UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


FORM 10-Q

(Mark One)

 

 

 

x

 

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2003 or

¨

 

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                         to                        

Commission file number 0-15071


ADAPTEC, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of incorporation or organization)

 

94-2748530
(I.R.S. Employer Identification No.)

 

 

 

691 S. MILPITAS BLVD., MILPITAS, CALIFORNIA
(Address of principal executive offices)

 

95035
(Zip Code)

Registrant’s telephone number, including area code (408) 945-8600

N/A
(Former name, former address and former fiscal year, if changed since last report)


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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes x    No ¨

The number of shares outstanding of Adaptec’s common stock as of October 23, 2003 was 108,810,737.

 



TABLE OF CONTENTS

 

 

 

 

 

 

Page

Part I.

 

Financial Information

 

 

 

 

Item 1. 

 

Financial Statements:

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations

 

3

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets

 

4

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows

 

5

 

 

 

 

Unaudited Notes to Condensed Consolidated Financial Statements

 

6

 

 

Item 2. 

 

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

 

28

 

 

Item 3. 

 

Quantitative and Qualitative Disclosures About Market Risk

 

49

 

 

Item 4. 

 

Controls and Procedures

 

50

Part II.

 

Other Information

 

 

 

 

Item 4. 

 

Submission of Matters to a Vote of Security Holders

 

51

 

 

Item 6. 

 

Exhibits and Reports on Form 8-K

 

51

 

 

Signatures

 

52

 

 

2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ADAPTEC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

 

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September  30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands, except per share amounts)

 

Net revenues

 

 

$

109,192

 

 

 

$

85,709

 

 

 

$

216,485

 

 

 

$

193,555

 

 

Cost of revenues

 

 

62,746

 

 

 

39,519

 

 

 

124,177

 

 

 

86,803

 

 

Gross profit

 

 

46,446

 

 

 

46,190

 

 

 

92,308

 

 

 

106,752

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development 

 

 

24,975

 

 

 

29,403

 

 

 

50,932

 

 

 

60,619

 

 

Selling, marketing and administrative

 

 

19,223

 

 

 

23,238

 

 

 

39,576

 

 

 

47,291

 

 

Amortization of acquisition-related intangible assets

 

 

4,713

 

 

 

3,743

 

 

 

9,537

 

 

 

7,487

 

 

Write-off of acquired in-process technology

 

 

 

 

 

 

 

 

3,649

 

 

 

 

 

Restructuring charges

 

 

1,478

 

 

 

7,139

 

 

 

1,826

 

 

 

7,139

 

 

Other charges

 

 

 

 

 

528

 

 

 

 

 

 

528

 

 

Total operating expenses 

 

 

50,389

 

 

 

64,051

 

 

 

105,520

 

 

 

123,064

 

 

Loss from operations

 

 

(3,943

)

 

 

(17,861

)

 

 

(13,212

)

 

 

(16,312

)

 

Interest and other income

 

 

4,252

 

 

 

9,633

 

 

 

60,311

 

 

 

18,468

 

 

Interest expense

 

 

(2,490

)

 

 

(4,011

)

 

 

(5,688

)

 

 

(9,185

)

 

Income (loss) from operations before provision for (benefit from) income taxes

 

 

(2,181

)

 

 

(12,239

)

 

 

41,411

 

 

 

(7,029

)

 

Provision for (benefit from) income taxes

 

 

(2,442

)

 

 

(1,419

)

 

 

348

 

 

 

1,237

 

 

Net income (loss)

 

 

$

261

 

 

 

$

(10,820

)

 

 

$

41,063

 

 

 

$

(8,266

)

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

0.00

 

 

 

$

(0.10

)

 

 

$

0.38

 

 

 

$

(0.08

)

 

Diluted

 

 

$

0.00

 

 

 

$

(0.10

)

 

 

$

0.35

 

 

 

$

(0.08

)

 

Shares used in computing net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

108,411

 

 

 

106,550

 

 

 

108,183

 

 

 

106,264

 

 

Diluted

 

 

110,219

 

 

 

106,550

 

 

 

126,400

 

 

 

106,264

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

3



 

ADAPTEC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

 

 

 September 30,  2003

 

March 31, 2003

 

 

 

(in thousands)

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

83,299

 

 

 

$

149,373

 

 

Marketable securities

 

 

600,126

 

 

 

592,929

 

 

Restricted marketable securities

 

 

7,464

 

 

 

7,429

 

 

Accounts receivable, net

 

 

57,369

 

 

 

50,137

 

 

Inventories

 

 

40,738

 

 

