal 2006 was due to an $18.6 million charge from the StorageTek legal settlement and cross license agreement settled in fiscal 2006 and a $1.9 million charge related to another settlement.

Interest Expense

The increase in interest expense in fiscal 2007 compared to fiscal 2006 was due to the new debt facilities entered into during the second quarter of fiscal 2007. We initially borrowed $496.5 million under these facilities. During the third and fourth quarters of fiscal 2007, we made required principal payments and in the fourth quarter of fiscal 2007 made $120.0 million in additional discretionary principal payments, bringing our revolving credit facility and term debt balance to $362.5 million at March 31, 2007. Interest expense also includes the amortization of debt issuance costs for these new debt facilities as well as the write off of unamortized debt issuance costs related to a credit facility that was terminated during the second quarter of fiscal 2007. For further information, refer to Note 10 “Convertible Subordinated Debt, Short-Term Debt and Long-Term Debt” in the Consolidated Financial Statements. The decrease in interest expense in fiscal 2006 compared to fiscal 2005 was mainly due to fewer letters of credit outstanding.

Looking Forward

We borrowed $50 million on our revolving credit facility on April 2, 2007 and anticipate various borrowings and payments on the revolving credit facility during fiscal 2008 as we plan to keep our cash to a minimum. In fiscal 2008, we anticipate our quarterly interest expense will decrease from the quarterly interest expense in the second half of fiscal 2007 as we maintain our efforts to pay down our debt balance and seek to refinance our debt at more favorable terms.

Income Taxes

Fiscal 2007 Compared to Fiscal 2006

The tax expense recorded for the fiscal year ended March 31, 2007 was $4.9 million compared to the tax expense of $1.4 million for the fiscal year ended March 31, 2006. Foreign taxes were higher in fiscal year 2007 due to increased foreign profits and withholding tax on dividend distributions.

In connection with the disposition of our hard-disk drive business, HDD, to Maxtor, we entered into a Tax Sharing and Indemnity Agreement with Maxtor, dated as of April 2, 2001 (the “Tax Sharing Agreement”) that, among other things, defined each company’s responsibility for taxes attributable to periods prior to April 2, 2001. Pursuant to a settlement agreement entered into between the companies dated as of December 23, 2004, Maxtor’s remaining tax indemnity liability under section 3(a) of the Tax Sharing Agreement was limited to $8.8 million. As of March 31, 2007, $6.2 million remains as the indemnity liability. We believe that this amount is sufficient to cover the remaining potential tax liabilities under this section of the Tax Sharing Agreement.

 

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Fiscal 2006 Compared to Fiscal 2005

The tax expense recorded for the fiscal year ended March 31, 2006 was $1.4 million compared to a tax benefit of $8.6 million recorded for the fiscal year ended March 31, 2005. During fiscal 2005, we recorded a tax benefit of $15.6 million offset by a tax expense of $3.5 million related to two discrete items. The $15.6 million tax benefit related to a reduction in the contingent tax accrual resulting from a favorable resolution of the Internal Revenue Service’s audit of our fiscal years ending March 31, 1997, 1998 and 1999. The $3.5 million tax expense related to the U.S. tax anticipated on the company’s declaration of a dividend of earnings from a foreign subsidiary.

Restructuring Charges

During fiscal 2007, management approved and began executing plans to restructure certain operations of Quantum and pre-merger ADIC to eliminate redundant costs resulting from the acquisition of ADIC, implement strategic roadmap decisions and improve efficiencies in operations. In fiscal 2007, 2006 and 2005, we took steps to reduce costs in an effort to return to profitability and rationalize our operations following acquisitions. The restructuring charges that resulted from these cost reduction efforts relate to the outsourcing of certain manufacturing, repair and service operations and consolidation of our operations. Substantial steps have been completed as of March 31, 2007, and the associated costs have been recorded.

The following tables show the type of restructuring expense or (reversal) for fiscal 2007, 2006 and 2005 (in thousands):

 

     For the year ended March 31,
     2007     2006    2005
By expense type        

Severance and benefits

   $ 11,150     $ 15,259    $ 9,465

Facilities

     (1,701 )     2,859      1,996

Research and development programs

     1,230       —        —  

Inventory

     900       512      —  

Fixed assets and other

     1,229       —        60
                     

Total

   $ 12,808     $ 18,630    $ 11,521
                     
By cost reduction actions        

Outsource certain manufacturing, repair and service functions

   $ 2,561     $ 9,027    $ 2,540

Consolidate our operations

     10,247       9,603      8,970

Other general expense reduction

     —         —        11
                     

Total

   $ 12,808     $ 18,630    $ 11,521
                     

Fiscal 2007

We recorded expenses of $11.2 million for severance and benefits associated with eliminating redundancies and streamlining operations identified in all areas of our business during the year ended March 31, 2007 resulting from our evaluation and integration of ADIC and the strategic direction of our business. Approximately 23% of our severance and benefits restructuring charges were related to outsourcing certain manufacturing, repair and service functions, the largest of which is due to closing our Scotland operation. We expect the severance and benefits restructuring charges to be paid to the impacted employees during fiscal 2008.

The $1.7 million facilities reversal resulted from our decision to use a previously vacated Colorado facility in which to consolidate our U.S. manufacturing, repair and service operations. We incurred a $1.2 million charge related to noncancellable purchase commitments related to research and development projects that were cancelled as we implemented strategic roadmap decisions. In addition to the research and development costs, we had $0.9 million of noncancellable purchase commitments for inventory related to planned future generation products that will not be produced. We also had $1.2 million in fixed asset write-offs for tooling and related CIP assets impacted by implementation of our strategic roadmap decisions.

In addition to the restructuring expenses in fiscal 2007, the net restructuring costs associated with exiting activities of pre-merger ADIC were $14.1 million, consisting primarily of severance and benefits costs for employees in a variety of functions throughout the world and, to a lesser extent, excess facilities obligations in the U.S. These costs were recognized as a liability assumed in the purchase business combination and were included in the allocation of the cost to acquire ADIC and, accordingly, resulted in an increase to goodwill rather than an expense in fiscal 2007.

 

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Fiscal 2006

In fiscal 2006, a total of $9.0 million in charges were recorded as severance as a result of the closing of the site in Dundalk, Ireland, and the outsourcing of repair operations in the European region. We classified $0.5 million of the charges associated with this closure as a component of cost of revenue during fiscal 2006. This closure was completed by March 31, 2007.

A charge of $6.7 million was recorded as severance as part of the continuing effort to streamline our IT, product development and marketing processes following the product platform transitions and the consolidation of the marketing function. In addition, a charge of $2.9 million was also recorded for our facility in Colorado Springs, Colorado to reflect changes in lease assumptions as a result of the completion of the sale-leaseback transaction. This facility was subsequently used for operations and reversed in fiscal 2007.

Fiscal 2005

A charge of $2.5 million was recorded primarily for severance as a result of outsourcing certain manufacturing and write-offs of fixed assets related to this plan.

A charge of $5.8 million was recorded primarily for severance benefits and severance related costs, impacting most Quantum functions and locations, particularly for research and development consolidation. In addition, $1.2 million was also recorded for separation costs related to our former Chief Operating Officer. A net charge of $2.0 million was recorded for vacant facilities in the United Kingdom; Boulder, Colorado; Colorado Springs, Colorado and San Jose, California as a result of changes to the original assumptions.

The following tables show the activity and the estimated timing of future payouts for cost reduction plans (in thousands):

 

     Severance and
benefits
    Facilities     Research and
development
programs
    Inventory     Fixed assets
and other
    Total  

Balance as of March 31, 2004

   $ 2,617     $ 4,647     $ —       $ —       $ —       $ 7,264  

Restructuring costs

     11,716       2,441       —         —         60       14,217  

Cash payments

     (8,216 )     (2,879 )     —         —         (60 )     (11,155 )

Non-cash charges and other

     (210 )     284       —         —         —         74  

Restructuring charge reversal

     (2,251 )     (445 )     —         —         —         (2,696 )
                                                

Balance as of March 31, 2005

     3,656       4,048       —         —         —         7,704  

Restructuring costs

     15,704       3,013       —         512         19,229  

Cash payments

     (8,736 )     (3,895 )     —         —           (12,631 )

Non-cash charges and other

     (151 )     (21 )     —         (512 )       (684 )

Restructuring charge reversal

     (427 )     (172 )     —         —         —         (599 )
                                                

Balance as of March 31, 2006

     10,046       2,973       —         —         —         13,019  

Restructuring costs

     29,243       898       1,230       900       1,232       33,503  

Cash payments

     (23,759 )     (1,378 )     (292 )     —         —         (25,429 )

Non-cash charges and other

     150       —         —         (88 )     (1,232 )     (1,170 )

Restructuring charge reversal

     (4,933 )     (1,701 )     —         —         —         (6,634 )
                                                

Balance as of March 31, 2007

   $ 10,747     $ 792     $ 938     $ 812     $ —       $ 13,289  
                                                

Estimated timing of future payouts:

            

Fiscal 2008

   $ 10,747     $ 118     $ 938     $ 812     $ —       $ 12,615  

Fiscal 2009 to 2013

     —         674       —         —         —       $ 674  
                                                
   $ 10,747     $ 792     $ 938     $ 812     $ —       $ 13,289  
                                                

The $13.3 million restructuring accrual as of March 31, 2007 is comprised of obligations for severance and benefits and vacant facilities for both Quantum and pre-merger ADIC in addition to noncancellable purchase obligations for inventory and research and development programs. The severance and benefits charges will be paid during fiscal 2008 as will the noncancellable purchase obligations for inventory and research and development. The facilities charges relating to vacant facilities in Boulder, Colorado; and Basingstoke, United Kingdom will be paid over their respective lease terms, which continue through fiscal 2013. With the acquisition of ADIC in the second quarter of fiscal 2007, we also acquired ADIC’s vacant facilities in Englewood, Colorado and Ithaca, New York. The facilities charges related to the vacant Englewood and Ithaca facilities will be paid over their respective lease terms. The Englewood lease ended in December 2006, and the Ithaca lease continues through fiscal 2012.

 

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In fiscal 2008, we expect to realize approximately $43.2 million of annualized cost savings from various restructuring programs that occurred in fiscal 2007. Of this $43.2 million, approximately $14.3 million of the savings is expected to reflect reduced cost of revenue and the remaining savings reflect reduced operating expenses. The anticipated savings result primarily from employee headcount reductions. However, many factors, including sales mix, reduced sales volumes or price reductions, which have impacted gross margins in the past, and the addition of, or increase in, other operating costs, may offset some or all of these anticipated savings.

Additional charges may be incurred in the future related to these restructurings, particularly if the actual costs associated with restructured activities are higher than estimated. In fiscal 2008, we plan additional implementation of integration savings plans to reduce our on going cost structure by consolidating facilities, reducing workforce and taking other discretionary expense reduction measures. Until we achieve sustained profitability, we may incur additional charges in the future related to additional cost reduction steps. Future charges that we may incur associated with future cost reduction activities are not estimable at this time.

Amortization of Intangible Assets

Amortization expense associated with intangible assets increased in fiscal 2007 compared to fiscal 2006 as a result of our acquisition of ADIC. Amortization expense associated with intangible assets in fiscal 2006 increased compared to fiscal 2005 as a result of our acquisition of Certance.

The following table details intangibles asset amortization expense by classification within our Consolidated Statements of Operations (in thousands):

 

     For the year ended March 31,    Increase (Decrease)  
     2007    2006    2005    2007 vs 2006     2006 vs 2005  

Cost of revenue

   $ 26,567    $ 16,222    $ 13,131    $ 10,345     $ 3,091  

Research and development

     999      581      1,446      418       (865 )

Sales and marketing

     14,217      4,290      3,773      9,927       517  

General and administrative

     209      585      528      (376 )     57  
                                     
   $ 41,992    $ 21,678    $ 18,878    $ 20,314     $ 2,800  
                                     

We assessed the recoverability of our long-lived assets, including intangible assets with finite lives, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets (“SFAS No. 144”), by comparing projected undiscounted net cash flows associated with those assets against their respective carrying amounts to determine whether impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. As of March 31, 2007, our evaluation indicated no such impairment with respect to our acquired intangible assets.

Refer to Note 8 “Goodwill and Intangible Assets” to the Consolidated Financial Statements for further information.

Share-Based Compensation

We adopted SFAS No. 123R, (revised 2004) Share-Based Payment (“SFAS No. 123R”) in the first quarter of fiscal 2007 under the modified prospective method. SFAS No. 123R requires us to expense share-based compensation. Prior to the adoption of SFAS No. 123R, we accounted for our equity incentive plans under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Accordingly, share-based compensation for the years ended March 31, 2006 and 2005 related only to the issuance of restricted stock awards since they were issued at a discount. Share-based compensation recorded for fiscal 2007, 2006 and 2005 was $9.0 million, $0.9 million and $1.4 million, respectively.

 

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The following table summarizes the effects of share-based compensation resulting from the application of SFAS No. 123R to options and restricted stock awards and units granted under our plans and rights to acquire stock under the our purchase plan (in thousands):

 

    

For the year ended

March 31, 2007

Share-based compensation expense included in operations:

  

Cost of revenue

   $ 1,191

Research and development

     2,544

Sales and marketing

     1,965

General and administrative

     3,272
      

Total share-based compensation expense

   $ 8,972
      

The total share-based compensation cost capitalized as part of inventory as of March 31, 2007 was not material. The total share-based compensation cost that would have been capitalized as part of inventory as of March 31, 2006 and 2005 would also not have been material, if we had applied the provisions of SFAS No. 123R. During fiscal 2007, no tax benefit was realized for the tax deduction from option exercises and other awards due to our net operating losses and tax benefit carryforwards.

As of March 31, 2007, there was $7.1 million of total unrecognized compensation costs related to stock options granted under our various share-based plans. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.1 years. Total intrinsic value of options exercised for the year ended March 31, 2007, 2006 and 2005 was $4.1 million, $1.7 million and $0.3 million, respectively. We settle stock option exercises with newly issued common shares.

As of March 31, 2007, there was $3.3 million of total unrecognized compensation costs related to nonvested restricted stock granted under our various share-based plans. The unrecognized compensation cost for restricted stock is expected to be recognized over a weighted-average period of 2.4 years. Total fair value of awards vested during the year ended March 31, 2007, 2006 and 2005 was $0.9 million, $1.3 million and $0.2 million, respectively. We issue new common shares upon vesting of restricted stock units.

For more information regarding Share-Based Compensation, refer to Note 4 “Stock Incentive Plans and Share-Based Compensation” to the Consolidated Financial Statements.

RECENT ACCOUNTING PRONOUNCEMENTS

See Recent Accounting Pronouncements in Note 3 “Summary of Significant Accounting Policies” to the Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

     As of or for the year ended March 31,  
(In thousands, except DSO and Inventory turns)    2007     2006     2005  

Cash and cash equivalents

   $ 60,581     $ 123,298     $ 225,136  

Short-term investments

     35,000       99,975       25,000  
                        

Total cash, cash equivalents and short-term investments

   $ 95,581     $ 223,273     $ 250,136  

Days sales outstanding (DSO)

     58.7       52.7       53.2  

Inventory turns

     7.6       7.7       9.7  

Net cash provided by operating activities

   $ 63,809     $ 3,419     $ 26,260  

Net cash used in investing activities

   $ (489,504 )   $ (115,038 )   $ (19,548 )

Net cash provided by financing activities

   $ 362,978     $ 9,781     $ 3,817  

Fiscal 2007

The difference between reported net loss and cash provided by operating activities was primarily due to non-cash items such as depreciation and amortization, in-process research and development and share-based compensation related to stock incentive plans. The cash used to fund operations during the period was primarily due to an increase in service parts for maintenance and payments on accrued restructuring. This was more than offset by a decrease in accounts receivable and inventories. Service parts for maintenance increased in order to support our growing installed base and meet the Restriction of Hazardous Substances (“RoHS”) compliance requirements in Europe. The cash outflow related to accrued restructuring was primarily due to severance payments made during the year related to restructuring obligations related to our acquisition of ADIC. Accounts receivable decreased primarily due to strong collections in the current year. Inventories decreased as a result of ongoing inventory reduction efforts and reduced inventory levels of certain end of life products. These decreased inventory levels also resulted in a decrease in accounts payable.

Cash used in investing activities during the year ended March 31, 2007 reflects $545.4 million of cash paid, net of cash acquired, for our acquisition of ADIC. Proceeds from the sale of short-term investments of $781.8 million were largely offset by purchases of short-term investments of $714.8 million. Additionally, we purchased $17.2 million of property and equipment and received $6.0 million in proceeds from the sale of our Ireland facility.

Cash provided by financing activities during the year ended March 31, 2007 was primarily related to borrowings of $496.5 million on new credit facilities, less loan fees of $9.8 million. Additionally, we received $10.3 million in net proceeds from the issuance of common stock. These cash proceeds were partially offset by debt repayments of $134.0 million.

Fiscal 2006

Cash provided by operating activities reflected changes in working capital that provided more cash than was used by the loss from operations, adjusted for non-cash items such as depreciation and amortization, deferred income taxes and compensation related to stock incentive plans. The cash that was provided by working capital during the year ended March 31, 2006 was primarily due to a decrease in accounts receivable primarily due to lower revenues in the fourth quarter of the fiscal year and improved DSOs, a decrease in other assets and liabilities primarily due to a receipt of various tax refunds, and an increase in accrued restructuring charges. These changes were partially offset by other working capital usages primarily due to a decrease in accounts payable and a decrease in warranty reserves due to a lower installed based and improved product quality. The cash that was used by the loss from operations, adjusted for non-cash items, included $20 million used to pay for the StorageTek legal settlement and cross license.

Cash used in investing activities during the year ended March 31, 2006 was primarily due to net purchases of short-term investments, purchases of property and equipment and approximately $20 million in payments made in relation to the Certance acquisition.

 

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Cash provided by financing activities during the year ended March 31, 2006 related to net proceeds from the exercise of employee stock options and activity related to the employee stock purchase plan, partially offset by payments of short-term debt.

Fiscal 2005

Cash provided by operating activities reflected cash provided from the loss from operations, adjusted for non-cash items such as depreciation and amortization, deferred income taxes and compensation related to stock incentive plans, partially offset by cash used for working capital changes. The cash that was provided by the loss from operations, adjusted for non-cash items, was $40.4 million. This was partially offset by working capital cash usage due to a decrease in income taxes payable due to a release of IRS related deferred taxes, a decrease in warranty reserves due to a decrease in the installed base, a decrease in other liabilities and accounts payable reflecting the impact of lower levels of operating expenses, partially offset by a decrease in accounts receivable.

Cash used in investing activities during the year ended March 31, 2005 was primarily due to the payments made in relation to the Certance acquisition and purchases of property and equipment, partially offset by net sales of short-term investments, proceeds from sale of a Malaysian facility, and proceeds from sale of an equity investment.

Cash provided by the financing activities of operations in the year ended March 31, 2005 related to proceeds from the exercise of employee stock options and activity related to the employee stock purchase plan, partially offset by principal payments on short-term debt.

Acquisition

On August 22, 2006, pursuant to the Agreement and Plan of Merger (the “Merger Agreement”), dated May 2, 2006, we completed our acquisition of ADIC. Pursuant to the Merger Agreement, each outstanding share of ADIC common stock was converted into the right to receive, at the election of the stockholder, either (a) $12.25 in cash or (b) a number of shares of Quantum common stock equal to the number of ADIC shares of common stock multiplied by 3.461. Substantially all stockholders elected to receive cash, and we paid $545.4 million in cash, net of cash acquired. We also issued 1.9 million shares of Quantum common stock to those electing shares. The cash portion of the merger consideration was funded in part from borrowings under the loans described in the “Long-Term Debt” section below.

Capital Resources and Financial Condition

Although we have been unprofitable in recent fiscal years, we have made progress in reducing operating costs, and we will continue to focus on improving our operating performance, including increasing revenue, reducing costs, and improving margins in an effort to return to consistent profitability and to generate positive cash flows from operating activities. We believe that our existing cash and capital resources will be sufficient to meet all currently planned expenditures, repayment of debt, contractual obligations, and sustain operations for at least the next 12 months. This belief is dependent upon our ability to maintain revenue around current levels, to maintain or improve gross margins and to reduce operating expenses in order to provide net income and positive cash flow from operating activities in the future. This belief also assumes we will not be forced to make any additional significant cash payments or otherwise be impacted by restrictions of available cash associated with our credit facility and our existing letters of credit.

Should any of the above assumptions prove incorrect, either in combination or individually, it would likely have a material negative effect on our cash balances and capital resources. As of March 31, 2007, we had credit available on our credit facility, described further in the “Long-Term Debt” section below.