 

23,496

 

 

Deferred income taxes

 

 

30,087

 

 

 

29,947

 

 

Prepaid expenses

 

 

15,533

 

 

 

15,012

 

 

Other current assets

 

 

10,141

 

 

 

24,603

 

 

Total current assets

 

 

844,757

 

 

 

892,926

 

 

Property and equipment, net

 

 

75,493

 

 

 

79,316

 

 

Restricted marketable securities, less current portion

 

 

3,692

 

 

 

7,360

 

 

Goodwill

 

 

63,407

 

 

 

53,854

 

 

Other intangible assets, net

 

 

47,133

 

 

 

47,395

 

 

Other long-term assets

 

 

15,108

 

 

 

22,128

 

 

Total assets

 

 

$

1,049,590

 

 

 

$

1,102,979

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

 

$

35,429

 

 

 

$

29,136

 

 

Accrued liabilities

 

 

107,208

 

 

 

136,025

 

 

43¤4% Convertible Subordinated Notes

 

 

 

 

 

82,445

 

 

Total current liabilities

 

 

142,637

 

 

 

247,606

 

 

3% Convertible Subordinated Notes

 

 

250,000

 

 

 

250,000

 

 

Other long-term liabilities

 

 

5,888

 

 

 

2,596

 

 

Commitments and contingencies (Note 14)

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

Common stock

 

 

109

 

 

 

108

 

 

Additional paid-in capital

 

 

182,666

 

 

 

178,580

 

 

Deferred stock-based compensation

 

 

(4,965

)

 

 

(8,114

)

 

Accumulated other comprehensive income, net of taxes

 

 

3,779

 

 

 

3,790

 

 

Retained earnings

 

 

469,476

 

 

 

428,413

 

 

Total stockholders’ equity

 

 

651,065

 

 

 

602,777

 

 

Total liabilities and stockholders’ equity

 

 

$

1,049,590

 

 

 

$

1,102,979

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

4



ADAPTEC, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

 

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands)

 

Cash Flows From Operating Activities:

 

 

 

 

 

 

 

 

 

Net income

 

 

$

41,063

 

 

 

$

(8,266

)

 

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

 

 

 

 

 

 

 

 

 

Non-cash restructuring charges

 

 

66

 

 

 

1,851

 

 

Write-off of acquired in-process technology

 

 

3,649

 

 

 

 

 

Stock-based compensation

 

 

2,352

 

 

 

5,600

 

 

Loss (gain) on extinguishment of debt

 

 

790

 

 

 

(3,297

)

 

Non-cash portion of DPT settlement gain

 

 

(18,256

)

 

 

 

 

Depreciation and amortization

 

 

26,849

 

 

 

22,849

 

 

Deferred income taxes

 

 

(5,535

)

 

 

1,536

 

 

Other items

 

 

245

 

 

 

825

 

 

Changes in assets and liabilities

 

 

10,108

 

 

 

8,222

 

 

Net Cash Provided by Operating Activities

 

 

$

61,331

 

 

 

$

29,320

 

 

Cash Flows From Investing Activities:

 

 

 

 

 

 

 

 

 

Payments for business acquisitions, net of cash acquired

 

 

(29,884

)

 

 

 

 

Payment of general holdback in connection with acquisition of Platys 

 

 

(159

)

 

 

(10,640

)

 

Purchases of other investments

 

 

 

 

 

(1,000

)

 

Purchases of property and equipment

 

 

(3,093

)

 

 

(5,016

)

 

Purchases of marketable securities

 

 

(393,994

)

 

 

(355,757

)

 

Sales of marketable securities

 

 

350,740

 

 

 

227,422

 

 

Maturities of marketable securities

 

 

31,063

 

 

 

52,800

 

 

Net Cash Used for Investing Activities

 

 

(45,327

)

 

 

(92,191

)

 

Cash Flows From Financing Activities:

 

 

 

 

 

 

 

 

 

Proceeds from issuance of common stock

 

 

3,302

 

 

 

4,564

 

 

Installment payments on acquisition of software licenses

 

 

(2,422

)

 

 

 

 

Repurchases and redemption of long-term debt

 

 

(83,010

)

 

 

(116,313

)

 

Net Cash Used for Financing Activities

 

 

(82,130

)

 

 

(111,749

)

 

Effect of Foreign Currency Translation on Cash and Cash Equivalents

 

 

52

 

 

 

298

 

 

Net Decrease in Cash and Cash Equivalents

 

 

(66,074

)

 

 

(174,322

)

 

Cash and Cash Equivalents at Beginning of Period

 

 