Generation of positive cash flow from operating activities has historically been an important source of our cash to fund operating needs and, prospectively, will be required for us to fund our business and to meet our current and long-term obligations. We have taken many actions to offset the negative impact of increased competition in our market segments. We cannot provide assurance that the actions we have taken in the past or any actions we may take in the future will ensure a consistent, sustainable and sufficient level of net income and positive cash flow from operating activities to fund, sustain or grow our businesses. Certain events that are beyond our control, including prevailing economic, competitive, and industry conditions, as well as various legal and other disputes, may prevent us from achieving these required financial objectives. Any inability to achieve consistent and sustainable net income and cash flow profiles could result in:

 

(i) Restrictions on our ability to manage or fund our existing operations, which could result in a material and adverse effect on our future results of operations and financial condition.

 

(ii) Unwillingness on the part of our bank group partners who provide our credit line to do any of the following:

 

 

   

Provide a waiver or amendment for any covenant violations we may experience in future periods, thereby triggering a default under and/or termination of the revolving credit line and term loans or

 

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Approve any other amendments of our credit line facility and term loans we might seek to obtain in order to improve our business.

Any lack of renewal, or waiver or amendment, if needed, could result in the credit line and term loans becoming unavailable to us and any amounts outstanding becoming immediately due and payable. In the case of our secured senior credit facility, this would mean $362.5 million is immediately payable.

 

(iii) Further impairment of our financial flexibility, which could require that we raise additional funding in the capital markets sooner than we otherwise would, and on terms less favorable to us, if available at all.

Any of the above mentioned items, individually or in combination, would have a material and adverse effect on our results of operations, available cash and cash flows, financial condition, access to capital and liquidity.

Convertible Subordinated Debt

On July 30, 2003, we issued 4.375% convertible subordinated notes in the aggregate principal amount of $160 million in a private placement transaction. The notes are unsecured obligations subordinated in right of payment to all of our existing and future senior indebtedness. The notes mature on August 1, 2010 and are convertible at the option of the holders at any time prior to maturity into an aggregate of 36.8 million shares of Quantum common stock at a conversion price of $4.35 per share. We cannot redeem the notes prior to August 5, 2008.

Long-Term Debt

In December 2002, we entered into a secured senior credit facility with a group of banks, providing us with a $100 million revolving credit line and a $50 million synthetic lease that contained the same financial covenants as the revolving credit line. In March 2004, we amended the secured senior credit facility to extend the maturity to March 2006 and adjust several covenant requirements. In January 2005, we amended the revolving credit line and the synthetic lease agreement to reflect an acquisition. The revolving credit line was amended to increase it from $100 million to $145 million and to adjust covenant requirements. In October 2005, we amended and restated the revolving credit line to extend the maturity to October 2008, adjust covenant levels and adjust the fee structure. In February 2006, we terminated the $50 million synthetic lease. In August 2006, the revolving credit line was terminated and replaced by the borrowings described below, and we wrote off $0.7 million of unamortized loan fees.

In August 2006, we entered into a secured senior credit facility with a group of lenders providing a $150 million revolving credit line and a $225 million term loan. We also entered into a secured $125 million second lien term loan. On August 22, 2006, we borrowed $445 million, which consisted of $225 million under the term loan, $125 million under the second lien term loan and $95 million borrowed on the revolving credit line,. On August 28, 2006, we borrowed an additional $51.5 million on the revolving credit line. We incurred loan fees of $9.8 million which are included in other long-term assets on the Consolidated Balance Sheets and are being amortized to interest expense over the respective loan terms. On November 27, 2006, we amended the credit facility to adjust covenant levels, adjust prepayment dates and increase the margin on the second lien term loan.

The $225 million term loan matures on August 22, 2012, but is subject to accelerated maturity on April 2, 2010, if we do not refinance to extend the maturity date of, or convert into equity, the existing $160 million convertible debt prior to January 1, 2010. Interest accrues on the term loan at either, at our option, a prime rate plus a margin of 2.15%, or LIBOR plus a margin of 4.00%. Interest is payable quarterly. As of March 31, 2007, the interest rates on the term loan were 9.35% on $87.5 million and $9.32% on the remaining $125 million outstanding. Beginning on December 31, 2006, principal payments on the term loan in an amount equal to $6.25 million are payable quarterly, and after September 30, 2008 principal payments in an amount equal to $0.6 million are payable quarterly with a final payment of all outstanding principal and interest to be paid at maturity. The term loan may be prepaid at any time, subject to an additional payment of 1.0% of the principal amount being prepaid for any prepayment made within one year of closing. As of March 31, 2007, the outstanding balance on the term loan was $212.5 million.

The $125 million second lien term loan matures on August 22, 2013, but is subject to accelerated maturity on May 2, 2010, if we do not refinance to extend the maturity date of, or convert into equity, the existing $160 million convertible debt prior to February 1, 2010. Interest accrues on the second lien term loan at either, at our option, a prime rate plus a margin of 6.75%, or LIBOR plus a margin of 8.25%. As of March 31, 2007, the interest rate on the second lien term loan was 13.60%. Interest on the second lien term loan is payable quarterly. All outstanding principal on the second lien term loan is payable at maturity. On November 27, 2006 we amended the second lien term loan to prohibit prepayment of amounts outstanding until August 22, 2008 and adjusted the prepayment penalties for the periods after that date. As of March 31, 2007, $125 million was outstanding on the second lien term loan.

 

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The revolving credit facility matures on August 22, 2009. Interest accrues on each drawdown of the revolving credit facility at either, at our option, a prime rate plus a margin ranging from 0.0% to 0.80%, depending on our senior leverage ratio, or LIBOR plus a margin ranging from 1.75% to 3.00%, depending on our senior leverage ratio. Interest is payable quarterly.

Amounts not borrowed on the revolving credit facility are subject to an annual unused line fee of between 0.30% and 0.75% on the unused portion of the credit facility. As of March 31, 2007, the interest rate on the revolving credit facility was 8.36% on the borrowed portion. The facility for the revolving loans may be terminated by us at any time without premium or penalty. As of March 31, 2007, $25 million was outstanding on the revolving credit facility. On April 2, 2007, we borrowed an additional $50 million on the revolving credit line at an interest rate of 9.05%.

During fiscal 2007, we made principal payments of $12.5 million on the term loan as required by the agreement. We also made principal payments on the revolving credit line of $121.5 million during fiscal 2007 of which $95 million repaid the amount borrowed on August 22, 2006 and $26.5 million reduced the amount borrowed on August 28, 2006. As of March 31, 2007, the total outstanding borrowed was $362.5 million and $2.3 million was committed to standby letters of credit.

The revolving credit facility, term loan and second lien term loan are secured by a blanket lien on all of our assets and contain certain financial and reporting covenants which we are required to satisfy as a condition of the credit line and term loans including a limitation on issuing dividends. As of March 31, 2007, we were in compliance with all of the covenants.

As of March 31, 2007 and continuing into the first quarter of fiscal 2008 the debt markets have been quite active. We expect this will provide opportunities to refinance our debt at better terms and improved covenants.

Interest Rate Collar

We are obligated under the terms of our credit facility to enter into a hedge agreement or other interest rate management arrangement that provides for not less than 25% of the indebtedness outstanding under our term loans to be subject to a fixed rate of interest over a term of two years. To meet this objective, we entered into an interest rate no cost collar transaction with a financial institution, effective November 15, 2006, that resulted in fixing the interest rate on $87.5 million of our variable rate term loans between a three month LIBOR rate floor of 4.64% and a cap of 5.49% through December 2008. Whenever the three month LIBOR rate is greater than the cap, we receive from the financial institution the difference between 5.49% and the current three month LIBOR rate on the notional amount. Conversely, whenever the three month LIBOR rate is lower than the floor, we remit to the financial institution the difference between 4.64% and the current three month LIBOR rate on the notional amount. As of March 31, 2007, the three month LIBOR rate was within the floor and cap.

During fiscal 2007, this transaction did not meet all of the criteria necessary for hedge accounting prescribed by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). We recorded the change in fair market value in other long-term assets in the Consolidated Balance Sheets and in interest income and other, net in the Consolidated Statements of Operations. As of March 31, 2007, the market value of the interest rate collar was $94,000. We do not engage in hedging activity for speculative or trading purposes.

Off Balance Sheet Arrangements—Synthetic Lease Commitment

Prior to February 2006, we had a five-year synthetic lease agreement with a group of financial institutions (collectively, the “lessor”) for a campus facility in Colorado Springs, Colorado, comprised of three buildings, which would have expired in December 2007. The lease for the three buildings was accounted for as an operating lease in accordance with SFAS No. 13, Accounting for Leases.

In February 2006, we terminated our synthetic lease agreement with the lessor and completed a sale–leaseback transaction for this facility. We sold the facility for $54.3 million and the total gain on this asset was approximately $3.2 million, of which $255,000 and $42,000 was recorded during fiscal 2007 and 2006, respectively. The remaining gain was deferred and is being recognized over the term of our lease. In connection with this sale, we leased the facility from the purchaser pursuant to three leases with initial terms of five, seven and 15 years, respectively. The Contractual Obligations schedule below includes $51.5 million remaining lease obligation for the aggregate base monthly rent for this facility. We expect to receive approximately $2.2 million under noncancellable subleases for portions of this facility through fiscal 2010.

 

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Commitments

The table below summarizes our contractual obligations as of March 31, 2007 (in thousands):

 

     Payments Due by Period
    

Less than

1 year

   1 – 3 years   

More than

3 – 5 years

  

More than

5 years

   Total

Convertible subordinated debt

   $ 7,000    $ 14,000    $ 163,500    $ —      $ 184,500

Long-term debt, including current portion

     70,209      177,934      86,591      321,816      656,550

Purchase obligations

     53,387      —        —        —        53,387

Operating leases

     17,593      26,470      19,178      33,742      96,983
                                  

Total contractual cash obligations

   $ 148,189    $ 218,404    $ 269,269    $ 355,558    $ 991,420
                                  

The contractual commitments include $268.6 million in interest payments on our various debt obligations based on current interest rates. Due to the nature of our agreements, the interest rate can vary over the terms of the loans. In addition to the contractual obligations as of March 31, 2007 as shown above, we borrowed $50 million on our revolving credit line on April 2, 2007 with an interest rate of 9.05%. We also have contractual subleases of $4.1 million which are not shown in the above table.

As of March 31, 2007, we had commitments to provide an additional $1.5 million in capital funding towards investments we currently hold in two limited partnership venture capital funds. Payments are made as capital calls are received, thus we cannot estimate when those payments will be made and have not included these amounts in the above table.

Stock Repurchases

As of March 31, 2007, there was approximately $87.9 million remaining on our authorization to repurchase Quantum common stock. No stock repurchases were made during the fiscal year ended March 31, 2007. Our ability to repurchase common stock is restricted under our credit facilities.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

Our discussion and analysis of the financial condition and results of operations is based on the accompanying Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these statements requires us to make significant estimates and judgments about future uncertainties that affect reported assets, liabilities, revenues and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. In the event that estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. We believe that the following accounting policies require our most difficult, subjective or complex judgments because of the need to make estimates about the effect of matters that are inherently uncertain. The judgments and uncertainties that affect the application of those policies in particular could result in materially different amounts being reported under different conditions or using different assumptions.

Revenue Recognition

Revenue from sales of hardware products to distributors, VARs, OEMs and end-users is recognized when the criteria of Staff Accounting Bulletin No. 104, Revenue Recognition, have been met: when passage of title and risk of ownership are transferred to customers; when persuasive evidence of an arrangement exists; when the price to the buyer is fixed or determinable; and when collection is reasonably assured. When significant post-delivery obligations exist, the related revenue is deferred until such obligations are fulfilled. If there are customer acceptance criteria in the contract, we recognize revenue upon end user acceptance, which typically occurs after delivery and installation are completed.

In the period when the revenue is recognized, allowances are provided for estimated future price adjustments, such as volume rebates, price protection and future product returns. These allowances are based on the customers’ master agreements, programs in existence at the time the revenue is recognized, historical information, contractual limits and plans regarding price adjustments and product returns. Since we have historically been able to reliably estimate the amount of allowances required for future price adjustments and product returns, we recognize revenue, net of projected allowances, upon shipment to our customers. If we were unable to reliably estimate the amount of future price adjustments and product returns in any specific reporting period, then we would be required to defer recognition of the revenue until the right to future price adjustments and product returns lapsed and we were no longer under any obligation to reduce the price or accept the return of the product.

We license certain intellectual property to third party manufacturers under arrangements that are represented by master contracts, allowing these third party manufacturers to manufacture and sell certain of our products. As consideration for licensing the intellectual property, the licensees pay us a per-unit royalty for sales of their products that incorporate the licensed technology. On a periodic basis, the licensees provide us with unit reports that include the quantity of units sold to end users subject to royalties. We recognize revenue based on the unit reports, which are provided to us in a timely fashion. The unit report substantiates that the delivery has occurred. Royalty revenue is measured by multiplying the units sold as reflected in the unit reports by the royalty per unit in accordance with the royalty agreements. Royalty payments are made to us on a per unit basis at a stipulated per unit amount.

 

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Revenue equal to the separately stated price of extended warranty and product service contracts for our hardware products is initially deferred and recognized as revenue ratably over the contract period in accordance with FASB Technical Bulletin 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts. For other arrangements, when elements such as hardware and services are contained in a single arrangement, or in related arrangements with the same customer, we allocate revenue to the separate elements based on relative fair value, provided we have fair value for all elements of the arrangement. If in an arrangement we have fair value for undelivered elements but not the delivered element, we defer the fair value of the undelivered elements and the residual revenue is allocated to the delivered elements. Undelivered elements typically include installation and services. If fair value does not exist for undelivered elements, then revenue for the entire arrangement is deferred until all elements have been delivered. Revenue from software sales is recognized when the criteria of Statement of Position No. 97-2, Software Revenue Recognition (“SOP 97-2”), have been met. These criteria include persuasive evidence of an arrangement, delivery of the software, a fixed and determinable fee, probable collection and vendor-specific objective evidence of fair value for undelivered elements. Vendor-specific objective evidence is typically based on the price charged when an element is sold separately or, if an element is not sold separately, on the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. We recognize revenue from software sales upon delivery provided that there is no customer acceptance clause in the purchase order or contract, there are no significant post-delivery obligations remaining, the price is fixed and collection of the resulting receivable is reasonably assured. When significant post-delivery obligations exist, the related revenue is deferred until such obligations are fulfilled. If there are customer acceptance criteria in the contract, we recognize revenue upon end user acceptance, which typically occurs after delivery and installation are completed. Revenue from postcontract customer support agreements, which entitle customers to both support and upgrades during the term of the agreement, when-and-if available, is recognized ratably over the life of the agreement. EITF Issue No. 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software (“EITF 03-5”), affirms that the revenue recognition guidance in SOP 97-2 also applies to non-software deliverables, such as computer hardware, in an arrangement if the software is essential to the functionality of the non-software deliverables. We do not currently have any non-software deliverables for which software is essential to the functionality.

Share-Based Compensation

In the first quarter of fiscal 2007, we adopted SFAS No. 123R using the modified prospective method, and therefore were not required to restate prior periods’ results. Under this method, for all awards subject to service vesting conditions that are expected to vest, we recognize compensation expense (a) for all equity incentive awards granted prior to, but not yet vested as of April 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and (b) for all equity incentive awards granted, modified or settled subsequent to April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. We recognize the fair value of stock options on a ratable basis over the requisite service periods, which are generally vesting periods.

Determining the appropriate fair-value model and calculating the fair value of share-based awards at the date of grant requires judgment. We use the Black-Scholes-Merton option pricing model to estimate the fair value of employee stock options and rights to purchase shares under stock participation plans, consistent with the provisions of SFAS No. 123R. The Black-Scholes-Merton model requires the use of input assumptions, including expected life, expected volatility, expected dividend rate and expected risk-free rate of return. We estimate expected life of the award based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. We estimate the volatility of our common stock based on the historical volatility over the most recent period corresponding with the estimated expected life of the award. Higher volatility and expected lives result in a proportional increase to share-based compensation determined at the date of grant. The expected dividend rate and expected risk-free rate of return are not as significant to the calculation of fair value. Although the fair value of our share-based awards is determined in accordance with SFAS No. 123R, the Black-Scholes-Merton option pricing model requires the input of highly subjective assumptions and other reasonable assumptions could provide differing results.

Under the provisions of SFAS 123R, the fair value of share-based grants with a market vesting condition must be modeled and valued with a path-dependent valuation technique. We valued certain restricted stock with both market and service vesting conditions that was granted in fiscal 2007 utilizing a Monte Carlo simulation model, and the stock price was simulated using Geometric Brownian Motion, a widely accepted model of stock price behavior used in option pricing models. The primary assumptions used in the valuation models to value our restricted stock with market and service vesting conditions include the time frame of the simulation the volatility rate, the risk-free interest rate and dividend yield. The time frame assumption is based on the grant specifications. We estimate the volatility of our common stock based on the historical volatility over the most recent period corresponding with the time frame assumption. We estimate the risk-free interest rate based on the zero coupon treasury constant maturity rate corresponding with the time frame assumption. Dividend rates are based on our historical experience. The fair value of this restricted stock with market and service vesting conditions is recognized ratably over the three and four years corresponding with the derived requisite service periods for these restricted shares.

In addition, SFAS No. 123R requires us to develop a forfeiture rate which is an estimate of the number of share-based awards that will be forfeited prior to vesting. Quarterly changes in the estimated forfeiture rate can potentially have a significant effect on reported share-based compensation, as the effect of adjusting the forfeiture rate for all expense amortization after April 1, 2006 is recognized in the period the forfeiture estimate is changed.

 

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Warranty Expense and Liability

We generally warrant our products against defects for 3 to 36 months from the date of sale and provide warranty service on tape drives on a return-to-factory basis. Our tape automation systems may carry service agreements available to customers to extend or upgrade the warranty service. We perform services to support warranty and service obligations for tape drives, automation systems and other storage products. We also provide automation systems warranty service from our facilities in Colorado Springs, Colorado and Böehmenkirch, Germany. Jabil Global Service provides screen and repair services in Reynosa, Mexico for North America tape drives and in Szombathely, Hungary for EMEA tape drives. Benchmark Electronics, Inc. (“BEI”) provides automation systems warranty service in Redmond, Washington and Huntsville, Alabama. In addition, we employ various other third party service providers throughout the world that perform tape drive and automation systems services for us.

We estimate future failure rates based upon historical product failure trends as well as anticipated future failure rates if believed to be significantly different from historical trends. Similarly, we estimate future costs of repair based upon historical trends and anticipated future costs if they are expected to significantly differ. We use a model and exercise considerable judgment in determining the underlying estimates. Our model requires an element of subjectivity for all of our products. For example, historical rates of return are not completely indicative of future return rates and we must therefore exercise judgment with respect to future deviations from our historical return rate. When actual failure rates differ significantly from our estimates, we record the impact of these unforeseen costs or cost reductions in subsequent periods and update our assumptions and forecasting models accordingly. As our new products mature and we continue to experience improved quality on our existing products, we are able to improve our estimates with respect to these products. It is reasonably likely that assumptions will be updated for failure rates and, therefore, warranty expense liability in the future.

Similarly, we are in the process of consolidating and outsourcing manufacturing repair sites, which affect the future costs of repair. Our expected costs associated with this outsourcing initiative consist of outsourcing product repairs to third parties, with whom we negotiate on-going outsourcing arrangements, as well as transition costs from in-house repair to outsourcing. If the actual costs were to differ significantly from our estimates, we would record the impact of these unforeseen costs or cost reductions in subsequent periods.

Inventory Valuation

Our inventory is stated at the lower of cost or market, with cost computed on a first-in, first-out basis (“FIFO”). Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolete or impaired balances. Factors influencing these adjustments include decline in demand, rapid technological changes, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if these factors differ from our estimates.

Service Parts for Maintenance

We value our service parts for maintenance at amortized cost less adjustments for excess or obsolete parts, if any. We carry service parts because we generally provide product warranty for 3 to 36 months and earn revenue by providing enhanced warranty and repair service outside this warranty period. Service parts consist of both component parts, which are primarily used to repair defective units, and finished units, which are provided for customer use permanently or on a temporary basis while the defective unit is being repaired. Cost includes direct material, direct labor, overhead and other direct costs. Estimates of excess and obsolete parts involve significant estimates and judgments about the future, including the estimated amount of component parts expected to be consumed in the future warranty and out of warranty service and the estimated number of parts required to meet future customer needs. Amortization of the aggregate service parts is computed on a straight-line basis over the estimated useful life of eight years. Should the technology or our customers’ service needs change and cause an increase or decrease in the estimated useful lives of such service parts, an adjustment to expense would be recorded.

During the second quarter of fiscal 2007, we changed our accounting estimate related to the valuation of service parts for maintenance. Previously, we amortized the value of our finished goods service parts over a five year period and evaluated the difference between cost and market value for our component service parts on a quarterly basis, recording write-downs if the cost exceeded estimated market value. Beginning in the second quarter of fiscal 2007, we are amortizing all of our service parts for maintenance on a straight-line basis over a total life of eight years and will record additional write-downs when excess and obsolete parts not covered by the amortization are identified. This change in estimate reflects our usage of service parts, which are used to support our products during their life cycles as well as generally five years after a product reaches end of life. In addition to this change in estimate, we have also reclassified service parts for maintenance from current assets to long-term assets to reflect the expected life of these assets. During the year ended March 31, 2007, we estimate both our cost of revenue and net loss were higher by $5.5 million compared to what would have been recorded using previous estimates. Our net loss increased $0.03 per share for the year ended March 31, 2007 using the changed estimate.

 

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Goodwill and Intangible Assets

We have a significant amount of goodwill and intangible assets on our balance sheet related to acquisitions. Intangible assets are carried and reported at acquisition cost, net of accumulated amortization subsequent to acquisition. Intangible assets are amortized over the estimated useful lives, which generally range from one to ten years. Intangible assets are reviewed for impairment whenever events or circumstances indicate impairment might exist in accordance with SFAS No. 144. Projected undiscounted net cash flows expected to be derived from the use of those assets are compared to the respective net carrying amounts to determine whether any impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.

The determination of the net carrying value of goodwill and intangible assets and the extent to which, if any, there is impairment are dependent on material estimates and judgments on our part, including the useful life over which the intangible assets are to be amortized, and the estimates of the value of future net cash flows, which are based upon further estimates of future revenues, expenses and operating margins. In applying SFAS No. 142, we review our goodwill annually for impairment in the fourth fiscal quarter, or more frequently when indicators of impairment are present.

Restructuring Charges

In recent periods and over the past several years, we recorded significant restructuring charges related to the realignment and restructuring of our business operations. These charges represent expenses incurred in connection with certain cost reduction programs and acquisition integrations that we have implemented and consist of the cost of involuntary termination benefits, separation benefits, stock compensation charges, facilities charges, asset write-offs and other costs of exiting activities or geographies.

The charges for severance and exit costs require the use of estimates, primarily related to the number of employees paid severance, the amount of severance and related benefits to be paid primarily based on years of service or statutory requirements and the cost of exiting facilities. Facilities exit costs typically require estimates and assumptions related to future maintenance costs, our ability to secure a sub-tenant, if applicable, and any sublease income to be received in the future.

We account for severance and other postemployment benefits resulting from involuntary terminations in accordance with SFAS No. 112, Employers’ Accounting for Postemployment Benefits (“SFAS No. 112”) because we maintain a benefit plan with defined termination benefits from which payment amounts are reasonably estimable. Under SFAS No. 112, we record a severance liability at the time management commits to a plan with sufficient detail to reasonably estimate benefits.

We account for facilities and all other restructuring charges not subject to SFAS No. 112 in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (“SFAS No. 146”). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than at the date of an entity’s commitment to an exit plan. SFAS No. 146 establishes fair value as the objective for initial measurement of the liability. Any employee benefit arrangements not subject to SFAS No. 112 that require future service beyond a minimum retention period are recognized over the future service period. Restructuring charges we have incurred under SFAS No. 146 in recent years include facilities charges, noncancellable purchase commitments related to cost of revenue and noncancellable purchase commitments for operating activities as well as fixed asset write-offs.

Income Taxes

We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”), which requires that deferred tax assets and liabilities be recognized for the effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized.

We have provided a full valuation allowance against our U.S. net deferred tax assets due to our history of net losses, difficulty in predicting future results and our conclusion that we cannot rely on projections of future taxable income to realize the deferred tax assets. In addition, we have provided a full valuation allowance against certain of our international net deferred tax assets. Due to reorganizations in these jurisdictions, it is unclear whether we will be able to realize a benefit from these deferred tax assets.

Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support the reversal of the valuation allowance. Future income tax expense will be reduced to the extent that we have sufficient positive evidence to support a reversal or decrease in this allowance.

 

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We believe that, based on current applicable tax laws, we have provided adequate amounts and recorded liabilities for probable and estimable tax adjustments that may be proposed by various taxing authorities in the U.S. and foreign jurisdictions. These estimated liabilities are recorded on a quarterly basis and estimates are revised based upon new information that was not available at the time of prior estimates. Our estimates have in the past been subject to change and we expect that some of our estimates will be subject to change in the future. While our estimated liabilities are recorded based upon existing tax laws, events may occur in the future that indicate payments of these amounts will be less than estimated, in which event, reversals of these liabilities would create tax benefits that we would recognize in the periods when we determine that the liabilities have been reduced. Conversely, events may occur in the future that indicate that payments of these amounts will be greater than estimated, in which event we would record tax charges and additional liabilities. For example, we may in the future, decide to negotiate with tax authorities regarding our tax liability in a particular jurisdiction, which could result in a different outcome than our estimated liability. In addition, the regulatory audit statute of limitations for a particular jurisdiction may expire without us becoming subject to an audit by that jurisdiction or an audit may occur but result in a smaller tax liability than we had estimated, and we would no longer be required to incur any or all of the liability for that audit, as the case may be.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to a variety of risks, including changes in interest rates and foreign currency fluctuations.

Market Interest Rate Risk

Changes in interest rates affect interest income earned on our cash equivalents and short-term investments and interest expense on short-term and long-term borrowings.

Our cash equivalents and short-term investments consist primarily of money market funds and auction rate securities, respectively, during the fiscal years ended March 31, 2007 and 2006. The main objective of these investments is safety of principal and liquidity while maximizing return, without significantly increasing risk. A hypothetical 100 basis point decrease in interest rates would have resulted in an approximate $0.6 million and $1.2 million decrease in interest income in fiscal 2007 and 2006, respectively.

As of March 31, 2007, our senior credit facilities were comprised of a $150 million revolving credit facility expiring in August 2009, a $225 million term loan expiring in August 2012 and a second lien term loan of $125 million expiring in August 2013. Borrowings under the revolving credit facility and term loans bear interest at either the London interbank offering rate (“LIBOR”) with option periods of one to nine months or a base rate, plus a margin determined by a senior leverage ratio as defined in the credit agreement. A hypothetical 100 basis point increase in interest rates would have resulted in an approximately $3.1 million increase in interest expense in the year ended March 31, 2007, and we had no material outstanding variable rate debt during the year ended March 31, 2006. As of March 31, 2006, our senior credit facilities were comprised of a $145 million revolving credit facility from which we did not have any debt outstanding.

As of March 31, 2007 and March 31, 2006, our outstanding convertible subordinated notes in the aggregate principal amount of $160 million have a fixed interest rate of 4.375% paid semi-annually in February and August, and mature on August 1, 2010 (refer to Note 10 “Convertible Subordinated Debt, Short-Term Debt and Long-Term Debt” to the Consolidated Financial Statements).

We are obligated under the terms of our credit facility to enter into a hedge agreement or other interest rate management arrangement that provides for not less than 25% of the indebtedness outstanding under our term loans to be subject to a fixed rate of interest over a term of two years. To meet this objective, we entered into an interest rate no cost collar transaction with a financial institution, effective November 15, 2006, that resulted in fixing the interest rate on $87.5 million of our variable rate term loans between a three month LIBOR floor of 4.64% and a cap of 5.49% through December 2008. During fiscal 2007, this transaction did not meet all of the criteria necessary for hedge accounting prescribed by SFAS No. 133. As of March 31, 2007, the three month LIBOR rate was within the floor and cap; therefore there was no impact to our interest expense from this interest rate collar. We did not enter into derivative transactions related to our cash equivalents or short-term investments nor for our existing or anticipated liabilities during the year ended March 31, 2006. We do not engage in hedging activity for speculative or trading purposes.

Foreign Currency Exchange Rate Risk

As a multinational corporation, we are exposed to changes in foreign exchange rates. These exposures may change over time and could have a material adverse impact on our financial results. During the fiscal years ended March 31, 2007 and 2006, we did not utilize foreign currency forward contracts to manage the risk of exchange rate fluctuations because we believed that we had a natural hedge through our worldwide operating structure. We do not anticipate any material effect on our consolidated financial position utilizing our current hedging strategy.

 

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ITEM 8. Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Quantum Corporation – Financial Statements

  

Consolidated Statements of Operations for the years ended March 31, 2007, 2006 and 2005

   47

Consolidated Balance Sheets as of March 31, 2007 and 2006

   48

Consolidated Statements of Cash Flows for the years ended March 31, 2007, 2006 and 2005

   49

Consolidated Statements of Stockholders’ Equity for the years ended March 31, 2007, 2006 and 2005

   50

Notes to Consolidated Financial Statements

   51

Reports of Ernst & Young LLP, Independent Registered Public Accounting Firm

   80

Schedule II – Consolidated Valuation and Qualifying Accounts

   82

 

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QUANTUM CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per-share data)

 

     For the year ended March 31,  
     2007     2006     2005  

Product revenue

   $ 902,256     $ 705,606     $ 670,194  

Royalty revenue

     113,918       128,681       123,974  
                        

Total revenue

     1,016,174       834,287       794,168  
                        

Cost of revenue

     721,889       601,847       558,689  

Restructuring charges related to cost of revenue

     900       512       —    
                        

Total cost of revenue

     722,789       602,359       558,689  
                        

Gross margin

     293,385       231,928       235,479  

Operating expenses:

      

Research and development

     115,220       107,407       96,680  

Sales and marketing

     126,840       85,388       87,029  

General and administrative

     51,871       41,979       49,784  

Restructuring charges

     11,908       18,118       11,521  

In-process research and development

     14,700       —         —    
                        
     320,539       252,892       245,014  
                        

Loss from operations

     (27,154 )     (20,964 )     (9,535 )

Interest income and other, net

     8,746       11,376       8,612  

Loss on litigation settlement

     —         (20,517 )     —    

Interest expense

     (40,748 )     (9,976 )     (11,212 )
                        

Loss before income taxes

     (59,156 )     (40,081 )     (12,135 )

Income tax provision (benefit)

     4,938       1,398       (8,639 )
                        

Net loss

   $ (64,094 )   $ (41,479 )   $ (3,496 )
                        

Basic and diluted net loss per share

   $ (0.33 )   $ (0.23 )   $ (0.02 )

Basic and diluted weighted-average common and common equivalent shares

     192,236       184,063       181,111  

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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QUANTUM CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

 

     March 31,
2007
    March 31,
2006
Assets     

Current assets:

    

Cash and cash equivalents

   $ 60,581     $ 123,298

Short-term investments

     35,000       99,975

Accounts receivable, net of allowance for doubtful accounts of $6,431 and $7,843

     149,435       114,020

Inventories

     91,153       88,963

Deferred income taxes

     17,137       7,422

Other current assets

     33,155       30,869
              

Total current assets

     386,461       464,547

Long-term assets:

    

Property and equipment, less accumulated depreciation

     50,241       38,748

Service parts for maintenance, less accumulated amortization

     82,361       57,316

Purchased technology, less accumulated amortization

     106,524       41,237

Other intangible assets, less accumulated amortization

     92,077       8,572

Goodwill

     390,032       47,178

Other long-term assets

     18,133       5,746
              

Total long-term assets

     739,368       198,797
              
   $ 1,125,829     $ 663,344
              
Liabilities and Stockholders’ Equity     

Current liabilities:

    

Accounts payable

   $ 98,757     $ 67,306

Accrued warranty

     30,669       32,422

Accrued compensation

     32,814       24,903

Income taxes payable

     15,490       8,627

Deferred revenue, current

     57,617       22,107

Current portion of long-term debt

     25,000       —  

Accrued restructuring charges

     13,289       13,019

Other accrued liabilities

     55,814       46,825
              

Total current liabilities

     329,450       215,209

Long-term liabilities:

    

Deferred income taxes

     16,751       6,995

Long-term debt

     337,500       —  

Convertible subordinated debt

     160,000       160,000

Deferred revenue, long-term

     27,634       —  

Other long-term liabilities

     53       69
              

Total long-term liabilities

     541,938       167,064

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock:

    

Preferred stock, 20,000,000 shares authorized; no shares issued as of March 31, 2007 and March 31, 2006

     —         —  

Common stock:

    

Common stock, $0.01 par value; 1,000,000,000 shares authorized; 197,816,871 and 188,840,566 shares issued and outstanding as of March 31, 2007 and 2006, respectively

     1,978       1,889

Capital in excess of par value

     306,409       272,690

Retained earnings (deficit)

     (60,472 )     3,622

Accumulated other comprehensive income

     6,526       2,870
              

Stockholders’ equity

     254,441       281,071
              
   $ 1,125,829     $ 663,344
              

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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QUANTUM CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     For the year ended March 31,  
     2007     2006     2005  

Cash flows from operating activities:

      

Net loss

   $ (64,094 )   $ (41,479 )   $ (3,496 )

Adjustments to reconcile net loss to net cash provided by operating activities:

      

Depreciation

     29,416       20,759       22,195  

Amortization

     55,784       22,665       20,270  

In-process research and development

     14,700       —         —    

Gain on Ireland facility closure

     (476 )     —         —    

Deferred income taxes

     1,006       (40 )     2  

Share-based compensation

     8,972       901       1,423  

Fixed assets written off in restructuring

     1,229       —         —    

Common stock received for license fee

     (3,319 )     —         —    

Changes in assets and liabilities, net effects of acquisition:

      

Accounts receivable

     47,667       14,607       18,291  

Inventories

     26,430       (21,872 )     1,152  

Service parts for maintenance

     (19,767 )     (2,100 )     (2,849 )

Accounts payable

     (4,914 )     (14,141 )     (1,520 )

Accrued warranty

     (8,698 )     (5,316 )     (5,044 )

Accrued compensation

     (6,742 )     (3,165 )     (7,666 )

Income taxes payable

     1,305       (1,374 )     (9,264 )

Deferred revenue

     8,425       1,618       2,958  

Accrued restructuring charges

     (13,515 )     5,315       (779 )

Other assets and liabilities

     (9,600 )     27,041       (9,413 )
                        

Net cash provided by operating activities

     63,809       3,419       26,260  

Cash flows from investing activities:

      

Purchases of short-term investments

     (714,758 )     (1,748,925 )     (2,958,185 )

Proceeds from sale of short-term investments

     781,834       1,673,950       2,983,985  

Purchases of property and equipment

     (17,195 )     (20,024 )     (19,792 )

Proceeds from sale of facility

     6,000       —         5,137  

Proceeds from sale of equity investment

     —         —         5,138  

Payments made in connection with business acquisitions, net of cash acquired

     (545,385 )     (20,039 )     (35,831 )
                        

Net cash used in investing activities

     (489,504 )     (115,038 )     (19,548 )

Cash flows from financing activities:

      

Borrowings of long-term debt, net

     486,683       —         —    

Principal payments on debt

     (134,000 )     (1,488 )     (2,048 )

Proceeds from issuance of common stock, net

     10,295       11,269       5,865  
                        

Net cash provided by financing activities

     362,978       9,781       3,817  
                        

Net increase (decrease) in cash and cash equivalents

     (62,717 )     (101,838 )     10,529  

Cash and cash equivalents at beginning of period

     123,298       225,136       214,607  
                        

Cash and cash equivalents at end of period

   $ 60,581     $ 123,298     $ 225,136  
                        

Supplemental disclosure of cash flow information:

      

Cash paid during the year for:

      

Interest

   $ 34,962     $ 10,732     $ 10,820  
                        

Income taxes, net of refunds

   $ 2,515     $ (1,663 )   $ 1,390  
                        

Notes payable issued in respect of M4 Data (Holdings) Ltd. acquisition

   $ —       $ —       $ 1,511  
                        

Deferred gain on sale-leaseback

   $ —       $ 3,140     $ —    
                        

Fair value of stock and options issued in connection with business acquisitions

   $ 14,541     $ —       $ —    
                        

Value of common stock tendered in satisfaction of employees’ income taxes on vesting of employee stock options

   $ 213     $ 351     $ 16  
                        

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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QUANTUM CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

     Common Stock    Capital
in Excess of
Par Value
    Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income
    Total  
     Shares    Amount         

Balances as of March 31, 2004

   180,317    $ 1,804    $ 253,317     $ 48,597     $ 2,831     $ 306,549  

Comprehensive loss:

              

Net loss

   —        —        —         (3,496 )     —         (3,496 )

Other comprehensive income:

              

Foreign currency translation adjustments

   —        —        —         —         342       342  

Comprehensive loss

                 (3,154 )

Shares issued under employee stock purchase plan

   2,191      20      4,630       —         —         4,650  

Shares issued under employee stock incentive plans, net

   1,367      15      1,180       —         —         1,195  

Share-based compensation expense

   —        —        1,423       —         —         1,423  

Tax benefits related to stock option plans

   —        —        20       —         —         20  
                                            

Balances as of March 31, 2005

   183,875      1,839      260,570       45,101       3,173       310,683  

Comprehensive loss:

              

Net loss

   —        —        —         (41,479 )     —         (41,479 )

Other comprehensive loss:

              

Foreign currency translation adjustments

   —        —        —         —         (303 )     (303 )

Comprehensive loss

                 (41,782 )

Shares issued under employee stock purchase plan

   2,148      22      5,145       —         —         5,167  

Shares issued under employee stock incentive plans, net

   2,818      28      6,074       —         —         6,102  

Share-based compensation expense

   —        —        901       —         —         901  
                                            

Balances as of March 31, 2006

   188,841      1,889      272,690       3,622       2,870       281,071  

Comprehensive loss:

              

Net loss

   —        —        —         (64,094 )     —         (64,094 )

Other comprehensive income:

              

Foreign currency translation adjustments

   —        —        —         —         3,656       3,656  

Comprehensive loss

                 (60,438 )

Shares issued under employee stock purchase plan

   2,451      24      4,110       —         —         4,134  

Shares issued under employee stock incentive plans, net

   4,650      46      6,921       —         —         6,967  

Shares issued in connection with business acquisitions

   1,875      19      4,051       —         —         4,070  

Stock options assumed in connection with business acquisition

   —        —        10,471       —         —         10,471  

Share registration costs

   —        —        (806 )     —         —         (806 )

Share-based compensation expense

   —        —        8,972       —         —         8,972  
                                            

Balances as of March 31, 2007

   197,817    $ 1,978    $ 306,409     $ (60,472 )   $ 6,526     $ 254,441  
                                            

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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QUANTUM CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1: Description of Business

Quantum Corporation (“Quantum”, the “Company”, “us” or “we”) (NYSE:QTM), founded in 1980, is a leading global storage company specializing in backup, recovery and archive solutions. Combining focused expertise, customer-driven innovation, and platform independence, we provide a comprehensive, integrated range of disk, tape and software solutions supported by our sales and service organization. We work closely with a broad network of value-added resellers (“VARs”), original equipment manufacturers (“OEMs”) and other suppliers to meet customers’ evolving data protection needs. Our stock is traded on the New York Stock Exchange.

Note 2: Basis of Presentation

The accompanying Consolidated Financial Statements include the accounts of Quantum and our wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated.

In previous years, we reported two business segments: Tape Drive and Storage Systems. Beginning with the first quarter of fiscal 2007, we report one business segment as a result of organizational changes. These changes include the integration of marketing, sales and research and development functions to enhance the product positioning and to lower the cost platforms within our business. As a result of these integration efforts, discrete financial information for these former segments is no longer tracked below the gross margin level; management no longer measures operating performance nor makes resource allocation decisions on a segmented basis.

On August 22, 2006, we completed our acquisition of Advanced Digital Information Corporation (“ADIC”). ADIC’s results of operations and cash flows are included in our Consolidated Statements of Operations and Cash Flows from this date.

During the second quarter of fiscal 2007, we changed our accounting estimate related to the valuation of service parts for maintenance. Previously, we amortized the value of our finished goods service parts over a five year period and evaluated the difference between cost and market value for our component service parts on a quarterly basis, recording write-downs if the cost exceeded estimated market value. Beginning in the second quarter of fiscal 2007, we are amortizing all of our service parts for maintenance on a straight-line basis over a total life of eight years and will record additional write-downs when excess and obsolete parts not covered by the amortization are identified. This change in estimate reflects our usage of service parts, which are used to support our products during their life cycles as well as generally five years after a product reaches end of life. In addition to this change in estimate, we have also reclassified service parts for maintenance from current assets to long-term assets to reflect the expected life of these assets. During the year ended March 31, 2007, we estimate both our cost of revenue and net loss were higher by $5.5 million compared to what would have been recorded using previous estimates. Our net loss increased $0.03 per share for the year ended March 31, 2007 using the changed estimate. See Note 3 below for a description of our accounting policy regarding amortization of service parts for maintenance.

Certain prior period balances in the Consolidated Balance Sheets have been reclassified to conform to current period presentation. In addition to the service parts for maintenance reclassification described above, in the Consolidated Balance Sheets we reclassified other long-term liabilities from other accrued liabilities. These reclassifications have no effect on total assets, stockholders’ equity, net loss or cash flows as previously presented.

Note 3: Summary of Significant Accounting Policies

Use of Estimates

The preparation of our Consolidated Financial Statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. We base estimates on historical experience and on various assumptions about the future that are believed to be reasonable based on available information. Our reported financial position or results of operations may be materially different under different conditions or when using different estimates and assumptions, particularly with respect to critical accounting policies, which are discussed below. In the event that estimates or assumptions prove to differ from actual results, adjustments are made in subsequent periods to reflect more current information.