149,373

 

 

 

331,324

 

 

Cash and Cash Equivalents at End of Period

 

 

$

83,299

 

 

 

$

157,002

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

5



ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Basis of Presentation

In the opinion of management, the accompanying Unaudited Condensed Consolidated Interim Financial Statements (“financial statements”) of Adaptec, Inc. and its wholly-owned subsidiaries (collectively the “Company”) have been prepared on a consistent basis with the March 31, 2003 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly present the information set forth therein. The financial statements have been prepared in accordance with the regulations of the SEC, and, therefore, omit certain information and footnote disclosure necessary to present the statements in accordance with generally accepted accounting principles. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2003, which was filed with the SEC on June 26, 2003. The second quarters of fiscal 2004 and fiscal 2003 ended September 26, 2003 and September 27, 2002, respectively. For presentation purposes, the accompanying financial statements have been shown as ending on the last day of the calendar month. Certain amounts reported in previous periods have been reclassified to conform to the current period presentation. The results of operations for the second quarter and first half of fiscal 2004 are not necessarily indicative of the results to be expected for the entire fiscal year.

The glossary of acronyms and accounting rules and regulations referred to within this Quarterly Report on Form 10-Q is listed in alphabetical order in Note 20.

2. Recent Accounting Pronouncements

In May 2003, a consensus was reached on EITF No. 03-5, which was ratified by the FASB in August 2003. EITF No. 03-5 affirms that AICPA SOP 97-2 applies to non-software deliverables, such as hardware, in an arrangement if the software is essential to the functionality of the non-software deliverables. This statement is effective for new revenue arrangements entered into for  reporting periods commencing after August 13, 2003. The Company is currently evaluating the effect that the adoption of EITF No. 03-5, if any, will have on its financial position and results of operations.

In May 2003, the FASB issued SFAS No. 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. This statement was effective immediately for all financial instruments created or modified after May 31, 2003 and by the first interim period commencing after June 15, 2003 for existing financial instruments. The adoption of SFAS No. 150 does not currently affect the Company’s financial position or results of operations.

In January 2003, the FASB issued FIN 46, an Interpretation of ARB No. 51. FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. During October 2003, the FASB issued FSP 46-6 which is effective for financial statements issued after October 9, 2003, and provides a broad deferral of the latest date by which all public entities must apply FIN 46 to certain variable interest entities, to the first reporting period ending after December 15, 2003. The Company does not expect the adoption of FIN 46 to have a material impact on its financial position and results of operations.

6




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

2. Recent Accounting Pronouncements (Continued)

In November 2002, a consensus was reached on EITF No. 00-21 which provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF No. 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF No. 00-21 did not have a material impact on the Company’s financial position and results of operations.

3. Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with APB Opinion No. 25 as interpreted by FIN 44 and complies with the disclosure provisions of SFAS No. 148, an amendment of SFAS No. 123. The following table illustrates the effect on net income (loss) and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to employee and director stock option plans, including shares issued under the Company’s ESPP, collectively called “options” for all periods presented:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands, except per share amounts)

 

Net income (loss), as reported 

 

 

$

261

 

 

 

$

(10,820

)

 

 

$

41,063

 

 

 

$

(8,266

)

 

Add: Deferred stock-based compensation expense included in reported net income (loss), net of
taxes

 

 

975

 

 

 

1,228

 

 

 

2,099

 

 

 

2,507

 

 

Deduct: Total stock-based compensation expense determined under the fair value-based method, net of taxes

 

 

(8,270

)

 

 

(8,835

)

 

 

(15,161

)

 

 

(18,423

)

 

Pro forma net income
(loss)

 

 

$

(7,034

)

 

 

$

(18,427

)

 

 

$

28,001

 

 

 

$

(24,182

)

 

Basic net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As reported

 

 

$

0.00

 

 

 

$

(0.10

)

 

 

$

0.38

 

 

 

$

(0.08

)

 

Pro forma

 

 

$

(0.06

)

 

 

$

(0.17

)

 

 

$

0.26

 

 

 

$

(0.23

)

 

Diluted net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As reported

 

 

$

0.00

 

 

 

$

(0.10

)

 

 

$

0.35

 

 

 

$

(0.08

)

 

Pro forma

 

 

$

(0.06

)

 

 

$

(0.17

)

 

 

$

0.24

 

 

 

$

(0.23

)

 

SFAS No. 123 requires the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option pricing model, used by the Company, was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions,