 

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Revenue Recognition

Revenue from sales of hardware products to distributors, VARs, OEMs and end-users is recognized when the criteria of Staff Accounting Bulletin No. 104, Revenue Recognition, have been met: when passage of title and risk of ownership are transferred to customers; when persuasive evidence of an arrangement exists; when the price to the buyer is fixed or determinable; and when collection is reasonably assured. When significant post-delivery obligations exist, the related revenue is deferred until such obligations are fulfilled. If there are customer acceptance criteria in the contract, we recognize revenue upon end user acceptance, which typically occurs after delivery and installation are completed.

In the period when the revenue is recognized, allowances are provided for estimated future price adjustments, such as volume rebates, price protection, and future product returns. These allowances are based on the customers’ master agreements, programs in existence at the time the revenue is recognized, historical information, contractual limits and plans regarding price adjustments and product returns. Since we have historically been able to reliably estimate the amount of allowances required for future price adjustments and product returns, we recognize revenue, net of projected allowances, upon shipment to our customers. If we were unable to reliably estimate the amount of future price adjustments and product returns in any specific reporting period, then we would be required to defer recognition of the revenue until the right to future price adjustments and product returns lapsed and we were no longer under any obligation to reduce the price or accept the return of the product.

We license certain intellectual property to third party manufacturers under arrangements that are represented by master contracts, allowing these third party manufacturers to manufacture and sell certain of our products. As consideration for licensing the intellectual property, the licensees pay us a per-unit royalty for sales of their products that incorporate the licensed technology. On a periodic basis, the licensees provide us with unit reports that include the quantity of units sold to end users subject to royalties. We recognize revenue based on the unit reports, which are provided to us in a timely fashion. The unit report substantiates that the delivery has occurred. Royalty revenue is measured by multiplying the units sold as reflected in the unit reports by the royalty per unit in accordance with the royalty agreements. Royalty payments are made to us on a per unit basis at a stipulated per unit amount.

Revenue equal to the separately stated price of extended warranty and product service contracts for our hardware products is initially deferred and recognized as revenue ratably over the contract period in accordance with FASB Technical Bulletin 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts. For other arrangements, when elements such as hardware and services are contained in a single arrangement, or in related arrangements with the same customer, we allocate revenue to the separate elements based on relative fair value, provided we have fair value for all elements of the arrangement. If in an arrangement we have fair value for undelivered elements but not the delivered element, we defer the fair value of the undelivered elements and the residual revenue is allocated to the delivered elements. Undelivered elements typically include installation and services. If fair value does not exist for undelivered elements, then revenue for the entire arrangement is deferred until all elements have been delivered.

Revenue from software sales is recognized when the criteria of Statement of Position No. 97-2, Software Revenue Recognition (“SOP 97-2”), have been met. These criteria include persuasive evidence of an arrangement, delivery of the software, a fixed and determinable fee, probable collection and vendor-specific objective evidence of fair value for undelivered elements. Vendor-specific objective evidence is typically based on the price charged when an element is sold separately or, if an element is not sold separately, on the price established by authorized management, if it is probable that the price, once established, will not change before market introduction. We recognize revenue from software sales upon delivery provided that there is no customer acceptance clause in the purchase order or contract, there are no significant post-delivery obligations remaining, the price is fixed and collection of the resulting receivable is reasonably assured. When significant post-delivery obligations exist, the related revenue is deferred until such obligations are fulfilled. If there are customer acceptance criteria in the contract, we recognize revenue upon end user acceptance, which typically occurs after delivery and installation are completed. Revenue from postcontract customer support agreements, which entitle customers to both support and upgrades during the term of the agreement, when-and-if available, is recognized ratably over the life of the agreement. EITF Issue No. 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software (“EITF 03-5”), affirms that the revenue recognition guidance in SOP 97-2 also applies to non-software deliverables, such as computer hardware, in an arrangement if the software is essential to the functionality of the non-software deliverables. We do not currently have any non-software deliverables for which software is essential to the functionality.

 

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Warranty Expense and Liability

We generally warrant our products against defects for 3 to 36 months from the date of sale and provide warranty service on tape drives on a return-to-factory basis. Our tape automation systems may carry service agreements available to customers to extend or upgrade the warranty service. We perform services from our Penang, Malaysia facility to support warranty and service obligations for tape drives, automation systems and other storage products. We also provide automation systems warranty service from our facilities in Colorado Springs, Colorado, and Böehmenkirch, Germany. Jabil Global Service provides screen and repair services in Reynosa, Mexico for North America tape drives and in Szombathely, Hungary for EMEA tape drives. BEI provides automation systems warranty service in Redmond, Washington and Huntsville, Alabama. In addition, we employ various other third party service providers throughout the world that perform tape drive and automation systems services for us.

We estimate future failure rates based upon historical product failure trends as well as anticipated future failure rates if believed to be significantly different from historical trends. Similarly, we estimate future costs of repair based upon historical trends and anticipated future costs if they are expected to significantly differ. We use a model and exercise considerable judgment in determining the underlying estimates. Our model requires an element of subjectivity for all of our products. For example, historical rates of return are not completely indicative of future return rates and we must therefore exercise judgment with respect to future deviations from our historical return rate. When actual failure rates differ significantly from our estimates, we record the impact of these unforeseen costs or cost reductions in subsequent periods and update our assumptions and forecasting models accordingly. As our new products mature and we continue to experience improved quality on our existing products, we are able to improve our estimates with respect to these products. It is reasonably likely that assumptions will be updated for failure rates and, therefore, warranty expense liability in the future.

Share-Based Compensation

Effective April 1, 2006, we adopted the provisions of SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R requires employee stock options and rights to purchase shares under stock participation plans to be accounted for under the fair value method and requires the use of an option pricing model for estimating fair value. Accordingly, share-based compensation is measured at the grant date, based on the fair value of the award. The exercise price of options is equal to the market price of our common stock on the date of grant. In prior fiscal years, we accounted for awards granted under our equity incentive plans under the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), and related interpretations, and provided the required pro forma disclosures prescribed by SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), as amended. Prior to the adoption of SFAS No. 123R, only share-based compensation related to the issuance of restricted stock awards was recognized in the Consolidated Statements of Operations, since the restricted stock awards were issued at a discount.

We adopted SFAS No. 123R using the modified prospective method, which does not require prior periods’ results to be restated. Under this method, for all awards subject to service vesting conditions that are expected to vest, we recognize compensation expense (a) for all equity incentive awards granted prior to, but not yet vested as of April 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and (b) for all equity incentive awards granted, modified or settled subsequent to April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. We recognize the fair value of stock options on a ratable basis over the requisite service periods, which are generally the vesting periods.

Determining the appropriate fair-value model and calculating the fair value of share-based awards at the date of grant requires judgment. We use the Black-Scholes-Merton option pricing model to estimate the fair value of employee stock options and rights to purchase shares under stock participation plans, consistent with the provisions of SFAS No. 123R. The Black-Scholes-Merton model requires the use of input assumptions, including expected life, expected volatility, expected dividend rate and expected risk-free rate of return. We estimate expected life of the award based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules and pre-vesting and post-vesting forfeitures. We estimate the volatility of our common stock based on the historical volatility over the most recent period corresponding with the estimated expected life of the award. Higher volatility and expected lives result in a proportional increase to share-based compensation determined at the date of grant. The expected dividend rate and expected risk-free rate of return are not as significant to the calculation of fair value. Although the fair value of our share-based awards is determined in accordance with SFAS No. 123R, the Black-Scholes-Merton option pricing model requires the input of highly subjective assumptions, and other reasonable assumptions could provide differing results.

 

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Under the provisions of SFAS 123R, the fair value of share-based grants with a market vesting condition must be modeled and valued with a path-dependent valuation technique. We valued certain restricted stock with both market and service vesting conditions that was granted in fiscal 2007 utilizing a Monte Carlo simulation model, and the stock price was simulated using Geometric Brownian Motion, a widely accepted model of stock price behavior used in option pricing models. The primary assumptions used in the valuation models to value our restricted stock with market and service vesting conditions include the time frame of the simulation, the volatility rate, the risk-free interest rate and dividend yield. The time frame assumption is based on the grant specifications. We estimate the volatility of our common stock based on the historical volatility over the most recent period corresponding with the time frame assumption. We estimate the risk-free interest rate based on the zero coupon treasury constant maturity rate corresponding with the time frame assumption. Dividend rates are based on our historical experience. The fair value of this restricted stock with market and service vesting conditions is recognized ratably over the three and four years corresponding with the derived requisite service periods for these restricted shares.

In addition, SFAS No. 123R requires us to develop a forfeiture rate which is an estimate of the number of share-based awards that will be forfeited prior to vesting. Quarterly changes in the estimated forfeiture rate can potentially have a significant effect on reported share-based compensation, as the effect of adjusting the forfeiture rate for all expense amortization after April 1, 2006 is recognized in the period the forfeiture estimate is changed. During fiscal 2007 our forfeiture rate remained consistent and there was no forfeiture rate adjustment impact.

Shipping and Handling Fees

Shipping and handling fees are included in cost of revenue and were $34.8 million, $25.4 million and $20.7 million in fiscal 2007, 2006 and 2005, respectively.

Advertising Expense

We expense advertising costs as incurred. Advertising expense for the years ended March 31, 2007, 2006 and 2005 was $9.3 million, $11.0 million and $9.6 million, respectively.

Research and Development Costs

Expenditures relating to the development of new products and processes are expensed as incurred. These costs include expenditures for employee compensation, materials used in the development effort, other internal costs, as well as expenditures for third party professional services. We have determined that technological feasibility for our software products is reached shortly before the products are released to manufacturing. Costs incurred after technological feasibility is established have not been material and we have expensed all software-related research and development costs when incurred.

Cash Equivalents, Short-Term Investments and Other Investments

We consider all highly liquid debt instruments with a maturity of 90 days or less at the time of purchase to be cash equivalents. Cash equivalents are carried at fair value, which approximates their cost.

Investments in marketable debt securities with maturities of greater than three months at the time of purchase are classified as short-term investments. These investments generally consist of highly marketable securities that are intended to be available to meet current cash requirements. All of our investments are classified as available-for-sale and are carried at fair market value. Realized gains and losses and declines in value judged to be other-than-temporary are recorded in interest income and other, net. The cost of securities sold is based on the specific identification method.

We also hold investments in privately held technology companies and private technology venture limited partnerships. These investments individually represent voting ownership interests of less than 20%. Ownership interests in private technology limited partnerships are accounted for under the equity method unless our interest is so minor (typically less than 5%) that we have virtually no influence over the partnership operating and financial policies, in which case the cost method is used. Currently, our investments in private technology limited partnerships are accounted for using the equity method.

Our investments in other privately held companies are accounted for under the cost method. We review these non-marketable equity investments on a regular basis to determine if there has been any impairment of value which is other than temporary by reviewing their financial information, gaining knowledge of any new financing or other business agreements and assessing their operating viability.

 

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Allowance for Doubtful Accounts

We perform ongoing credit evaluations of our customers’ financial condition and generally require no collateral from our customers. These evaluations require significant judgment and are based on multiple sources of information and analyze such factors as our historical bad debt experiences, industry and geographic concentrations of credit risk, current economic trends and changes in customer payment terms. We maintain an allowance for doubtful accounts based on historical experience and expected collectibility of outstanding accounts receivable. We record bad debt expense in general and administrative expenses.

Inventory Valuation

Our inventory is stated at the lower of cost or market, with cost computed on a first-in, first-out basis (“FIFO”). Adjustments to reduce the cost of inventory to its net realizable value, if required, are made for estimated excess, obsolete or impaired balances. Factors influencing these adjustments include decline in demand, rapid technological changes, product life cycle and development plans, component cost trends, product pricing, physical deterioration and quality issues. Revisions to these adjustments would be required if these factors differ from our estimates.

Property and Equipment

Property and equipment are carried at cost, less accumulated depreciation and amortization, computed on a straight-line basis over the estimated useful lives of the assets as follows:

 

Buildings

   25 years

Machinery and equipment

   3 to 7 years

Computer equipment

   3 to 5 years

Software

   3 to 10 years

Furniture and fixtures

   7 years

Other office equipment

   5 to 10 years

Leasehold improvements

   Life of lease

Service Parts for Maintenance

We value our service parts for maintenance at amortized cost less adjustments for excess or obsolete parts, if any. We carry service parts because we generally provide product warranty for 3 to 36 months and earn revenue by providing enhanced warranty and repair service outside this warranty period. Service parts consist of both component parts, which are primarily used to repair defective units, and finished units, which are provided for customer use permanently or on a temporary basis while the defective unit is being repaired. Cost includes direct material, direct labor, overhead and other direct costs. Estimates of excess and obsolete parts involve significant estimates and judgments about the future, including the estimated amount of component parts expected to be consumed in the future warranty and out of warranty service and the estimated number of parts required to meet future customer needs. Amortization of the aggregate service parts is computed on a straight-line basis over the estimated useful life of eight years. Should the technology or our customers’ service needs change and cause an increase or decrease in the estimated useful lives of such service parts, an adjustment to expense would be recorded.

Goodwill and Intangible Assets

Goodwill is reviewed for impairment annually in the fiscal fourth quarter, or more frequently when indicators of impairment are present. Refer to Note 8 “Goodwill and Intangible Assets” for a discussion of the impact of applying Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets.

Intangible assets are carried and reported at acquisition cost, net of accumulated amortization subsequent to acquisition. Intangible assets are amortized over their estimated useful lives, which range from one to ten years. Intangible assets are reviewed for impairment whenever events or circumstances indicate impairment might exist in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. Projected undiscounted net cash flows expected to be derived from the use of those assets are compared to the respective net carrying amounts to determine whether any impairment exists. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.

 

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Restructuring Charges

In recent periods and over the past several years, we recorded significant restructuring charges related to the realignment and restructuring of our business operations. These charges represent expenses incurred in connection with certain cost reduction programs and acquisition integrations that we have implemented and consist of the cost of involuntary termination benefits, separation benefits, stock compensation charges, facilities charges, asset write-offs and other costs of exiting activities or geographies.

The charges for severance and exit costs require the use of estimates, primarily related to the number of employees paid severance, the amount of severance and related benefits to be paid primarily based on years of service or statutory requirements and the cost of exiting facilities. Facilities exit costs typically require estimates and assumptions related to future maintenance costs, our ability to secure a sub-tenant, if applicable, and any sublease income to be received in the future.

We account for severance and other postemployment benefits resulting from involuntary terminations in accordance with SFAS No. 112, Employers’ Accounting for Postemployment Benefits (“SFAS No. 112”) because we maintain a benefit plan with defined termination benefits from which payment amounts are reasonably estimable. Under SFAS No. 112, we record a severance liability at the time management commits to a plan with sufficient detail to reasonably estimate benefits.

We account for facilities and all other restructuring charges not subject to SFAS No. 112 in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, (“SFAS No. 146”). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred rather than at the date of an entity’s commitment to an exit plan. SFAS No. 146 establishes fair value as the objective for initial measurement of the liability. Any employee benefit arrangements not subject to SFAS No. 112 that require future service beyond a minimum retention period are recognized over the future service period. Restructuring charges we have incurred under SFAS No. 146 in recent years include facilities charges, noncancellable purchase commitments related to cost of revenue and noncancellable purchase commitments for operating activities as well as fixed asset write-offs. Only costs resulting from an exit plan that were not associated with, or that did not benefit activities that would be continued, were eligible for recognition as liabilities at the commitment date.

Income Taxes

We account for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”), which requires that deferred tax assets and liabilities be recognized for the effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.

Concentration of Credit Risk

We invest our excess cash in deposits with major banks and in money market funds and short-term debt securities of companies with strong credit ratings from a variety of industries. These securities generally mature within 365 days and, therefore, bear minimal risk. We have not experienced any material losses on these investments and limit the amount of credit exposure to any one issuer and to any one type of investment.

We sell products to customers in a wide variety of industries on a worldwide basis. In countries or industries where we are exposed to material credit risk, we require collateral, including cash deposits, letters of credit and/or credit insurance, prior to the completion of a transaction. We do not believe there is a credit risk beyond that provided for in the financial statements in the ordinary course of business.

Sales to the top five customers in fiscal 2007 represented 42% of revenue compared to 49% of revenue in fiscal year 2006 and 52% of revenue in fiscal 2005. Sales to Dell were 20% of revenue in fiscal 2007, compared to 18% of revenue in fiscal 2006 and 17% of revenue in fiscal 2005. Sales to Hewlett-Packard (“HP”) were 9% of revenue in fiscal 2007, compared to 18% of revenue in fiscal 2006 and 22% of revenue in fiscal 2005. These sales concentrations do not include revenues from sales of media that were sold directly to these customers by our licensees, for which we earn royalty revenue, or revenues from sales of tape libraries sold directly to these customers by our other OEM tape drive customers.

 

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Foreign Currency Translation and Transactions

Assets, liabilities and operations of foreign offices and subsidiaries are recorded based on the functional currency of the entity. For a majority of our material foreign operations, the functional currency is the U.S. dollar. The assets and liabilities of foreign offices with a local functional currency are translated, for consolidation purposes, at current exchange rates from the local currency to the reporting currency, the U.S. dollar. The resulting gains or losses are reported as a component of other comprehensive income within stockholders’ equity. Although approximately one third of our sales are made to customers in non-U.S. locations, a majority of our material transactions are denominated in U.S. dollars. Accordingly, transaction gains or losses have been immaterial to our Consolidated Financial Statements for all years presented. The effect of foreign currency exchange rate fluctuations on cash was also immaterial for the years presented. Assets and liabilities denominated in other than the functional currency are remeasured each month with the remeasurement gain or loss recorded in interest income and other, net. The effect of this remeasurement was immaterial to our Consolidated Financial Statements for all years presented.

Derivative Financial Instruments

In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activity (“SFAS No. 133”), all derivatives, whether designated in hedging relationships or not, are recognized on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item are recognized in earnings. If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in the income statement when the hedged item affects earnings. Derivatives not designated or qualifying as a hedging instrument are adjusted to fair value through earnings. We may, from time to time, enter into derivative instruments to hedge against known or forecasted market exposures. We may also enter into derivative instruments to meet the requirements of our credit facility.

Risks and Uncertainties

As is typical in the information storage industry, a significant portion of our customer base is concentrated among a small number of OEMs. The loss of any one of our more significant customers, or a significant decrease in the sales volume with one of these significant customers, could have a material adverse effect on our results of operations and financial condition. Furthermore, if general economic conditions were to worsen, the resulting effect on IT spending could also have a material adverse effect on our results of operations and financial condition. We also face future uncertainties since HP, one of our OEM customers, also owns competing LTO tape drive and media.

A limited number of tape drive storage products make up a significant majority of our sales, and due to increasingly rapid technological change in the industry, our future operating results depend on our ability to develop and successfully introduce new products.

Our main supplier of tape heads is located in China. Political instability, trade restrictions, changes in tariff or freight rates or currency fluctuations in China could result in increased costs and delays in shipment of our products and could materially and adversely impact our operating results.

We have outsourced a significant portion of our manufacturing to a small number of contract manufacturers. This concentration presents risks of component shortages or other delays in customer deliveries, increased costs for products manufactured for us and risks associated with unacceptable quality of the products.

Accumulated Other Comprehensive Income

Accumulated other comprehensive income consisting of foreign currency translation adjustments was $6.5 million and $2.9 million as of March 31, 2007 and March 31, 2006, respectively. The change in this balance during fiscal 2007 includes $2.7 million of currency translation adjustments recorded to foreign exchange expense resulting from the liquidation of our Ireland entity.

 

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Recent Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments (“SFAS No. 155”), which amends SFAS No. 133 and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 140”). SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. This statement is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006, and is effective for us beginning in fiscal 2008. Adoption of this standard is not expected to have a significant impact on our financial position or results of operations.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes (“FIN No. 48”). Under FIN No. 48 a company would recognize the benefit from a tax position only if it is more-likely-than-not that the position would be sustained upon audit based solely on the technical merits of the tax position. FIN No. 48 clarifies how a company would measure the income tax benefits from the tax positions that are recognized, provides guidance as to the timing of the derecognition of previously recognized tax benefits and describes the methods for classifying and disclosing the liabilities within the financial statements for any unrecognized tax benefits. FIN No. 48 also addresses when a company should record interest and penalties related to tax positions and how the interest and penalties may be classified within the income statement and presented in the balance sheet. FIN No. 48 is effective for fiscal years beginning after December 15, 2006 and is effective for us in the first quarter of fiscal 2008. Differences between the amounts recognized in the statements of operations prior to and upon the adoption of FIN No. 48 would be accounted for as a cumulative effect adjustment to the beginning balance of retained earnings. We are currently evaluating FIN No. 48 and its possible impacts on our financial statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This statement applies to other accounting pronouncements that require or permit fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and is effective for us beginning in fiscal 2009. Adoption of this standard is not expected to have a significant impact on our financial position or results of operations.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses for which the fair value option has been elected will be reported in earnings. This statement is effective for us beginning in fiscal 2009. We are currently evaluating the impact this statement will have on our consolidated financial statements.

Note 4: Stock Incentive Plans and Share-Based Compensation

Description of Stock Incentive Plans

Long-Term Incentive Plan

We have a Long-Term Incentive Plan (the “Plan”) that provides for the issuance of stock options, stock appreciation rights, stock purchase rights and long-term performance awards to our employees, consultants, officers and affiliates. The Plan has reserved for future issuance 46.7 million shares of stock and 20.3 million shares of stock were available for grant as of March 31, 2007.

Beginning in the first quarter of fiscal 2007, under the Plan we began granting restricted stock units with a zero purchase price rather than options in most cases to our existing employees. We continue to grant options to our existing employees in certain circumstances. Newly hired employees are typically granted stock options under the Plan. Stock options granted to newly hired employees in fiscal 2007 generally vest 25% on the first anniversary of the grant date with the remainder vesting monthly at the rate of 1/48th over the following three years and have contractual terms of seven years. Stock options granted to existing employees in fiscal 2007 generally vest monthly over four years and have contractual terms of seven years. Grants in prior fiscal years typically had contractual terms of seven to ten years. Restricted stock awards and units (“restricted stock”) granted under the Plan are subject to forfeiture if employment terminates prior to the release of the restrictions and generally vest over two to four years. We do not have any performance-based awards outstanding as of March 31, 2007. We have 1.1 million shares of restricted stock with both market and service vesting conditions as of March 31, 2007 that, upon meeting certain market conditions over one and two year periods from initial grant, will begin to vest over the following two years.

In fiscal 2007, 2006 and 2005, we granted rights to 3.7 million, 0.5 million and 1.6 million shares, respectively, of our restricted stock under the Plan at an exercise price of $0.00 in fiscal 2007 and an exercise price of $0.01 per share in fiscal 2006 and 2005.

 

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Supplemental Stock Plan

We have a Supplemental Stock Plan (the “SSOP”), which is not approved by our stockholders, that provides for the issuance of stock options and stock purchase rights to our employees and consultants. Options under the SSOP generally vest over two to four years and expire ten years after the grant date. Restricted stock granted under the SSOP is subject to forfeiture if employment terminates prior to the release of the restrictions and generally vests over two to three years.

The SSOP was terminated effective April 1, 2003, from which time no new stock options or stock purchase rights have been or will be granted under the SSOP. Outstanding stock options and stock purchase rights granted under the SSOP prior to April 1, 2003 remain outstanding and continue to be governed by the terms and conditions of the SSOP.

Assumed Stock Option Plans

During the second quarter of fiscal 2007, in connection with our acquisition of ADIC, we assumed 2.5 million outstanding stock options granted under the four stock option plans of ADIC (“assumed option plans”). Based on the exchange ratio formula in the Agreement and Plan of Merger (“Merger Agreement”), these assumed options are exercisable for an aggregate 14.7 million shares of Quantum common stock. Options under the assumed option plans generally vest over four years from initial grant date and expire from one month to eight years from March 31, 2007. No additional options will be granted under these assumed option plans.

Other Stock Option Plans

We have other stock option plans (the “Other Plans”) under which 1.0 million shares of common stock as of March 31, 2007 were reserved for future issuance of stock options, stock appreciation rights, stock purchase rights, restricted stock awards and long-term performance awards to our employees, consultants, officers and affiliates. Options under the Other Plans are granted at prices determined by the Board of Directors, but at not less than the fair market value. As of March 31, 2007, 0.3 million shares of stock were available for grant.

In fiscal 2007, 2006 and 2005, we granted 62,000 shares, 44,000 shares and 6,000 shares, respectively, of Quantum Corporation restricted stock under the Other Plans at an exercise price of $0.01 per share.

Stock Purchase Plan

We have an employee stock purchase plan (the “Purchase Plan”) that allows for the purchase of stock at 85% of fair market value at the date of grant or the exercise date, whichever value is less. The Purchase Plan is qualified under Section 423 of the Internal Revenue Code. Under the Stock Purchase Plan, rights to purchase shares are only granted during the second and fourth quarter of each fiscal year. In January 2005, the Stock Purchase Plan was modified from a 2-year look back to a 6-month look back option. As a result, the option life decreased from fiscal 2005 to fiscal 2006. There were 3.7 million shares available for issuance as of March 31, 2007.

Employees purchased 2.5 million shares, 2.2 million shares and 2.2 million shares of Quantum Corporation common stock under the Purchase Plan in fiscal 2007, 2006 and 2005, respectively. The weighted-average price of Quantum Corporation stock purchased under the Purchase Plan was $1.69, $2.40 and $2.12, in fiscal 2007, 2006 and 2005, respectively.

 

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Determining Fair Value Under SFAS No. 123R

Stock Options

Share-based compensation recognized in fiscal 2007 as a result of the adoption of SFAS No. 123R, as well as pro forma disclosures according to the original provisions of SFAS No. 123 for periods prior to the adoption of SFAS No. 123R, use the Black-Scholes-Merton option valuation model for estimating fair value of stock options granted under our plans and rights to acquire stock granted under our Purchase Plan. We amortize the fair value of stock options on a ratable basis over the requisite service periods, which are generally the vesting periods. The expected life of awards granted represents the period of time that they are expected to be outstanding. We determine the expected life based on historical experience with similar awards, giving consideration to the contractual terms, vesting schedules, exercise patterns and pre-vesting and post-vesting forfeitures. We estimate the volatility of our common stock based on the historical volatility of our own common stock over the most recent period corresponding with the estimated expected life of the award. We base the risk-free interest rate used in the Black-Scholes-Merton option valuation model on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term equal to the expected life of the award. We have not paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes-Merton option valuation model. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation for those awards that are expected to vest. In accordance with SFAS No. 123R, we adjust share-based compensation for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate for all expense amortization after April 1, 2006 is recognized in the period the forfeiture estimate is changed. During fiscal 2007 our forfeiture rate remained consistent and there was no forfeiture rate adjustment impact.

The weighted-average estimated fair values and the assumptions used in calculating such values for stock options during each fiscal period are as follows:

 

     For the year ended March 31,  
     2007     2006     2005  

Option life (in years)

     4.2       3.2       3.1  

Risk-free interest rate

     4.94 %     3.88 %     3.26 %

Stock price volatility

     0.60       0.67       0.76  

Dividend yield

     —         —         —    

Weighted-average grant date fair value

   $ 1.13     $ 1.32     $ 1.44  

The above assumptions were used to calculate the fair value of options granted under the legacy Quantum plans. As of August 22, 2006, ADIC had approximately 2.5 million stock options outstanding. Based on the exchange ratio of 5.9756 calculated in accordance with the formula in the Merger Agreement, we assumed the outstanding options of ADIC, which are exercisable for an aggregate of 14.7 million shares of Quantum common stock. The per option exercise price is equal to the per option exercise price of each such option prior to the merger divided by the exchange ratio of 5.9756.

The fair value of the assumed options was calculated using a Black-Scholes-Merton option valuation model with the following assumptions for vested and unvested ADIC options assumed, respectively: expected life of 1.4 and 2.7 years, risk-free interest rate of 5.22% and 5.07%, expected volatility of 36.8% and 45.8% and no dividend yield. The portion of the estimated fair value of unvested options related to future service was allocated to future share-based compensation and is being recognized over the remaining vesting period.

Stock Purchase Plan

Under the Purchase Plan, rights to purchase shares are granted during the second and fourth quarter of each fiscal year. The weighted-average fair values and the assumptions used in calculating fair values during each fiscal period are as follows:

 

     For the year ended March 31,  
     2007     2006     2005  

Option life (in years)

     0.50       0.50       1.25  

Risk-free interest rate

     5.17 %     3.99 %     2.21 %

Stock price volatility

     0.41       0.41       0.73  

Dividend yield

     —         —         —    

Weighted-average grant date fair value

   $ 0.60     $ 0.84     $ 1.26  

 

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Restricted Stock

Following the provisions of SFAS No. 123R, the fair value of the majority of our restricted stock is the intrinsic value as of the grant date. During fiscal 2007, certain restricted stock was granted with both market and service vesting conditions that, under SFAS No. 123R must be modeled and valued using a path-dependent valuation technique. The restricted stock with a market and service vesting condition was valued utilizing a Monte Carlo simulation model, and the stock price was simulated using Geometric Brownian Motion, a widely accepted model of stock price behavior used in option pricing models. The fair value of this restricted stock with a market and service vesting condition is recognized ratably over the three and four years corresponding with the requisite service periods for these restricted shares. The primary assumptions used in the valuation models to value the restricted stock with a market condition during the year ended March 31, 2007 are as follows:

 

Time frame of simulation

     2 years  

Risk-free interest rate

     4.77 %

2-year historical volatility

     0.43  

Dividend yield

     —    

Weighted-average grant date fair value

   $ 0.25  

Share-Based Compensation Under SFAS No. 123R

The following table summarizes the effects of share-based compensation resulting from the application of SFAS No. 123R to stock options and restricted stock granted under our plans and rights to acquire stock under our Purchase Plan (in thousands, except per-share amount):

 

     For the year ended March 31, 2007  
     SFAS No. 123R Impact     As Reported  

Cost of revenue

   $ 1,191     $ 722,789  

Gross margin

     (1,191 )     293,385  

Operating expenses:

    

Research and development

     2,544       115,220  

Sales and marketing

     1,965       126,840  

General and administrative

     3,272       51,871  

Loss from operations

     (8,972 )     (27,154 )

Net loss

   $ (8,972 )   $ (64,094 )
                

Basic and diluted net loss per share

   $ (0.05 )   $ (0.33 )
                

 

      For the year ended
March 31, 2007

Share-based compensation (by type of award):

  

Stock options

   $ 5,330

Stock purchase plan

     1,340

Restricted stock

     2,302
      
   $ 8,972
      

The total share-based compensation cost capitalized as part of inventory as of March 31, 2007 was not material. The total share-based compensation cost that would have been capitalized as part of inventory as of March 31, 2006 and 2005 would also not have been material, if we had applied the provisions of SFAS No. 123R. During fiscal 2007, no tax benefit was realized for the tax deduction from option exercises and other awards due to our net operating losses and tax benefit carryforwards

As of March 31, 2007, there was $7.1 million of total unrecognized compensation costs related to stock options granted under our plans. This unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.1 years. Total intrinsic value of options exercised for the year ended March 31, 2007, 2006 and 2005 was $4.1 million, $1.7 million and $0.3 million, respectively. We settle stock option exercises with newly issued common shares.

As of March 31, 2007, there was $3.3 million of total unrecognized compensation costs related to nonvested restricted stock granted under our Plans. The unrecognized compensation cost for restricted stock is expected to be recognized over a weighted-average period of 2.4 years. Total fair value of awards vested during the year ended March 31, 2007, 2006 and 2005 was $0.9 million, $1.3 million and $0.2 million, respectively. We issue new common shares upon vesting of restricted stock units.

 

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Pro Forma Information Under SFAS No. 123

Prior to fiscal 2007, we accounted for our share-based compensation plans using the intrinsic value method prescribed in APB No. 25 and related Interpretations. Only share-based compensation relating to restricted stock was reflected in net loss in the year ended March 31, 2006, as generally all other stock options granted under our share-based compensation plans had an exercise price equal to or greater than the market value of the underlying common stock on the date of grant. Had compensation cost for the plans been determined based on the fair value at the grant dates for awards under our plans consistent with the method of SFAS No. 123, our net loss and basic and diluted net loss per share would have been changed to the pro forma amounts indicated below (in thousands, except per-share data):

 

     For the year ended March 31,  
     2006     2005  

Reported net loss

   $ (41,479 )   $ (3,496 )

Add back employee stock option expense

     —         509  

Share-based employee compensation determined under the fair value method for all awards, net of tax effects

     (8,717 )     (11,743 )
                

Pro forma net loss

   $ (50,196 )   $ (14,730 )
                

Pro forma basic and diluted net loss per share

   $ (0.27 )   $ (0.08 )
                

As reported basic and diluted net loss per share

   $ (0.23 )   $ (0.02 )
                

Stock Activity

Stock Options

A summary of activity relating to all of our stock option plans is as follows (options and intrinsic value in thousands):

 

     Options     Weighted-
Average
Exercise Price
   Weighted-
Average
Remaining
Contractual Term
   Aggregate
Intrinsic Value

Outstanding as of March 31, 2004

   33,855     $ 6.39      

Granted

   6,517     $ 2.14      

Exercised

   (1,441 )   $ 0.83      

Expired

   (558 )   $ 13.92      

Forfeited

   (6,941 )   $ 6.86      
              

Outstanding as of March 31, 2005

   31,432     $ 5.52      

Granted

   6,645     $ 2.51      

Exercised

   (3,141 )   $ 2.10      

Expired

   (5,619 )   $ 7.60      

Forfeited

   (1,549 )   $ 3.29      
              

Outstanding as of March 31, 2006

   27,768     $ 4.90      

Granted and assumed

   20,269     $ 1.73      

Exercised

   (4,854 )   $ 1.48      

Expired

   (1,096 )   $ 2.96      

Forfeited

   (5,828 )   $ 5.14      
              

Outstanding as of March 31, 2007

   36,259     $ 3.62    4.39    $ 14,529
              

Vested and expected to vest at March 31, 2007

   33,307     $ 3.75    4.32    $ 12,675
              

Exercisable as of March 31, 2007

   22,774     $ 4.48    3.87    $ 6,509
              

 

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Included in stock options granted and assumed were 14.7 million stock options assumed in connection with our acquisition of ADIC during the second quarter of fiscal 2007. The following table summarizes information about options outstanding and exercisable as of March 31, 2007 (options in thousands):

 

Range of Exercise Prices

   Options
Outstanding
   Weighted-
Average
Exercise
Price
   Weighted-
Average
Remaining
Contractual Life
(Years)
   Options
Exercisable
   Weighted-
Average
Exercise
Price

$      0.88    -    $      1.32

   679    $ 0.95    5.77    596    $ 0.93

$      1.39    -    $      2.00

   7,932    $ 1.52    4.64    3,693    $ 1.53

$      2.05    -    $      3.01

   18,027    $ 2.57    4.50    9,373    $ 2.73

$      3.02    -    $      4.53

   3,433    $ 3.68    6.20    2,924    $ 3.69

$      4.55    -    $      6.81

   1,894    $ 6.64    3.08    1,894    $ 6.64

$      6.85    -    $    10.23

   2,567    $ 9.10    2.47    2,567    $ 9.10

$    10.37    -    $    15.36

   1,350    $ 12.31    2.58    1,350    $ 12.31

$    15.75    -    $    22.73

   377    $ 18.08    1.40    377    $ 18.08
                  
   36,259    $ 3.62    4.39    22,774    $ 4.48
                  

Expiration dates ranged from April 25, 2007 to August 1, 2015 for options outstanding at March 31, 2007. Employee stock options issued generally have contractual lives of seven to ten years. Prices for options exercised during the three-year period ended March 31, 2007, range from $0.03 to $3.44.

Restricted Stock

A summary of activity relating to our restricted stock follows (shares in thousands):

 

     Shares     Weighted-
Average
Grant Date Fair
Value

Nonvested at March 31, 2006

   789     $ 2.82

Granted

   3,811     $ 1.59

Vested

   (373 )   $ 2.81

Forfeited

   (513 )   $ 1.83
        

Nonvested at March 31, 2007

   3,714     $ 1.69
        

Note 5: Acquisitions

Acquisitions have been recorded using the purchase method of accounting and the results of operations are included in our consolidated results as of the date of each acquisition. We allocate the purchase price of our acquisitions to the tangible assets, liabilities, and intangible assets acquired, including in-process research and development (“IPR&D”), based on their estimated fair values. The excess purchase price over those fair values is recorded as goodwill. The excess fair values over the purchase price is allocated as a pro-rata reduction of the amounts that otherwise would have been assigned to all of the acquired assets except (a) financial assets other than investments accounted for by the equity method, (b) assets to be disposed of by sale, (c) deferred tax assets, (d) prepaid assets relating to pension or other postretirement benefit plans and (e) any other current assets.

Advanced Digital Information Corporation

On August 22, 2006 (the “Acquisition Date”), we completed our acquisition of ADIC, a publicly traded provider of storage solutions for the open systems marketplace, pursuant to the terms of the Agreement and Plan of Merger (“Merger Agreement”), dated May 2, 2006. ADIC’s results of operations are included in our Consolidated Statements of Operations and Cash Flows from the Acquisition Date. We acquired ADIC to expand our global sales force, market access and product offerings into the enterprise and data management software space.

 

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The total purchase price for ADIC is comprised of (in thousands, except share and per-share data):

 

Acquisition of 63.4 million shares of outstanding common stock of ADIC at $12.25 per share:   

In cash (62.9 million shares)

   $ 770,612

In exchange for Quantum stock (0.5 million ADIC shares converted to 1.9 million Quantum shares)

     4,070

Fair value of ADIC stock options assumed

     10,471

Acquisition related transaction costs

     7,791
      

Total purchase price

   $ 792,944
      

Pursuant to the Merger Agreement, each outstanding share of ADIC common stock was converted into the right to receive either (a) $12.25 in cash or (b) a number of shares of Quantum common stock equal to the number of ADIC shares of common stock multiplied by 3.461, with ADIC stockholders given the choice to elect to receive cash, stock or a combination of the two.

As of August 22, 2006, ADIC had approximately 2.5 million stock options outstanding. Based on the exchange ratio of 5.9756 calculated in accordance with the formula in the Merger Agreement, we assumed the outstanding options of ADIC, which are exercisable for an aggregate of 14.7 million shares of Quantum common stock. The fair value of options assumed was calculated using a Black-Scholes-Merton valuation model with the following assumptions for vested and unvested options assumed, respectively: expected life of 1.4 to 2.7 years, risk-free interest rate of 5.22% and 5.07%, expected volatility of 36.8% to 45.8% and no dividend yield. The portion of the estimated fair value of unvested ADIC options related to future service is being recognized over the remaining vesting period.

The total purchase price was allocated to ADIC’s net tangible and identifiable intangible assets based on their estimated fair values as set forth below. The excess of the purchase price over the net tangible and identifiable intangible assets was recorded as goodwill. The estimates and assumptions underlying the fair values below are subject to change with regard to completion of the ADIC integration plan and finalizing restructuring costs (in thousands):

 

Current assets

   $ 390,262  

Property and equipment

     29,758  

Service parts for maintenance

     16,067  

Long-term assets

     2,349  

Intangible assets

     190,278  

Goodwill

     342,854  

Current liabilities *

     (155,439 )

Long-term liabilities

     (37,885 )

In-process research and development

     14,700  
        

Total purchase price

   $ 792,944  
        

* Current liabilities include approximately $14.1 million of a restructuring liability related to the acquisition. The restructuring liability is primarily related to the severance benefits for pre-merger ADIC employees at the time of the acquisition.

During fiscal 2007, goodwill related to the ADIC acquisition increased $4.6 million from our original preliminary purchase price allocation due to a decrease of $6.7 million in the estimated fair value of certain IT assets and $0.6 million related to net change in the estimate of amounts to be paid to certain vendors and service providers. This was partially offset by a $1.7 million net decrease in the estimate of severance benefits paid to certain pre-merger ADIC employees and $1.0 million of other items.

In performing our purchase price allocation, we considered, among other factors, our intention for future use of acquired assets, analyses of historical financial performance and estimates of future performance of ADIC’s products. The fair value of intangible assets was based, in part, on a valuation completed by a third-party valuation firm using a discounted cash flow approach and other valuation techniques as well as estimates and assumptions provided by management. The following table sets forth the components of intangible assets associated with the acquisition and the weighted-average amortization period (fair value in thousands):

 

     Fair Value   

Amortization

(Years)

Purchased technology

   $ 92,493    4.7

Customer lists

     92,600    7.1

Trademarks

     4,700    5.8

Non-compete agreements

     485    5.0
         

Total intangible assets acquired

   $ 190,278    5.9
         

 

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Purchased technology, which comprises products that have reached technological feasibility, includes products in most of ADIC’s product lines, principally the ADIC Scalar i2000 and Scalar i500 libraries and StorNext data management software. It also includes a combination of ADIC processes, patents and trade secrets related to the design and development of ADIC’s products. This proprietary know-how can be leveraged to develop new technology and improve our products. Customer lists represent the underlying relationships and agreements with ADIC’s installed customer base.

We expensed IPR&D upon acquisition as it represented incomplete ADIC research and development projects that had not reached technological feasibility and had no alternative future use as of the Acquisition Date.

Technological feasibility is established when an enterprise has completed all planning, designing, coding and testing activities that are necessary to establish that a product can be produced to meet its design specifications including functions, features and technical performance requirements. The value assigned to IPR&D of $14.7 million was determined by considering the importance of each project to our overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows using a discount rate of 18% to their present value based on the percentage of completion of the IPR&D projects. Purchased IPR&D relates to projects associated with the ADIC Scalar i2000 and Scalar i500 products that had not yet reached technological feasibility as of the Acquisition Date and have no alternative future use.