7




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

3. Stock-Based Compensation (Continued)

including the option’s expected life and the price volatility of the underlying stock. Because the Company’s options have characteristics significantly different from those of traded options, and because changes in the  subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable measure of the fair value of options. The fair value of options granted in the second quarter and first half of fiscal 2004 and 2003, as reported were estimated at the date of grant using the Black-Scholes valuation model with the following weighted average assumptions:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

Employee Stock Option Plans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected life (in years)

 

 

2.3

 

 

 

4.0

 

 

 

2.3 - 3.0

 

 

 

4.0

 

 

Risk-free interest rates

 

 

1.5

%

 

 

2.4

%

 

 

1.5% - 1.7

%

 

 

2.4

%

 

Expected volatility

 

 

64

%

 

 

76

%

 

 

64% - 66

%

 

 

76

%

 

Dividend yield

 

 

 

 

 

 

 

 

 

 

 

 

 

ESPP:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected life (in years)

 

 

0.5 - 2.0

 

 

 

0.5

 

 

 

0.5 - 2.0

 

 

 

0.5

 

 

Risk-free interest rates

 

 

1.1% - 1.8

%

 

 

1.1

%

 

 

1.1% -  1.8

%

 

 

1.1

%

 

Expected volatility

 

 

39% - 66

%

 

 

76

%

 

 

39% - 66

%

 

 

76

%

 

Dividend yield

 

 

 

 

 

 

 

 

 

 

 

 

 

4. Business Acquisitions

During the first quarter of fiscal 2004, the Company purchased Eurologic Systems Group Limited (“Eurologic”) and ICP vortex Computersysteme GmbH (“ICP vortex”). The acquisitions were accounted for under the purchase method of accounting in accordance with SFAS No. 141. Accordingly, the estimated fair value of assets acquired and liabilities assumed in the acquisitions and the results of operations of the acquired entities were included in the Company’s consolidated financial statements as of the respective effective dates of the acquisitions. There were no significant differences between the Company’s accounting policies and those of Eurologic and ICP vortex.

Eurologic:   On April 2, 2003, the Company completed the acquisition of Eurologic, a provider of external and networked storage solutions. The Company acquired Eurologic to further enhance its direct-attached and fibre-attached server storage capabilities by allowing it to provide end-to-end block- and file-based networked storage solutions. As consideration for the acquisition of all of the outstanding capital stock of Eurologic, the Company paid $25.6 million in cash (subject to the Holdback as described below) and assumed stock options to purchase 0.5 million shares of the Company’s common stock, with a fair value of $1.6 million. The Company also incurred $1.1 million in transaction fees, including legal, valuation and accounting fees. The assumed stock options were valued using the Black-Scholes valuation model with the following assumptions: volatility rate ranging from 57%-81%; a risk-free interest rate ranging from 1.1%-2.5%; and an estimated life ranging from 0.08-4 years. Eurologic is being integrated into the Company’s SSG segment.

Holdback:   As part of the Eurologic purchase agreement, $3.8 million of the cash payment was held back (the “Holdback”) for unknown liabilities that may have existed as of the acquisition date. The Holdback, which was included as part of the purchase price, is included in “Other long-term liabilities” in the Unaudited Condensed Consolidated Balance Sheet as of September 30, 2003 and will be paid to the

8




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

4. Business Acquisitions (Continued)

former Eurologic stockholders 18 months after the acquisition closing date, except for funds necessary to provide for any unknown liabilities.

Earn-out Payments:   The Company also committed to pay the stockholders of Eurologic contingent consideration of up to $10.0 million in cash, also referred to as earn-out payments. The earn-out payments become payable if certain revenue levels are achieved by the acquired Eurologic business, in the period from July 1, 2003 through June 30, 2004. The earn-out payments will be recorded as purchase price adjustments in the period, if any, in which the attainment of the milestones become probable and the contingent consideration becomes determinable.

The preliminary allocation of the Eurologic purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed is summarized below (in thousands). The preliminary allocation was based on an independent appraisal and management’s estimates of fair value. The allocation of the purchase price may be subject to change based on final estimates of fair value.

Cash

 

$

3,321

 

Accounts receivable

 

10,624

 

Inventory

 

4,066

 

Other current assets

 

2,107

 

Property and equipment

 

2,861

 

Total assets acquired

 

22,979

 

Accounts payable

 

(7,292

)

Current liabilities

 

(7,830

)

Total liabilities assumed

 

(15,122

)

Net tangible assets acquired

 

$

7,857

 

The allocation of the purchase price to the tangible and intangible assets acquired and liabilities assumed is as follows (in thousands):

Net tangible assets acquired

 

$

7,857

 

Acquired in-process technology

 

3,649

 

Goodwill

 

8,836

 

Other intangible assets:

 

 

 

Core technology

 

5,046

 

Covenants-not-to-compete

 

148

 

Customer relationships

 

880

 

Trade name

 

1,476

 

Current backlog

 

395

 

 

 

7,945

 

Net assets acquired

 

$

28,287

 

The other intangible assets are being amortized over periods which reflect the pattern in which the economic benefits of the assets are expected to be realized. The core technology and customer relationships are being amortized over an estimated useful life of four years, the trade name and covenants-not-to-compete are being amortized over two years and the current backlog was fully amortized in the first quarter of fiscal 2004. The estimated weighted average useful life of other intangible assets,

9




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

4. Business Acquisitions (Continued)

created as a result of the acquisition of Eurologic, is approximately three years. No residual value is estimated for the other intangible assets. In accordance with SFAS No. 142, the Company will not amortize the goodwill, but will evaluate it at least annually for impairment. Goodwill is not expected to be deductible for tax purposes.

In-process Technology:   The amount allocated to acquired in-process technology was determined through established valuation techniques in the high-technology computer industry. Approximately $3.6 million was written off in the first quarter of fiscal 2004 because technological feasibility had not been established and no alternative future uses existed. The Company acquired various external and networked storage products that enable organizations to install, manage and scale multiterabyte storage solutions. The identified projects focus on increased performance while reducing the storage controller form factor. The value was determined by estimating the net cash flows from the products once commercially viable and discounting the estimated net cash flows to their present value.

Net Cash Flows.   The net cash flows from the identified projects were based on estimates of revenues, cost of revenues, research and development expenses, including costs to complete the projects, selling, marketing and administrative expenses, royalty expenses and income taxes from the projects. The Company believes the assumptions used in the valuation as described below were reasonable at the time of the acquisition.

Net Revenues.   The estimated net revenues were based on management’s projections of the projects. The business projections were compared with and found to be in line with industry analysts’ forecasts of growth in substantially all of the relevant markets. Estimated total net revenues from the projects were expected to grow through fiscal 2008, and decline thereafter as other new products are expected to become available. These projections were based on estimates of market size and growth, expected trends in technology, and the nature and expected timing of new product introductions by the Company and those of its competitors.

Gross Margins.   Projected gross margins were based on Eurologic’s historical margins, which were in line with industry averages.

Operating Expenses.   Estimated operating expenses used in the valuation analysis of Eurologic included research and development expenses and selling, marketing and administrative expenses. In developing future expense estimates and evaluation of Eurologic’s overall business model, an assessment of specific product results, including both historical and expected direct expense levels and general industry metrics, was conducted.

Research and Development Expenses.   Estimated research and development expenses include costs to bring the projects to technological feasibility and costs associated with activities undertaken to correct errors or keep products updated with current information (also referred to as “maintenance” research and development) after a product is available for general release to customers. These activities include routine changes and additions. The estimated maintenance research and development expense was 5.0% of net revenues for the in-process technologies throughout the estimation period.

Selling, Marketing and Administrative Expenses.   Estimated selling, marketing and administrative expenses were consistent with the general industry cost structure in the first year net revenues were generated and increased in later years.

10




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

4. Business Acquisitions (Continued)

Effective Tax Rate.   The effective tax rate utilized in the analysis of the in-process technologies reflects a combined historical industry specific average for the United States Federal and state statutory income tax rates.

Royalty Rate.   The Company applied a royalty charge of approximately 2% of the estimated net revenues for each in-process project to attribute value for dependency on existing technology.

Discount Rate.   The cost of capital reflects the estimated time to complete the projects and the level of risk involved. The discount rate used in computing the present value of net cash flows was approximately 27% for each of the projects.

Percentage of Completion.   The percentage of completion was determined using costs incurred by Eurologic prior to the acquisition date compared to the estimated remaining research and development to be completed to bring the projects to technological feasibility. The Company estimated, as of the acquisition date, the projects were approximately 60% complete. The Company expects  remaining costs of approximately $1 million to bring the planned in-process projects to completion. Development of these projects remains a significant risk to the Company due to the remaining effort to achieve technological feasibility and rapidly changing customer markets. Failure to bring these products to market in a timely manner, in a competitive environment, could adversely impact the Company’s future sales, results of operations and growth. Additionally, the value of the intangible assets acquired may become impaired.