We have currently not identified any material pre-acquisition contingencies. If we identify a material pre-acquisition contingency during the remainder of the purchase price allocation period, we will attempt to determine its fair value and include it in the purchase price allocation. If information becomes available to us prior to the end of the one year purchase price allocation period which would indicate that it is probable that such events had occurred and the amounts can be reasonably estimated, such items will be included in the purchase price allocation.

The following unaudited pro forma financial information presents the combined results of operations of Quantum and ADIC as if the acquisition had occurred as of the beginning of each period presented (in thousands, except per-share data):

 

     For the year ended March 31,  
     2007     2006  

Pro forma revenue

   $ 1,195,715     $ 1,296,417  

Pro forma net loss

   $ (97,923 )   $ (132,171 )

Pro forma basic and diluted net loss per share

   $ (0.51 )   $ (0.71 )

Pro forma net loss for the year ended March 31, 2007 includes $15.1 million of IPR&D expense related to an acquisition completed by ADIC prior to our acquisition of ADIC.

The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have occurred had the transaction been completed at the beginning of the period indicated, nor is it necessarily indicative of future operating results.

Certance Holdings

On January 5, 2005, we acquired all of the shares of Certance Holdings and its subsidiaries (“Certance”), a privately held supplier of tape backup drives and data protection solutions, for $60 million in cash paid to the Certance shareholders plus $2.5 million for the direct costs of the acquisition. Under the terms of the acquisition, the total consideration of $60 million payable by us upon acquisition was paid as of March 31, 2006.

With the acquisition, we offer end-users a broad range of tape technology choices for meeting their individual backup, recovery and archive needs. The acquisition also enhanced our tape drive and media business by expanding our product and intellectual property portfolio, broadening our end-user customer base and further strengthening our revenue and cash generating foundation.

 

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The purchase price at the time of the acquisition was allocated based on the estimated fair value of net tangible and intangible assets acquired, and liabilities assumed, to the following assets and liabilities (in thousands):

 

Current assets

   $ 69,311  

Property and equipment

     4,248  

Long-term assets

     2,261  

Intangibles

     25,070  

Current liabilities *

     (36,605 )

Long-term liabilities

     (1,980 )
        

Total purchase price

   $ 62,305  
        

* Current liabilities included approximately $3.7 million of a restructuring liability related to the acquisition as of March 31, 2005. The restructuring liability related to the severance benefits for pre-merger Certance employees at the time of the acquisition and the facility charges for certain vacant facilities in the United Kingdom. There was no remaining restructuring liability related to Certance as of March 31, 2007.

The following table sets forth the components of intangible assets associated with the acquisition and the weighted-average amortization period (fair value in thousands):

 

     Fair Value   

Amortization

(Years)

Purchased technology

   $ 23,340    6.7

Customer lists

     1,534    2.0

Order backlog and other

     196    0.3
         

Total intangible assets acquired

   $ 25,070    6.4
         

Note 6: Financial Instruments and Other Investments

Cash, Cash Equivalents and Short-term Investments

The following is a summary of our cash, cash equivalents and short-term investments (in thousands):

 

     As of March 31,
     2007    2006

Cash

   $ 40,122    $ 63,140

Certificates of deposit

     —        11,664

Money market funds

     20,459      48,494

Auction rate securities

     35,000      99,975
             
   $ 95,581    $ 223,273
             

Included in cash and cash equivalents

   $ 60,581    $ 123,298

Included in short-term investments

     35,000      99,975
             
   $ 95,581    $ 223,273
             

A substantial portion of cash was invested in overnight interest-bearing accounts as of March 31, 2007.

Our auction rate securities are classified as available for sale investments. The difference between the amortized cost of auction rate securities and fair value was immaterial as of March 31, 2007 and March 31, 2006. There were no unrealized gains or losses on short-term investments as of March 31, 2007 and 2006. As of March 31, 2007, the average auction rate securities portfolio duration was less than 45 days and the securities had contractual maturities greater than ten years.

 

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During fiscal 2007, 2006 and 2005, we sold auction rate securities and marketable equity securities and realized gains and losses as follows (in thousands):

 

    

Realized

Gains

  

Realized

Losses

  

Net

Gains

2007

   $ 617    $ —      $ 617

2006

     —        —        —  

2005

     1,238      —        1,238

Other Investments

Other investments consist of privately held technology companies and private technology venture limited partnerships and are recorded in other long-term assets on the Consolidated Balance Sheets.

We held $1.5 million of investments in private technology venture limited partnerships that are accounted for under the equity method. During fiscal 2007, we recorded gains of $0.2 million reflecting our pro-rata share of the limited partnerships’ net gains. These gain amounts were primarily based on the general partners’ estimates of the fair value of non-marketable securities held by the partnerships and, to a lesser extent, realized gains and losses from the partnerships’ disposal of securities. We did not have investments in private technology venture limited partnerships in fiscal 2006 and 2005.

Our other investments in privately held technology companies of $3.5 million are accounted for under the cost method. We review these non-marketable equity investments on a regular basis to determine if there has been any impairment of value which is other than temporary by reviewing their financial information, gaining knowledge of any new financing or other business agreements and assessing their operating viability. There were no gains or losses on these investments during fiscal 2007, and we had no investments accounted under the cost method in fiscal 2006 or 2005.

Derivatives

We are obligated under the terms of our credit facility to enter into a hedge agreement or other interest rate management arrangement that provides for not less than 25% of the indebtedness outstanding under our term loans to be subject to a fixed rate of interest over a term of two years. To meet this objective, we entered into an interest rate no cost collar transaction with a financial institution, effective November 15, 2006, that resulted in fixing the interest rate on $87.5 million of our variable rate term loans between a three month LIBOR rate floor of 4.64% and a cap of 5.49% through December 2008. Whenever the three month LIBOR rate is greater than the cap, we receive from the financial institution the difference between 5.49% and the current three month LIBOR rate on the notional amount. Conversely, whenever the three month LIBOR rate is lower than the floor, we remit to the financial institution the difference between 4.64% and the current three month LIBOR rate on the notional amount. As of March 31, 2007, the three month LIBOR rate was within the floor and cap.

During fiscal 2007, this transaction did not meet all of the criteria necessary for hedge accounting prescribed by SFAS No. 133. We recorded the change in fair market value in other long-term assets in the Consolidated Balance Sheets and in interest income and other, net in the Consolidated Statements of Operations. As of March 31, 2007, the market value of the interest rate collar was $94,000. We do not engage in hedging activity for speculative or trading purposes.

We did not utilize foreign currency forward exchange contracts in fiscal 2007, 2006 or 2005 and there were no foreign currency forward contracts outstanding as of March 31, 2007 or March 31, 2006.

Summary Table of Fair Value and Related Carrying Amounts of Financial Instruments

 

     As of March 31, 2007    As of March 31, 2006
     Carrying Value    Fair Value    Carrying Value    Fair Value

Cash and cash equivalents

   $ 60,581    $ 60,581    $ 123,298    $ 123,298

Short-term investments

     35,000      35,000      99,975      99,975

Convertible subordinated debt

     160,000      148,800      160,000      162,400

Revolving credit facility

     25,000      25,000      —        —  

Term loans

     337,500      337,500      —        —  
                           
   $ 618,081    $ 606,881    $ 383,273    $ 385,673
                           

Refer to Note 10, “Convertible Subordinated Debt, Short-Term Debt and Long-Term Debt”, for additional disclosures regarding our debt financial instruments.

 

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Note 7: Inventories, Property and Equipment and Service Parts for Maintenance

Inventories consisted of (in thousands):

 

     As of March 31,  
     2007     2006  

Materials and purchased parts

   $ 45,011     $ 35,061  

Work in process

     7,234       8,571  

Finished goods

     38,908       45,331  
                
   $ 91,153     $ 88,963  
                
Property and equipment consisted of (in thousands):     
     As of March 31,  
     2007     2006  

Machinery and equipment

   $ 157,966     $ 137,794  

Furniture and fixtures

     19,367       9,069  

Buildings and leasehold improvements

     23,715       28,536  

Land

     —         257  
                
   $ 201,048     $ 175,656  

Less accumulated depreciation

     (150,807 )     (136,908 )
                
   $ 50,241     $ 38,748  
                
Service parts for maintenance consisted of (in thousands):     
     As of March 31,  
     2007     2006  

Service parts for maintenance

   $ 114,016     $ 79,651  

Less accumulated amortization

     (31,655 )     (22,335 )
                
   $ 82,361     $ 57,316  
                

Sale of Ireland Facility

In May 2006, we completed the sale of our facility in Dundalk, Ireland, where we performed service operations for several products. We sold the facility for $6.0 million, and the total gain on this asset held for sale was approximately $3.2 million which was recorded during the current fiscal year in interest income and other, net in the Consolidated Statements of Operations.

Asset Retirement Obligations

We have asset retirement obligations related to certain leased facilities where we have contractual commitments to remove leasehold improvements and return the property to a specified condition when the lease terminates. At March 31, 2007 and 2006, the value of these obligations was $2.1 million and $1.2 million, respectively, and is classified in other accrued liabilities in the Consolidated Balance Sheets. At March 31, 2007, the net book value of the leasehold assets solely related to our asset retirement obligations approximated $6.9 million. The amount of amortization expense of the associated leasehold assets and accretion expense associated with our asset retirement obligations for the years ended March 31, 2007 and 2006 were $0.3 million and $0.5 million, respectively.

Note 8: Goodwill and Intangible Assets

Net goodwill and intangible assets as of March 31, 2007 and 2006 represented approximately 52% and 15% of total assets, respectively. The goodwill and intangible asset balances, net of amortization, as of March 31, 2007 and 2006 were $588.6 million and $97.0 million, respectively. Amortization expense related to finite-lived purchased intangible assets was approximately $42.0 million in fiscal 2007, $21.7 million in fiscal 2006, and $18.9 million in fiscal 2005.

 

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Acquired intangible assets are amortized over their estimated useful lives, which generally range from one to ten years. In estimating the useful lives of intangible assets, we considered the following factors:

 

 

The cash flow projections used to estimate the useful lives of the intangible assets showed a trend of growth that was expected to continue for an extended period of time;

 

 

Our tape automation products, in particular, have long development cycles and have experienced long product life cycles; and

 

 

Our ability to leverage core technology into new tape automation products and, therefore, to extend the lives of these technologies.

Intangible amortization within our Consolidated Statements of Operations for the years ended March 31, 2007, 2006 and 2005 follows (in thousands):

 

     For the year ended March 31,
     2007    2006    2005

Cost of revenue

   $ 26,567    $ 16,222    $ 13,131

Research and development

     999      581      1,446

Sales and marketing

     14,217      4,290      3,773

General and administrative

     209      585      528
                    
   $ 41,992    $ 21,678    $ 18,878
                    

The following tables provide a summary of the carrying amount of intangible assets that will continue to be amortized (in thousands):

 

     As of March 31, 2007    As of March 31, 2006
     Gross
Amount
   Accumulated
Amortization
    Net
Amount
   Gross
Amount
   Accumulated
Amortization
    Net
Amount

Purchased technology

   $ 189,119    $ (82,595 )   $ 106,524    $ 112,518    $ (71,281 )   $ 41,237

Trademarks

     27,260      (19,221 )     8,039      22,560      (15,865 )     6,695

Non-compete agreements

     2,000      (1,568 )     432      2,516      (2,516 )     —  

Customer lists

     108,272      (24,666 )     83,606      15,672      (13,795 )     1,877

Assembled workforce

     —        —         —        1,582      (1,582 )     —  
                                           
   $ 326,651    $ (128,050 )   $ 198,601    $ 154,848    $ (105,039 )   $ 49,809
                                           

The total expected future amortization related to intangible assets is provided in the table below (in thousands):

 

     Amortization

Fiscal 2008

   $ 48,945

Fiscal 2009

     41,076

Fiscal 2010

     36,785

Fiscal 2011

     28,815

Fiscal 2012 and thereafter

     42,980
      

Total as of March 31, 2007

   $ 198,601
      

 

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Note 9: Accrued Warranty and Indemnifications

Accrued Warranty

The following table details the change in the accrued warranty balance (in thousands):

 

     For the year ended March 31,  
     2007     2006  

Balance as of April 1

   $ 32,422     $ 37,738  

Warranties assumed from ADIC

     6,945       —    

Additional warranties issued

     23,208       21,416  

Adjustments for warranties issued in prior fiscal years

     —         1,570  

Settlements

     (31,906 )     (28,302 )
                

Balance as of March 31

   $ 30,669     $ 32,422  
                

We generally warrant our products against defects from 3 to 36 months. A provision for estimated future costs and estimated returns for credit relating to warranty is recorded when products are shipped and revenue recognized. Our estimate of future costs to satisfy warranty obligations is primarily based on historical trends and, if believed to be significantly different from historical trends, estimates of future failure rates and future costs of repair including materials consumed in the repair, labor and overhead amounts necessary to perform the repair.

If future actual failure rates differ from our estimates, we record the impact in subsequent periods. If future actual costs to repair were to differ significantly from our estimates, we would record the impact of these unforeseen cost differences in subsequent periods.

Indemnifications

We have certain financial guarantees, both express and implied, related to product liability and potential infringement of intellectual property. Other than certain product liabilities recorded as of March 31, 2007, we did not record a liability associated with these guarantees, as we have little or no history of costs associated with such indemnification requirements. Contingent liabilities associated with product liability may be mitigated by insurance coverage that we maintain.

In the normal course of business to facilitate transactions of our services and products, we indemnify certain parties with respect to certain matters. We have agreed to hold certain parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. In addition, we have entered into indemnification agreements with our officers and directors, and our bylaws contain similar indemnification obligations to our agents.

It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by us under these agreements have not had a material impact on our operating results, financial position or cash flows.

Note 10: Convertible Subordinated Debt, Short-Term Debt and Long-Term Debt

Our debt includes the following (in thousands):

 

     As of March 31,  
     2007     2006  

Convertible subordinated debt

   $ 160,000     $ 160,000  

Revolving credit facility

     25,000       —    

Term loans

     337,500       —    
                
   $ 522,500     $ 160,000  
                
     For the year ended
March 31,
 
     2007     2006  

Weighted-average interest rate

     8.11 %     4.38 %

 

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Short-Term Debt

During fiscal 2007, short-term debt is the current portion of long-term debt due within the next twelve months, as described in the “Long-Term Debt” section below. In fiscal 2006, short-term debt related to M4 Data. Per the purchase agreement for the acquisition of M4 Data in April 2001, we issued $1.5 million debentures under the earn out provisions during the year ended March 31, 2006. These debentures were also redeemed during the year ended March 31, 2006. We are not obligated to issue any additional debentures.

Convertible Subordinated Debt

On July 30, 2003, we issued 4.375% convertible subordinated notes in the aggregate principal amount of $160 million in a private placement transaction. The notes are unsecured obligations subordinated in right of payment to all of our existing and future senior indebtedness. The notes mature on August 1, 2010 and are convertible at the option of the holders at any time prior to maturity into an aggregate of 36.8 million shares of Quantum common stock at a conversion price of $4.35 per share. We cannot redeem the notes prior to August 5, 2008.

Long-Term Debt

In December 2002, we entered into a secured senior credit facility with a group of banks, providing us with a $100 million revolving credit line and a $50 million synthetic lease that contained the same financial covenants as the revolving credit line. In March 2004, we amended the secured senior credit facility to extend the maturity to March 2006 and adjust several covenant requirements. In January 2005, we amended the revolving credit line and the synthetic lease agreement to reflect an acquisition. The revolving credit line was amended to increase it from $100 million to $145 million and to adjust covenant requirements. In October 2005, we amended and restated the revolving credit line to extend the maturity to October 2008, adjust covenant levels and adjust the fee structure. In February 2006, we terminated the $50 million synthetic lease. In August 2006, the revolving credit line was terminated and replaced by the borrowings described below, and we wrote off $0.7 million of unamortized loan fees.

In August 2006, we entered into a secured senior credit facility with a group of lenders providing a $150 million revolving credit line and a $225 million term loan. We also entered into a secured $125 million second lien term loan. On August 22, 2006, we borrowed $445 million, which consisted of $225 million under the term loan, $125 million under the second lien term loan and $95 million borrowed on the revolving credit line. On August 28, 2006, we borrowed an additional $51.5 million on the revolving credit line. We incurred loan fees of $9.8 million which are included in other long-term assets on the Consolidated Balance Sheets and are being amortized to interest expense over the respective loan terms. On November 27, 2006, we amended the credit facility to adjust covenant levels, adjust prepayment dates and increase the margin on the second lien term loan.

The $225 million term loan matures on August 22, 2012, but is subject to accelerated maturity on April 2, 2010, if we do not refinance to extend the maturity date of, or convert into equity, the existing $160 million convertible debt prior to January 1, 2010. Interest accrues on the term loan at either, at our option, a prime rate plus a margin of 2.15%, or LIBOR plus a margin of 4.00%. Interest is payable quarterly. As of March 31, 2007, the interest rates on the term loan were 9.35% on $87.5 million and 9.32% on the remaining $125 million outstanding. Beginning on December 31, 2006, principal payments on the term loan in an amount equal to $6.25 million are payable quarterly, and after September 30, 2008 principal payments in an amount equal to $0.6 million are payable quarterly with a final payment of all outstanding principal and interest to be paid at maturity. The term loan may be prepaid at any time, subject to an additional payment of 1.0% of the principal amount being prepaid for any prepayment made within one year of closing. As of March 31, 2007, the outstanding balance on the term loan was $212.5 million.

The $125 million second lien term loan matures on August 22, 2013, but is subject to accelerated maturity on May 2, 2010, if we do not refinance to extend the maturity date of, or convert into equity, the existing $160 million convertible debt prior to February 1, 2010. Interest accrues on the second lien term loan at either, at our option, a prime rate plus a margin of 6.75%, or LIBOR plus a margin of 8.25%. As of March 31, 2007, the interest rate on the second lien term loan was 13.60%. Interest on the second lien term loan is payable quarterly. All outstanding principal on the second lien term loan is payable at maturity. On November 27, 2006 we amended the second lien term loan to prohibit prepayment of amounts outstanding until August 22, 2008 and adjusted the prepayment penalties for the periods after that date. As of March 31, 2007, $125 million was outstanding on the second lien term loan.

The revolving credit facility matures on August 22, 2009. Interest accrues on each drawdown of the revolving credit facility at either, at our option, a prime rate plus a margin ranging from 0.0% to 0.80%, depending on our senior leverage ratio, or LIBOR plus a margin ranging from 1.75% to 3.00%, depending on our senior leverage ratio. Interest is payable quarterly.

Amounts not borrowed on the revolving credit facility are subject to an annual unused line fee of between 0.30% and 0.75% on the unused portion of the credit facility. As of March 31, 2007, the interest rate on the revolving credit facility was 8.36% on the borrowed portion. The facility for the revolving loans may be terminated by us at any time without premium or penalty. As of March 31, 2007, $25 million was outstanding on the revolving credit facility. On April 2, 2007, we borrowed an additional $50 million on the revolving credit line at an interest rate of 9.05%.

 

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During fiscal 2007, we made principal payments of $12.5 million on the term loan as required by the agreement. We also made principal payments on the revolving credit line of $121.5 million during fiscal 2007 of which $95 million repaid the amount borrowed on August 22, 2006 and $26.5 million reduced the amount borrowed on August 28, 2006. As of March 31, 2007, the total outstanding borrowed was $362.5 million and $2.3 million was committed to standby letters of credit.

The revolving credit facility, term loan and second lien term loan are secured by a blanket lien on all of our assets and contain certain financial and reporting covenants which we are required to satisfy as a condition of the credit line and term loans including a limitation on issuing dividends. As of March 31, 2007, we were in compliance with all of the covenants.

Debt Maturities

A summary of the maturities for our convertible subordinated debt, term loans and revolving credit facility follows (in thousands):

 

Fiscal 2008

   $ 25,000

Fiscal 2009

     13,625

Fiscal 2010

     27,250

Fiscal 2011

     162,250

Fiscal 2012

     2,250

Fiscal 2013 and thereafter

     292,125
      

Total as of March 31, 2007

   $ 522,500
      

In addition, we borrowed $50 million from our revolving credit facility on April 2, 2007 which becomes due in fiscal 2010.

Fair Value of Debt

The estimated fair values of our borrowings are summarized as follows (in thousands):

 

     As of March 31, 2007    As of March 31, 2006
     Carrying Value    Fair Value    Carrying Value    Fair Value

Convertible subordinated debt

   $ 160,000    $ 148,800    $ 160,000    $ 162,400

Revolving credit facility

     25,000      25,000      —        —  

Term loans

     337,500      337,500      —        —  
                           
   $ 522,500    $ 511,300    $ 160,000    $ 162,400
                           

The fair value for the convertible subordinated debt is based on the quoted market price at the balance sheet dates. The fair value of the revolving credit facility and the term loans approximates the carrying value due to frequent interest rate resets on these instruments.