Acquisition-Related Restructuring:   During the second quarter of fiscal 2004, the Company refined its plans to integrate the Eurologic operations. The current integration plan includes the involuntary termination or relocation of approximately 110 employees over the next six months, exiting duplicative facilities and the transition of all manufacturing operations from Dublin, Ireland to the Company’s manufacturing facility in Singapore. The Company had recorded a preliminary estimate of $3.1 million in the first quarter of fiscal 2004 for these activities. The acquisition-related restructuring liabilities were accounted for under EITF No. 95-3 and therefore were included in the purchase price allocation of the cost to acquire Eurologic.  In the second quarter of fiscal 2004, the Company recorded a reduction of approximately $0.1 million to the accrued restructuring charges with a corresponding decrease to goodwill as its plans were further refined. The Company expects to execute the integration plan as currently designed; however, actual results and costs may differ as the plan is executed. Any further changes to the Company’s estimate of executing the currently approved plans of integration will be recorded as an increase or decrease to goodwill. As of September 30, 2003, the Company had utilized approximately $0.6 million of these charges. The Company expects the consolidation of the manufacturing operations discussed above as well as involuntary employee terminations to be substantially completed by the first half of fiscal 2005.

11




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

4. Business Acquisitions (Continued)

The activity in the accrued restructuring reserve related to the acquisition-related restructuring plan was as follows for the first half of fiscal 2004:

 

 

Severance And
Benefits

 

Other Charges

 

Total

 

 

 

(in thousands)

 

Eurologic Acquisition-Related Restructuring Plan:

 

 

 

 

 

 

 

 

 

 

 

Restructuring Provision:

 

 

 

 

 

 

 

 

 

 

 

Severance and benefits

 

 

$

2,813

 

 

 

$

 

 

$

2,813

 

Accrued lease costs

 

 

 

 

 

297

 

 

297

 

Total

 

 

2,813

 

 

 

297

 

 

3,110

 

Cash Paid

 

 

(252

)

 

 

(28

)

 

(280

)

Reserve balance at June 30, 2003

 

 

2,561

 

 

 

269

 

 

2,830

 

Adjustments

 

 

(89

)

 

 

11

 

 

(78

)

Cash paid

 

 

(280

)

 

 

(30

)

 

(310

)

Reserve balance at September 30, 2003

 

 

$

2,192

 

 

 

250

 

 

$

2,442

 

 

Pro forma financials have not been presented for the second quarter and first half of fiscal 2004 as the results of Eurologic have been included in our financial statements from April 2, 2003. Pro forma financial results for the second quarter and first half of fiscal 2003, as if the Company had acquired Eurologic at the beginning of the periods, after applying certain adjustments, including amortization of acquired other intangible assets, would have been as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2002

 

September 30, 2002

 

 

 

(in thousands, except per share amounts)

 

Net revenues

 

 

$

98,112

 

 

 

$

218,714

 

 

Net income (loss)

 

 

(16,501

)

 

 

(19,095

)

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

 

$

(0.15

)

 

 

$

(0.18

)

 

Diluted

 

 

$

(0.15

)

 

 

$

(0.18

)

 

The pro forma financial information does not necessarily reflect the results of operations that would have occurred had the Company and Eurologic constituted a consolidated entity during such periods.

ICP Vortex:   On June 5, 2003, the Company completed the acquisition of ICP vortex. ICP vortex was an indirect wholly-owned subsidiary of Intel Corporation and provided a broad range of hardware and software RAID data protection solutions, including SCSI, Serial ATA and fibre channel products. The Company paid $14.2 million in cash to acquire ICP vortex. The Company also incurred $0.3 million in transaction fees, including legal, valuation and accounting fees. ICP vortex is being integrated into the Company’s SSG segment.

12




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

4. Business Acquisitions (Continued)

The preliminary allocation of the ICP vortex purchase price to the tangible and identifiable intangible assets acquired and liabilities assumed is summarized below (in thousands). The preliminary allocation was based on an independent appraisal and management’s estimate of fair value. The allocation of the purchase price may be subject to change based on the final estimates of fair value.

Cash

 

$

2,850

 

Accounts receivable

 

2,539

 

Inventory

 

2,113

 

Other current assets

 

2,167

 

Property and equipment

 

1,458

 

Total assets acquired

 

11,127

 

Accounts payable

 

(362

)

Current liabilities

 

(1,456

)

Long-term liabilities

 

(393

)

Total liabilities assumed

 

(2,211

)

Net tangible assets acquired

 

$

8,916

 

The allocation of the purchase price to the tangible and intangible assets acquired and liabilities assumed is as follows (in thousands):

Net tangible assets acquired

 

$

8,916

 

Goodwill

 

717

 

Other intangible assets:

 

 

 

Core technology

 

3,630

 

Customer relationships

 

410

 

Trade name

 

830

 

Royalties

 

60

 

 

 

4,930

 

Net assets acquired

 

$

14,563

 

The other intangible assets are being amortized over periods which reflect the pattern in which the economic benefits of the assets are expected to be realized. The core technology and trade name are being amortized over an estimated useful life of three years, the customer relationships are being amortized over four years and the royalties are being amortized through the end of the third quarter of 2004. The estimated weighted average useful life of other intangible assets, created as a result of the acquisition of ICP vortex, is approximately three years. No residual value is estimated for the other intangible assets. In accordance with SFAS No. 142, the Company will not amortize the goodwill, but will evaluate it at least annually for impairment. Goodwill is not expected to be deductible for tax purposes.

In connection with the acquisition, the Company initiated a plan to integrate the ICP vortex operations. The plan includes the transfer of manufacturing operations to Singapore and the integration of certain duplicative resources. The Company substantially completed its plans in this regard in the second quarter of fiscal 2004 and accordingly, recorded $0.4 million related to severance and benefits related to the involuntary termination of 19 employees through the end of fiscal 2004. The acquisition-related restructuring liabilities will be accounted for under EITF No. 95-3 and therefore were included in the purchase price allocation of the cost to acquire ICP vortex. Any changes to the Company’s estimate will

13




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

4. Business Acquisitions (Continued)

result in an increase or decrease to the accrued restructuring charges and a corresponding increase or decrease to goodwill. The Company utilized accrued severance charges of $0.1 million through September 30, 2003.

Pro forma results of operations have not been presented because the effects of the acquisition were not material to the Company.

Platys:   In connection with our acquisition of Platys Communications, Inc. (“Platys”) in the second quarter of fiscal 2002, approximately $53.4 million of the purchase price was allocated to acquired in-process technology and written off in fiscal 2002 because technological feasibility had not been established and no alternative future uses existed. The Company acquired certain ASIC-based iSCSI technology for IP storage solutions. The value was determined by estimating the expected cash flows from the products once commercially viable, discounting the net cash flows to their present value, and then applying a percentage of completion to the calculated value.

The Company completed certain in-process projects and began shipping product in the fourth quarter of fiscal 2003 with additional in-process products expected to be completed by the end of fiscal 2004. The Company believes market acceptance of iSCSI technology will accelerate when leading storage OEMs complete development of their external storage arrays incorporating iSCSI technology. The Company expects remaining costs of approximately $5 million to bring the planned in-process projects to completion. Development of these projects remains a significant risk to the Company due to the remaining effort to achieve technological feasibility and rapidly changing customer markets. Failure to bring these products to market in a timely manner, in a competitive market, could adversely impact the Company’s future sales, profitability and growth. Additionally, the value of the intangible assets acquired may become impaired.

As part of the purchase agreement, $15.0 million of the cash payment was held back (the “General Holdback”) for unknown liabilities that may have existed as of the acquisition date. In fiscal 2003, the Company was notified of certain claims submitted by former Platys employees and consultants related to activities prior to the acquisition of Platys by the Company. During fiscal 2003, the Company paid $10.7 million of the General Holdback to the former Platys shareholders or to settle certain claims on their behalf. During the first half of fiscal 2004, the Company paid an additional $0.2 million of the General Holdback to settle certain claims on behalf of the former Platys shareholders. The remaining $4.1 million of the General Holdback will be paid to the Platys shareholders upon resolution of the outstanding claims, except for funds necessary to provide for liabilities with respect to the claims submitted by the former Platys employees and consultants.

5. Balance Sheets Details

Inventories:

 

 

September 30, 2003

 

March 31, 2003

 

 

 

(in thousands)

 

Raw materials

 

 

$

13,843

 

 

 

$

6,034

 

 

Work-in-process

 

 

6,934

 

 

 

5,458

 

 

Finished goods

 

 

19,961

 

 

 

12,004

 

 

Total

 

 

$

40,738

 

 

 

$

23,496

 

 

 

14



ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

5. Balance Sheets Details (Continued)

Accrued Liabilities:

 

 

September 30, 2003

 

March 31, 2003

 

 

 

(in thousands)

 

Tax related

 

 

$

67,800

 

 

 

$

72,687

 

 

Acquisition related

 

 

7,495

 

 

 

25,744

 

 

Accrued compensation and related taxes

 

 

16,846

 

 

 

21,991

 

 

Other

 

 

15,067

 

 

 

15,603

 

 

Total

 

 

$

107,208

 

 

 

$

136,025

 

 