Note 11: Restructuring Charges

During fiscal 2007, management approved and began executing plans to restructure certain operations of Quantum and pre-merger ADIC to eliminate redundant costs resulting from the acquisition of ADIC, implement strategic roadmap decisions and improve efficiencies in operations. In fiscal 2007, 2006 and 2005, we took steps to reduce costs in an effort to return to profitability and rationalize our operations following acquisitions. The restructuring charges that resulted from these cost reduction efforts relate to the outsourcing of certain manufacturing, repair and service operations and consolidation of our operations. Substantial steps have been completed as of March 31, 2007, and the associated costs have been recorded.

 

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The following tables show the type of restructuring expense or (reversal) for fiscal 2007, 2006 and 2005 (in thousands):

 

     For the year ended March 31,
      2007     2006    2005

By expense type

       

Severance and benefits

   $ 11,150     $ 15,259    $ 9,465

Facilities

     (1,701 )     2,859      1,996

Research and development programs

     1,230       —        —  

Inventory

     900       512      —  

Fixed assets and other

     1,229       —        60
                     

Total

   $ 12,808     $ 18,630    $ 11,521
                     

By cost reduction actions

       

Outsource certain manufacturing, repair and service functions

   $ 2,561     $ 9,027    $ 2,540

Consolidate our operations

     10,247       9,603      8,970

Other general expense reduction

     —         —        11
                     

Total

   $ 12,808     $ 18,630    $ 11,521
                     

Fiscal 2007

We recorded expenses of $11.2 million for severance and benefits associated with eliminating redundancies and streamlining operations identified in all areas of our business during the year ended March 31, 2007 resulting from our evaluation and integration of ADIC and the strategic direction of our business. Approximately 23% of our severance and benefits restructuring charges were related to outsourcing certain manufacturing, repair and service functions, the largest of which is due to closing our Scotland operation. We expect the severance and benefits restructuring charges to be paid to the impacted employees during fiscal 2008.

The $1.7 million facilities reversal resulted from the decision to use a previously vacated Colorado facility in which to consolidate our U.S. manufacturing, repair and service operations. We incurred a $1.2 million charge related to noncancellable purchase commitments related to research and development projects that were cancelled as we implemented strategic roadmap decisions. In addition to the research and development costs, we had $0.9 million of noncancellable purchase commitments for inventory related to planned future generation products that will not be produced. We also had $1.2 million in fixed asset write-offs for tooling and related CIP assets impacted by implementation of our strategic roadmap decisions.

In addition to the restructuring expenses in fiscal 2007, the net restructuring costs associated with exiting activities of pre-merger ADIC were $14.1 million, consisting primarily of severance and benefits costs for employees in a variety of functions throughout the world and, to a lesser extent, excess facilities obligations in the U.S. These costs were recognized as a liability assumed in the purchase business combination and were included in the allocation of the cost to acquire ADIC and, accordingly, resulted in an increase to goodwill rather than an expense in fiscal 2007.

Fiscal 2006

In fiscal 2006, a total of $9.0 million in charges were recorded as severance as a result of the closing of the site in Dundalk, Ireland, and the outsourcing of repair operations in the European region. We classified $0.5 million of the charges associated with this closure as a component of cost of revenue during fiscal 2006. This closure was completed by March 31, 2007.

A charge of $6.7 million was recorded as severance as part of the continuing effort to streamline our IT, product development and marketing processes following the product platform transitions and the consolidation of the marketing function. In addition, a charge of $2.9 million was also recorded for our facility in Colorado Springs, Colorado to reflect changes in lease assumptions as a result of the completion of the sale-leaseback transaction. This facility was subsequently used for operations and reversed in fiscal 2007.

Fiscal 2005

A charge of $2.5 million was recorded primarily for severance as a result of outsourcing certain manufacturing and write-offs of fixed assets related to this plan.

 

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A charge of $5.8 million was recorded primarily for severance benefits and severance related costs, impacting most Quantum functions and locations, particularly for research and development consolidation. In addition, $1.2 million was also recorded for separation costs related to our former Chief Operating Officer. A net charge of $2.0 million was recorded for vacant facilities in the United Kingdom; Boulder, Colorado; Colorado Springs, Colorado and San Jose, California as a result of changes to the original assumptions.

The following tables show the activity and the estimated timing of future payouts for cost reduction plans (in thousands):

 

     Severance and
benefits
    Facilities     Research and
development
programs
    Inventory     Fixed assets
and other
    Total  

Balance as of March 31, 2004

   $ 2,617     $ 4,647     $ —       $ —       $ —       $ 7,264  

Restructuring costs

     11,716       2,441       —         —         60       14,217  

Cash payments

     (8,216 )     (2,879 )     —         —         (60 )     (11,155 )

Non-cash charges and other

     (210 )     284       —         —         —         74  

Restructuring charge reversal

     (2,251 )     (445 )     —         —         —         (2,696 )
                                                

Balance as of March 31, 2005

     3,656       4,048       —         —         —         7,704  

Restructuring costs

     15,704       3,013       —         512       —         19,229  

Cash payments

     (8,736 )     (3,895 )     —         —         —         (12,631 )

Non-cash charges and other

     (151 )     (21 )     —         (512 )     —         (684 )

Restructuring charge reversal

     (427 )     (172 )     —         —         —         (599 )
                                                

Balance as of March 31, 2006

     10,046       2,973       —         —         —         13,019  

Restructuring costs

     29,243       898       1,230       900       1,232       33,503  

Cash payments

     (23,759 )     (1,378 )     (292 )     —         —         (25,429 )

Non-cash charges and other

     150       —         —         (88 )     (1,232 )     (1,170 )

Restructuring charge reversal

     (4,933 )     (1,701 )     —         —         —         (6,634 )
                                                

Balance as of March 31, 2007

   $ 10,747     $ 792     $ 938     $ 812     $ —       $ 13,289  
                                                

Estimated timing of future payouts:

            

Fiscal 2008

   $ 10,747     $ 118     $ 938     $ 812     $ —       $ 12,615  

Fiscal 2009 to 2013

     —         674       —         —         —       $ 674  
                                                
   $ 10,747     $ 792     $ 938     $ 812     $ —       $ 13,289  
                                                

The $13.3 million restructuring accrual as of March 31, 2007 is comprised of obligations for severance and benefits and vacant facilities for both Quantum and pre-merger ADIC in addition to noncancellable purchase obligations for inventory and research and development programs. The severance and benefits charges will be paid during fiscal 2008 as will the noncancellable purchase obligations for inventory and research and development. The facilities charges relating to vacant facilities in Boulder, Colorado; and Basingstoke, United Kingdom will be paid over their respective lease terms, which continue through fiscal 2013. With the acquisition of ADIC in the second quarter of fiscal 2007, we also acquired ADIC’s vacant facilities in Englewood, Colorado and Ithaca, New York. The facilities charges related to the vacant Englewood and Ithaca facilities will be paid over their respective lease terms. The Englewood lease ended in December 2006, and the Ithaca lease continues through fiscal 2012.

Additional charges may be incurred in the future related to these restructurings, particularly if the actual costs associated with restructured activities are higher than estimated. In fiscal 2008, we plan additional implementation of integration savings plans to reduce our on going cost structure by consolidating facilities, reducing workforce and taking other discretionary expense reduction measures. Until we achieve sustained profitability, we may incur additional charges in the future related to additional cost reduction steps. Future charges that we may incur associated with future cost reduction activities are not estimable at this time.

Note 12: Patent Cross-License Agreement

During the fourth quarter of fiscal year 2007, we recorded a $3.3 million license fee as royalty revenue relating to a patent cross-license agreement with Data Domain, a privately held company. The cross-license agreement provides each party a license to the other’s patents covering data de-duplication and certain other non-tape data storage technologies. Under the terms of our agreement, Data Domain paid the license fee with shares of its common stock.

 

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Note 13: Stockholder Rights Agreement, Common Stock and Common Stock Repurchases

We have a stockholder rights agreement (the “Rights Agreement”) that provides existing stockholders with the right to purchase preferred stock in the event of certain changes in our ownership. Specifically, existing stockholders will have the right to purchase one one-thousandth of a share of Series B Junior Participating Preferred Stock for each share of common stock held, or, under certain circumstances, shares of common stock with a market value twice the exercise price of such right. The purchase price in either case is determined by the Board of Directors, subject to adjustment.

On November 1, 2006, we amended our Rights Agreement in a second amendment such that the beneficial ownership by any person or entity of up to 25% of our common stock (including ownership of convertible notes or other securities convertible into our common stock) will not trigger a distribution pursuant to the Rights Agreement, provided that such person or entity beneficially owns no more than 20% of our outstanding common stock (including ownership of securities convertible into our common stock, but excluding ownership of notes convertible into our common stock).

Subject to certain exceptions, including the first amendment discussed below with respect to Private Capital Management, these rights may be exercised the tenth day after any person or group becomes the beneficial owner (or makes an offer that would result in such beneficial ownership) of 20% or more of the outstanding common stock. If such change in beneficial ownership is combined with a merger of Quantum or a sale of more than 50% of our assets, then the existing stockholders have the right to purchase, for the exercise price, a number of shares of common stock in the surviving entity having a market value of twice the exercise price of such right. The Rights Agreement may serve as a deterrent to takeover tactics that are not in the best interests of stockholders. There are 1,000,000 preferred shares reserved for issuance under the Rights Agreement.

On October 28, 2002, we amended our Rights Agreement to allow Private Capital Management to acquire up to 25% of our outstanding common stock without triggering the issuance of the preferred shares in exchange for its entering into a Stockholder Agreement with us that places certain restrictions on Private Capital Management with respect to its ownership and control of its shares of our common stock. The effect of both amendments to the Rights Agreement on holders of our common stock is that it is less likely that the preferred shares under the Rights Agreement will be issued to the holders of our common stock.

During fiscal 2000, the Board of Directors authorized us to repurchase up to $700 million of our common stock in open market or private transactions. As of March 31, 2007 and 2006, there was approximately $87.9 million remaining on our authorization to repurchase Quantum common stock, although our ability to repurchase our common stock is restricted under our credit facility covenants.

Note 14: Savings and Investment Plan

Substantially all of the regular domestic employees are eligible to make contributions to our 401(k) savings and investment plan. We match a percentage of our employees’ contributions and may also make additional discretionary contributions to the plan. Employer contributions were $4.5 million, $3.0 million and $2.8 million in fiscal 2007, 2006 and 2005, respectively.

Note 15: Income Taxes

The income tax provision (benefit) consists of the following (in thousands):

 

     As of March 31,  
     2007     2006     2005  

Federal:

      

Current

   $ (765 )   $ —       $ (11,922 )

Deferred

     —         —         —    
                        
     (765 )     —         (11,922 )

State:

      

Current

     626       464       395  

Deferred

     —         —         —    
                        
     626       464       395  

Foreign:

      

Current

     4,071       1,005       2,886  

Deferred

     1,006       (71 )     2  
                        
     5,077       934       2,888  
                        

Income tax provision (benefit)

   $ 4,938     $ 1,398     $ (8,639 )
                        

 

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The income tax provision (benefit) from continuing operations differs from the amount computed by applying the federal statutory rate of 35% to loss before income taxes as follows (in thousands):

 

     As of March 31,  
     2007     2006     2005  

Benefit at federal statutory rate

   $ (20,704 )   $ (13,909 )   $ (4,247 )

State taxes

     626       464       395  

Unbenefited losses and credits

     25,425       15,118       7,135  

Net release of contingent tax reserves

     —         —         (15,595 )

Taxes on dividend repatriation

     (765 )     —         3,500  

Other

     356       (275 )     173  
                        
   $ 4,938     $ 1,398     $ (8,639 )
                        

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Significant components of deferred tax assets and liabilities are as follows (in thousands):

 

     As of March 31,  
     2007     2006  

Deferred tax assets:

    

Inventory valuation methods

   $ 18,989     $ 7,567  

Accrued warranty expense

     12,322       13,940  

Distribution reserves

     5,743       4,401  

Loss carryforwards

     55,103       65,764  

Foreign tax and research and development credit carryforwards

     223,792       183,970  

Restructuring charge accruals

     4,271       3,271  

Other accruals and reserves not currently deductible for tax purposes

     25,782       9,970  

Depreciation and amortization methods

     34,128       41,044  
                
     380,130       329,927  

Less valuation allowance

     (263,437 )     (276,324 )
                

Deferred tax asset

   $ 116,693     $ 53,603  
                

Deferred tax liabilities:

    

Acquired intangibles

   $ (75,402 )   $ (17,054 )

Tax on unremitted foreign earnings

     (25,492 )     (18,622 )

Other

     (15,413 )     (17,500 )
                

Deferred tax liability

   $ (116,307 )   $ (53,176 )
                

Net deferred tax asset

   $ 386     $ 427  
                

Pretax income from foreign operations was $17.1 million for fiscal 2007 compared to $10.2 million for fiscal 2006 and a loss of $0.4 million for fiscal 2005.

In connection with the disposition of our hard-disk drive business, HDD, to Maxtor, we entered into a Tax Sharing and Indemnity Agreement with Maxtor, dated as of April 2, 2001 (the “Tax Sharing Agreement”) that, among other things, defined each company’s responsibility for taxes attributable to periods prior to April 2, 2001. Pursuant to a settlement agreement entered into between the companies dated as of December 23, 2004, Maxtor’s remaining tax indemnity liability under section 3(a) of the Tax Sharing Agreement was limited to $8.8 million. As of March 31, 2007, $6.2 million remains as the indemnity liability. We believe that this amount is sufficient to cover the remaining potential tax liabilities under this section of the Tax Sharing Agreement.

During the third quarter of fiscal 2007, the decision was made not to utilize the provisions of the Homeland Reinvestment Act for dividends paid from foreign subsidiaries on the fiscal 2006 income tax return filed.

 

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As of March 31, 2007, we had federal net operating loss and tax credit carryforwards of approximately $151.6 million and $189.5 million, respectively. $24.9 million of the federal net operating loss carryforwards are attributable to excess tax deductions from stock option exercises, and are not included in the deferred tax assets shown above. The benefit of these loss carryforwards will be credited to equity when realized. The net operating loss and tax credit carryforwards expire in varying amounts beginning in fiscal 2009 if not previously utilized. These carryforwards include $14.6 million of acquired net operating losses and $10.3 million of credits, the utilization of which is limited under the tax law ownership change provisions.

Manufacturing operations in Malaysia operate under a tax holiday which will expire in whole or in part during fiscal year 2016. The net impact of this tax holiday was to decrease our net loss by approximately $2.7 million in fiscal year 2007 ($0.01 per share, diluted). We had no material tax holiday benefits during fiscal years 2005 and 2006 respectively.

Due to our history of net losses, and the difficulty in predicting future results, we believe that we cannot rely on projections of future taxable income to realize the deferred tax assets. Accordingly, we have established a full valuation allowance against our U.S. net deferred tax assets.

Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support the reversal of the valuation allowance. Our income tax expense recorded in the future will be reduced to the extent that sufficient positive evidence materializes to support a reversal of, or decrease in, our valuation allowance.

Note 16: Net Loss Per Share

The following table set forth the computation of basic and diluted net loss per share (in thousands, except per-share data):

 

     For the year ended March 31,  
     2007     2006     2005  

Net loss

   $ (64,094 )   $ (41,479 )   $ (3,496 )

Weighted-average shares outstanding used to compute basic and diluted net loss per share

     192,236       184,063       181,111  
                        

Basic and diluted net loss per share

   $ (0.33 )   $ (0.23 )   $ (0.02 )
                        

The computations of diluted net loss per share for the periods presented excluded the effect of the following because the effect would have been antidilutive:

 

 

4.375% convertible subordinated notes issued in July 2003, which are convertible into 36.8 million shares of Quantum common stock (229.885 shares per $1,000 note) at a conversion price of $4.35 per share.

 

 

Options to purchase 36.3 million shares, 27.8 million shares, and 31.4 million shares of Quantum common stock, which were outstanding as of March 31, 2007, 2006, and 2005, respectively.

 

 

Unvested restricted stock of 3.7 million shares, 1.5 million shares and 0.8 million shares outstanding at March 31, 2007, 2006 and 2005, respectively.

Note 17: Litigation

On August 7, 1998, we were 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 (“Papst”), owns numerous United States patents, which Papst alleges are infringed upon by hard disk drive products that were sold by our former hard disk drive business. In October 1999, the case was transferred to a federal district court in New Orleans, Louisiana, where it has been joined with other lawsuits involving Papst for purposes of coordinated discovery under multi-district litigation rules. The other lawsuits have Maxtor, Minebea Limited and several other companies as parties. As part of the disposition of our hard disk drive business, HDD, to Maxtor in April 2001, Maxtor assumed the defense of the Papst claims and agreed to indemnify us with respect to litigation relating to this dispute. Maxtor has subsequently been acquired by Seagate, which has assumed Maxtor’s defense and indemnification obligations.

 

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On May 18, 2006, a lawsuit was filed in King County Superior Court, Seattle, Washington, naming ADIC and its directors as defendants. The lawsuit is a purported class action filed by Richard Carrigan on behalf of an alleged class of ADIC’s shareholders. Plaintiff alleged, among other things, that the director defendants breached their fiduciary duties in approving the proposed acquisition of ADIC by Quantum that was publicly announced on May 2, 2006. The suit sought to enjoin the defendants from consummating the proposed acquisition and other relief. Though the acquisition has since been consummated, the lawsuit remained pending and we have continued discussions with the plaintiff to reach a resolution. In January 2007 the parties entered into a memorandum of understanding to settle the litigation and the parties submitted a settlement agreement to the Court for approval in May 2007, which was preliminarily approved. A hearing for final approval is expected to occur in July 2007.

Note 18: Commitments and Contingencies

Lease Commitments

We lease certain facilities under non-cancelable lease agreements. Some of the leases have renewal options ranging from one to ten years and others contain escalation clauses and provisions for maintenance, taxes or insurance.

Rent expense was $17.6 million, $13.8 million and $14.6 million for fiscal 2007, 2006 and 2005, respectively. Sublease income was $1.5 million, $1.6 million and $1.2 million for fiscal 2007, 2006 and 2005, respectively.

Future minimum lease payments under operating leases and sublease income are as follows (in thousands):

 

     Lease Payments    Sublease Income

For the year ending March 31,

     

2008

   $ 17,593    $ 1,630

2009

     14,465      1,628

2010

     12,005      734

2011

     10,520      107

2012

     8,658      44

Thereafter

     33,742      —  
             

Total future minimum lease payments and sublease income

   $ 96,983    $ 4,143
             

Synthetic Lease Commitment

Prior to February 2006, we had a five-year synthetic lease agreement with a group of financial institutions (collectively, the “lessor”) for a campus facility in Colorado Springs, Colorado, comprised of three buildings, which would have expired in December 2007. The lease for the three buildings was accounted for as an operating lease in accordance with SFAS No. 13, Accounting for Leases.

In February 2006, we terminated our synthetic lease agreement with the lessor and completed a sale-leaseback transaction for this facility. We sold the facility for $54.3 million and the total gain on this transaction was approximately $3.2 million, of which $255,000 and $42,000 was recorded during fiscal 2007 and 2006, respectively. The remaining gain was deferred and is being recognized over the term of the lease. In connection with this sale, we leased the facility from the purchaser pursuant to three leases with initial terms of five, seven and 15 years, respectively. The future minimum lease payment schedule above includes $51.5 million remaining lease obligation for the aggregate base monthly rent for this facility. We expect to receive approximately $2.2 million under noncancellable subleases for portions of this facility through fiscal 2010.

Commitments for Additional Investments

As of March 31, 2007, we had commitments to provide an additional $1.5 million in capital funding towards investments we currently hold in two limited partnership venture capital funds. We will invest funds as required until our remaining commitments are satisfied.

 

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Commitments to Purchase Inventory

We use contract manufacturers for certain manufacturing functions. Under these arrangements, the contract manufacturer procures inventory to manufacture products based upon our forecast of customer demand. We are responsible for the financial impact on the contract manufacturer of any reduction or product mix shift in the forecast relative to materials that the contract manufacturer had already purchased under a prior forecast. Such a variance in forecasted demand could require a cash payment for finished goods in excess of current customer demand or for costs of excess or obsolete inventory. As of March 31, 2007, we had issued non-cancelable purchase orders for $53.4 million to purchase finished goods from our contract manufacturers and had accrued $2.8 million and $3.9 million as of March 31, 2007 and 2006, respectively, for finished goods in excess of current customer demand or for the costs of excess or obsolete inventory.

Note 19: Geographic and Customer Information

Revenue and long-lived assets (property and equipment, service inventories, goodwill and intangible assets) by region was as follows (revenue is attributed to regions based on the location of customers) (in thousands):

 

     For the year ended March 31,
     2007    2006    2005
     Revenue    Long-Lived
Assets
   Revenue    Long-Lived
Assets
   Revenue    Long-Lived
Assets

Americas

   $ 675,755    $ 696,891    $ 559,272    $ 178,785    $ 459,968    $ 192,192

Europe

     259,071      9,613      196,378      10,191      247,300      18,235

Asia Pacific

     81,348      14,731      78,637      4,075      86,900      2,702
                                         
   $ 1,016,174    $ 721,235    $ 834,287    $ 193,051    $ 794,168    $ 213,129
                                         

The following table shows two customers that accounted for 10% or more of our revenue in current or prior years (in millions):

 

     For the year ended March 31,  
     2007     2006     2005  
     Revenue    % of
Revenue
    Revenue    % of
Revenue
    Revenue    % of
Revenue
 

Dell

   $ 198.8    20 %   $ 152.4    18 %   $ 131.7    17 %

Hewlett-Packard

   $ 92.2    9 %   $ 149.8    18 %   $ 173.9    22 %

Note 20: Unaudited Quarterly Financial Data

(In thousands, except per-share data)

 

     For the year ended March 31, 2007  
     1st Quarter     2nd Quarter     3rd Quarter     4th Quarter  

Revenue

   $ 186,595     $ 250,370     $ 301,899     $ 277,310  

Gross margin

   $ 52,025     $ 70,613     $ 89,016     $ 81,731  

Net loss

   $ (3,576 )   $ (30,676 )   $ (9,524 )   $ (20,318 )

Basic and diluted loss per share

   $ (0.02 )   $ (0.16 )   $ (0.05 )   $ (0.10 )
     For the year ended March 31, 2006  
     1st Quarter     2nd Quarter     3rd Quarter     4th Quarter  

Revenue

   $ 206,637     $ 203,607     $ 218,365     $ 205,678  

Gross margin

   $ 57,442     $ 52,659     $ 63,660     $ 58,167  

Net income (loss)

   $ (5,477 )   $ (13,788 )   $ 819     $ (23,033 )

Basic and diluted income (loss) per share

   $ (0.03 )   $ (0.07 )   $ —       $ (0.12 )

During the second quarter of fiscal 2007, we completed our acquisition of ADIC and expensed $14.7 million of in-process research and development. This transaction is reflected in the net loss and the basic and diluted loss per share for the second quarter of fiscal 2007.

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Quantum Corporation

We have audited the accompanying consolidated balance sheets of Quantum Corporation as of March 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2007. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Quantum Corporation at March 31, 2007 and 2006 and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 3 to the financial statements, in fiscal 2007, Quantum Corporation changed its method of accounting for stock-based compensation in accordance with guidance provided in Statement of Financial Accounting Standards No. 123(R), Share-Based Payment.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Quantum Corporation’s internal control over financial reporting as of March 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 11, 2007 expressed an unqualified opinion thereon.

 

/s/ ERNST & YOUNG LLP

Palo Alto, California

June 11, 2007

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Quantum Corporation

We have audited management’s assessment, included in the accompanying Management Report on Internal Control over Financial Reporting, that Quantum Corporation maintained effective internal control over financial reporting as of March 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Quantum Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As indicated in the accompanying Management’s Report on Internal Control over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Advanced Digital Information Corporation (“ADIC”), which was acquired on August 22, 2006. As of and for the year ended March 31, 2007 total assets and net sales of ADIC represented 16% and 29% of consolidated total assets and net sales, respectively. Our audit of internal control over financial reporting for Quantum Corporation also did not include an evaluation of the internal control over financial reporting of ADIC.

In our opinion, management’s assessment that Quantum Corporation maintained effective internal control over financial reporting as of March 31, 2007, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Quantum Corporation maintained, in all material respects, effective internal control over financial reporting as of March 31, 2007, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Quantum Corporation as of March 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2007 of Quantum Corporation and our report dated June 11, 2007 expressed an unqualified opinion thereon.

 

/s/ ERNST & YOUNG LLP

Palo Alto, California

June 11, 2007

 

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QUANTUM CORPORATION

SCHEDULE II

CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS

Allowance for doubtful accounts

 

(in thousands)

   Balance at
beginning of
period
   Additions
assumed in
ADIC
Acquisition
   Additions
(Releases)
charged to
expense
    Deductions (i)     Balance at
end of
period

For the year ended:

            

March 31, 2005

   $ 9,988    $ —      $ 1,474     $ (2,500 )   $ 8,962

March 31, 2006

   $ 8,962    $ —      $ (581 )   $ (538 )   $ 7,843

March 31, 2007

   $ 7,843    $ 1,446    $ 133     $ (2,991 )   $ 6,431

(i) Uncollectible accounts written off, net of recoveries.

 

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ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Not applicable.

 

ITEM 9A. Controls and Procedures

Attached as exhibits to this Annual Report on Form 10-K are certifications of our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), which are required pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). This “Controls and Procedures” section of this Annual Report on Form 10-K includes information concerning the controls and controls evaluation referenced in the certifications. The report of Ernst & Young LLP, our independent registered public accounting firm, is set forth at the end of Part II, Item 8 of this Annual Report on Form 10-K. This report addresses Ernst & Young LLP’s audit of our internal control over financial reporting as of March 31, 2007 and of management’s assessment of internal control over financial reporting set forth below. This section of the Annual Report on Form 10-K should be read in conjunction with the certifications and the report of Ernst Young LLP for a more complete understanding of the matters presented.

Evaluation of Disclosure Controls

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. This control evaluation was performed under the supervision and with the participation of management, including our CEO and CFO. Disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, or the Exchange Act, such as this Annual Report on From 10-K is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission, or the SEC. Disclosure controls are also designed to ensure that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

Based on the controls evaluation, our CEO and CFO have concluded that, subject to the inherent limitations noted in this Part II, Item 9A, as of the end of the period covered by this Form 10-K, our disclosure controls were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information relating to us is made known to management, including the CEO and the CFO, particularly during the time when our periodic reports are being prepared.

Management Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of March 31, 2007 based on the guidelines established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on the results of our evaluation, our management concluded that our internal control over financial reporting was effective as of March 31, 2007 to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles. Management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of the operations acquired from Advanced Digital Information Corporation (“ADIC”), which was acquired on August 22, 2006. As allowed pursuant to guidance from the Securities and Exchange Commission, the evaluation of internal control over financial reporting of ADIC may be excluded. We provided Ernst & Young LLP, an independent registered public accounting firm, management’s assessment of the effectiveness of our internal control over financial reporting as of March 31, 2007 excluding all ADIC internal controls. As of and for the year ended March 31, 2007 total assets and net sales of ADIC represented 16% and 29% of consolidated total assets and net sales, respectively.

Management’s assessment of the effectiveness of our internal control over financial reporting as of March 31, 2007 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included at the end of Part II, Item 8 of this Annual Report on Form 10-K.

 

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Limitations on Effectiveness of Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additional controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Changes in Internal Controls over Financial Reporting

There was no change in our internal control over financial reporting that occurred during our fourth quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

Non-Audit Services of Independent Auditors

Sections 201 and 202 of the Sarbanes-Oxley Act of 2002, signed into law on July 30, 2002, require that all audit services and non-audit services by our independent auditors, Ernst & Young LLP, must be pre-approved by our Audit Committee. Furthermore, the Act prohibits an auditor from performing certain non-audit services for an audit client regardless of the Audit Committee’s approval, subject to certain exceptions issued by the Public Company Accounting Oversight Board.

All services performed by Ernst & Young LLP in the fiscal 2007 were approved by our Audit Committee, consistent with our internal policy.

 

ITEM 9B. Other information

None.

PART III

 

ITEM 10. Directors and Executive Officers of the Registrant

The information required by this item with respect to our directors, audit committee and audit committee financial expert is incorporated by reference to the information set forth in our proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of our fiscal year ended March 31, 2007. For information pertaining to our executive officers, refer to the “Executive Officers of Quantum Corporation” section of Part I, Item 1 of this Annual Report on Form 10-K.

We have adopted a code of ethics that applies to our principal executive officer and all members of our finance department, including the principal financial officer and principal accounting officer. This code of ethics is posted on our Website. The Internet address for our Website is http://www.quantum.com, and the code of ethics may be found by clicking “About Us” from the home page, selecting “Investor Relations” and then choosing “Corporate Governance.” Copies of the code are available free upon request by a stockholder.

We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of this code of ethics by posting such information on our website, at the address and location specified above.

We have adopted Corporate Governance Principles, which are available on our website at http://www.quantum.com, where they may be found by clicking “About Us” from the home page, selecting “Investor Relations” and then choosing “Corporate Governance.” Copies of our Corporate Governance Principles are available free upon request by a stockholder. The charters of our Audit Committee, Leadership and Compensation Committee and Corporate Governance and Nominating Committee are also available on our website at http://www.quantum.com, where they may be found by clicking “About Us” from the home page, selecting “Investor Relations” and then choosing “Corporate Governance.” Copies of these committee charters are available free upon request by a stockholder.

 

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ITEM 11. Executive Compensation

The information required by this item is incorporated by reference to the information set forth in our proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of our fiscal year ended March 31, 2007.

 

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item is incorporated by reference to the information set forth in our proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of our fiscal year ended March 31, 2007.

 

ITEM 13. Certain Relationships and Related Transactions

The information required by this item is incorporated by reference to the information set forth in our proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of our fiscal year ended March 31, 2007.

 

ITEM 14. Principal Accountant Fees and Services

The information required by this item is incorporated by reference to the information set forth in our proxy statement for the 2007 Annual Meeting of Stockholders to be filed with the Commission within 120 days after the end of our fiscal year ended March 31, 2007.

PART IV

 

ITEM 15. Exhibits and Financial Statement Schedules

Upon written request, we will provide, without charge, a copy of our Annual Report on Form 10-K, including the Consolidated Financial Statements, financial statement schedules and any exhibits for our most recent fiscal year. All requests should be sent to:

Investor Relations

Quantum Corporation

1650 Technology Drive Suite 700

San Jose, California 95110

408-944-4450

 

  (a) The following documents are filed as a part of this Report:

 

  1. Financial Statements—Our Consolidated Financials Statements are listed in the Index to Consolidated Financial Statements.

 

  2. Financial Statement Schedules—Our consolidated valuation and qualifying accounts (Schedule II) financial statement schedule is listed in the Index to Consolidated Financial Statements. All other schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the Consolidated Financial Statements or the notes hereto.

 

  (b) Exhibits

 

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     Incorporated by Reference
Exhibit
Number
  

Exhibit Description

   Form    File No.    Exhibit(s)  

Filing Date

3.1    Amended and Restated Certificate of Incorporation of Registrant.    10-K    001-13449    3.1   June 29, 2001
3.2    Certificate of Correction to the Amended and Restated Certificate of Incorporation of Registrant.    10-Q    001-13449    3.2   November 4, 2005
3.3    Amended and Restated By-laws of Registrant, as amended.    10-K    001-13449    3.2   June 28, 2000
3.4    Certificate of Amendment to Amended and Restated By-laws of Registrant, effective May 21, 2007.    8-K    001-13449    3.1   May 25, 2007
3.5    Certificate of Designation of Rights, Preferences and Privileges of Series B Junior Participating Preferred Stock.    S-3    333-109587    4.7   October 9, 2003
4.1    Amended and Restated Preferred Shares Rights Agreement between the Registrant and Harris Trust and Savings Bank.    S-4/A    333-75153    4.1   June 10, 1999
4.2    First Amendment to the Amended and Restated Preferred Shares Rights Agreement and Certification Of Compliance With Section 27 Thereof, dated as of October 28, 2002.    10-Q    001-13449    4.1   November 13, 2002
4.3    Second Amendment to the Amended and Restated Preferred Shares Rights Plan, dated November 1, 2006.    8-K    001-13449    4.1   November 6, 2006
4.4    Stockholder Agreement, dated as of October 28, 2002, by and between Registrant and Private Capital Management.    10-Q    001-13449    4.2   November 13, 2002
10.1    Form of Indemnification Agreement between Registrant and the Named Executive Officers and Directors. *    8-K    001-13449    10.4   April 4, 2007
10.2    Form of Officer Change of Control Agreement, dated April 1, 2007, between Registrant and the Executive Officers (other than the Chief Executive Officer). *    8-K    001-13449    10.2   April 4, 2007
10.3    Chief Executive Officer Change of Control Agreement, dated April 1, 2007, between Registrant and the Chief Executive Officer. *    8-K    001-13449    10.1   April 4, 2007
10.4    Form of Director Change of Control Agreement, dated April 1, 2007, between Registrant and the Directors. *    8-K    001-13449    10.3   April 4, 2007
10.5    1993 Long-Term Incentive Plan (as amended and restated effective February 27, 2006). *    8-K    001-13449    10.2   March 3, 2006
10.6    1993 Long-Term Incentive Plan Form of Restricted Stock Unit Agreement. *    8-K    001-13449    10.3   March 3, 2006
10.7    1993 Long-Term Incentive Plan Form of Stock Option Agreement. *    Schedule TO    005-35818    99(d)(5)   June 4, 2001
10.8    Nonemployee Director Equity Incentive Plan. *    Schedule 14A    001-13449    Appendix A   July 21, 2003
10.9    Nonemployee Director Equity Incentive Plan -Form of Restricted Stock Agreement. *    10-K    001-13449    10.9   June, 14, 2004
10.10    Amended Employee Stock Purchase Plan. *    8-K    001-13449    10.1   November 18, 2004

 

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     Incorporated by Reference
Exhibit
Number
  

Exhibit Description

   Form    File No.    Exhibit(s)   

Filing Date

10.11    Termination Agreement and General Release of All Claims, dated March 17, 2007, between Registrant and Howard L. Matthews III. *    8-K    001-13449    10.1    March 22, 2007
10.12    Employment Offer Letter, dated August 31, 2006, between Registrant and William C. Britts. *    8-K    001-13449    10.1    September 7, 2006
10.13    Employment Offer Letter, dated August 28, 2006, between Registrant and Jon W. Gacek. *    8-K    001-13449    10.3    September 7, 2006
10.14    Change of Control Agreement, dated as of May 14, 1999, between ADIC and William C. Britts. *    8-K    001-13449    10.1    September 7, 2006
10.15    Change of Control Agreement, dated November 5, 1999, between ADIC and Jon W. Gacek. *    8-K    001-13449    10.1    July 25, 2006
10.16    Offer Letter, dated May 25, 2007, between Registrant and Joseph A. Marengi. *    8-K    001-13449    10.1    May 25, 2007
10.17    Transaction Bonus and Severance Protection Agreement, dated January 4, 2005, between Certance, LLC and Howard L. Matthews III. *    8-K    001-13449    10.3    June 2, 2005
10.18    Form of Director Grant Agreement. *    8-K    001-13449    10.1    September 29, 2005
10.19    Indenture, dated as of July 30, 2003, between Registrant and U.S. Bank National Association, related to the Registrant’s convertible debt securities.    S-3    333-109587    4.1    October 9, 2003
10.20    Resale Registration Rights Agreement, dated July 30, 2003, between Registrant, Lehman Brothers Inc., Morgan Stanley & Co. Incorporated and McDonald Investments Inc.    S-3    333-109587    4.3    October 9, 2003
10.21    Credit Agreement, dated as of August 22, 2006, by and among Registrant, the lenders from time to time party thereto, and KeyBank National Association    8-K    001-13449    99.2    August 28, 2006
10.22    Term Loan Agreement, dated as of August 22, 2006, by and among Registrant, the lenders from time to time party thereto, and KeyBank National Association.    8-K    001-13449    99.3    August 28, 2006
10.23    Commitment Letter, dated as of April 27, 2006, between Registrant and KeyBank National Association.    8-K    001-13449    99.4    August 28, 2006
10.24    Side Letter, dated as of August 22, 2006 and effective August 18, 2006, between Registrant and KeyBank National Association.    8-K    001-13449    99.5    August 28, 2006
10.25    First Amendment to Credit Agreement, dated as of November 27, 2006, by and among Registrant, the lenders from time to time party thereto, and KeyBank National Association.    8-K    001-13449    10.1    December 1, 2006

 

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          Incorporate by Reference
    

Exhibit Description

   Form    File No.    Exhibit(s)   

Filing Date

10.26    First Amendment to Term Loan Agreement, dated as of November 27, 2006, by and among Registrant, the lenders from time to time party thereto, and KeyBank National Association.    8-K    001-13449    10.2    December 1, 2006
10.27    Side Letter, dated as of November 27, 2006, between Registrant and KeyBank National Association.    8-K    001-13449    10.3    December 1, 2006
10.28    Agreement for Purchase and Sale of Real Property, dated as November 18, 2005, among Registrant, SELCO Service Corporation and CS/Federal Drive LLC, as amended by Amendments 1 through 6.    8-K    001-13449    10.1    February 10, 2006
10.29    Lease Agreement, dated February 6, 2006, between Registrant and CS/Federal Drive AB LLC (for Building A).    8-K    001-13449    10.2    February 10, 2006
10.30    Lease Agreement, dated February 6, 2006, between Registrant and CS/Federal Drive AB LLC (for Building B).    8-K    001-13449    10.3    February 10, 2006
10.31    Lease Agreement, dated February 6, 2006, between Registrant and CS/Federal Drive AB LLC (for Building C).    8-K    001-13449    10.4    February 10, 2006
10.32    Patent Cross License Agreement, dated February 27, 2006, between Registrant and Storage Technology Corporation.    8-K    001-13449    10.1    March 3, 2006
10.33    Agreement and Plan of Merger by and among Registrant, Agate Acquisition Corp. and Advanced Digital Information Corporation, dated May 2, 2006.    8-K    001-13449    2.1    May 5, 2006
10.34    Form of Voting Agreement entered into with certain Directors and Officers, dated May 2, 2006.    8-K    001-13449    10.1    May 5, 2006
10.35    Particulars and Conditions of Sale between Quantum Perepheral Products (Ireland) Limited (as Vendor) and Ronan Egan ( in Trust) (as Purchaser).    8-K    001-13449    10.1    May 9, 2006
10.36    License Agreement, between Quantum Perepheral Products (Ireland) Limited (as Licensee) and Ciaran O’ Donoghue and Nuiall O’ Donoghue (as Licensor).    8-K    001-13449    10.2    May 9, 2006
10.37    Amended and Restated Agreement and Plan of Merger and Reorganization dated as of October 3, 2000 by and among Registrant, Maxtor Corporation, Insula Corporation and Hawaii Corporation (excluding exhibits).    10-Q    001-13449    10.1    February 14, 2001
10.38    Tax Sharing and Indemnity Agreement by and among Registrant, Maxtor Corporation and Insula Corporation, dated April 2, 2001.    8-K    001-13449    10.1    December 29, 2004
10.39    Mutual General Release and Global Settlement Agreement, dated as of December 23, 2004, between Maxtor Corporation and Registrant.    10-Q    001-13449    10.4    February 2, 2005

 

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          Incorporated by Reference
Exhibit
Number
  

Exhibit Description

   Form    File No.    Exhibit(s)   

Filing Date

10.40    Agreement and Plan of Merger, dated as of October 20, 2004, among Registrant, Certance Holdings, an exempted company organized under the laws of the Cayman Islands, New SAC, an exempted company organized under the laws of the Cayman Islands and the principal stockholder of Certance, and Quartz Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Registrant.    8-K    001-13449    10.1    October 25, 2004
10.41    Letter Agreement, dated December 19, 2005, between Registrant and New SAC.    8-K    001-13449    10.1    December 22, 2005
12.1    Ratio of Earnings to Fixed Charges. ‡            
21    Quantum Subsidiaries. ‡            
23.1    Consent of Independent Registered Public Accounting Firm. ‡            
24    Power of Attorney (see signature page).            
31.1    Certification of the Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. ‡            
31.2    Certification of the Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002. ‡            
32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002. †            
32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley act of 2002. †            

* Indicates management contract or compensatory plan, contract or arrangement.
Filed herewith.
Furnished herewith.

 

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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, thereunto duly authorized.

 

QUANTUM CORPORATION

/s/ JON W. GACEK

Jon W. Gacek
Executive Vice President and
Chief Financial Officer

Dated: June 13, 2007

 

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POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard E. Belluzzo and Jon W. Gacek, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons in the capacities and on June 13, 2007.

 

Signature

     

Title

/s/ RICHARD E. BELLUZZO

   

Chairman of the Board and Chief Executive Officer

Richard E. Belluzzo         (Principal Executive Officer)

/s/ JON W. GACEK

   

Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Jon W. Gacek    

/s/ MICHAEL A. BROWN

    Director
Michael A. Brown    

/s/ THOMAS S. BUCHSBAUM

    Director
Thomas S. Buchsbaum    

/s/ ALAN L. EARHART

    Director
Alan L. Earhart    

/s/ EDWARD M. ESBER, JR.

    Director
Edward M. Esber, Jr    

/s/ ELIZABETH A. FETTER

    Director
Elizabeth A. Fetter    

/s/ JOSEPH A. MARENGI

    Director
Joseph A. Marengi    

/s/ JOHN M. PARTRIDGE

    Director
John M. Partridge    

/s/ STEVEN C. WHEELWRIGHT

    Director
Steven C. Wheelwright    

 

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