6. Goodwill and Other Intangible Assets

Goodwill:

Goodwill allocated to the Company’s reportable segments and changes in the carrying amount of goodwill for the first half of fiscal 2004 was as follows:

 

 

SSG

 

SNG

 

Total

 

 

 

(in thousands)

 

Balance at March 31, 2003

 

$

8,187

 

$

45,667

 

$

53,854

 

Goodwill acquired

 

9,824

 

 

9,824

 

Goodwill adjustments

 

(271

)

 

(271

)

Balance at September 30, 2003

 

$

17,740

 

$

45,667

 

$

63,407

 

Goodwill increased by approximately $9.8 million as a result of our acquisitions of Eurologic and ICP vortex in the first quarter of fiscal 2004 (Note 4). In the second quarter of fiscal 2004, adjustments were made to goodwill for changes to the acquisition-related restructuring reserves and other adjustments for both Eurologic and ICP vortex.

Other Intangible Assets:

 

 

September 30, 2003

 

March 31, 2003

 

 

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

 

 

(in thousands)

 

Acquisition-related intangible assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Patents and core technology

 

 

$

62,330

 

 

 

$

(45,240

)

 

 

$

53,654

 

 

 

$

(37,514

)

 

Covenants-not-to-compete

 

 

4,818

 

 

 

(3,280

)

 

 

4,670

 

 

 

(2,464

)

 

Customer relationships

 

 

1,290

 

 

 

(147

)

 

 

 

 

 

 

 

Trade name

 

 

2,306

 

 

 

(456

)

 

 

 

 

 

 

 

Backlog and royalties

 

 

455

 

 

 

(429

)

 

 

 

 

 

 

 

Subtotal

 

 

71,199

 

 

 

(49,552

)

 

 

58,324

 

 

 

(39,978

)

 

Intellectual property assets

 

 

43,892

 

 

 

(18,406

)

 

 

43,892

 

 

 

(14,843

)

 

Total

 

 

$

115,091

 

 

 

$

(67,958

)

 

 

$

102,216

 

 

 

$

(54,821

)

 

 

Other intangible assets increased by approximately $12.9 million as a result of our acquisitions of Eurologic and ICP vortex in the first quarter of fiscal 2004 (Note 4). Amortization expenses of other intangible assets were $6.5 million and $4.9 million for the second quarters of fiscal 2004 and 2003,

15




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

6. Goodwill and Other Intangible Assets (Continued)

respectively. Amortization expenses of other intangible assets were $13.1 million and $9.0 million for the first half of fiscal 2004 and 2003, respectively.

The annual amortization expense of the other intangible assets that existed as of September 30, 2003, is expected to be as follows:

 

 

Estimated Amortization Expense

 

 

 

Acquisition-related
intangible assets

 

Intellectual
property assets

 

 

 

(in thousands)

 

Fiscal Years:

 

 

 

 

 

 

 

 

 

2004 (remaining six months)

 

 

$

6,852

 

 

 

$

3,564

 

 

2005

 

 

8,290

 

 

 

7,005

 

 

2006

 

 

4,637

 

 

 

6,670

 

 

2007

 

 

1,854

 

 

 

6,316

 

 

2008

 

 

14

 

 

 

1,931

 

 

Total

 

 

$

21,647

 

 

 

$

25,486

 

 

 

7. Line of Credit

In May 2001, the Company obtained an unsecured $20.0 million revolving line of credit. The line of credit had a term, as amended, through August 2003 and bore interest at a “Prime Rate” in effect or at a “Fixed Term Rate” as elected by the Company. Prime Rate refers to the rate of interest as established by the line of credit provider while the Fixed Term Rate is determined in relation to the London Interbank Offered Rate. In addition, the Company was charged a fee equal to 0.15% per annum on the average daily unused amount of the line of credit. Under the terms of the line of credit, the Company was required to maintain certain financial ratios, among other restrictive covenants. No borrowings were outstanding under the line of credit during the first half of fiscal 2004. The Company did not renew the line of credit upon its expiration in August 2003.

8. 43¤4% Convertible Subordinated Notes

In the first quarter of fiscal 2004, the Company redeemed the outstanding $82.4 million balance of its 43¤4% Convertible Subordinated Notes (“43¤4 Notes”) for an aggregate price of $83.0 million resulting in a loss on extinguishment of debt of $0.8 million (including unamortized debt issuance costs of $0.2 million). In the second quarter of fiscal 2003, the Company repurchased 43¤4% Notes with a book value of $73.0 million for an aggregate price of $70.4 million, resulting in a gain on extinguishment of debt of $2.2 million (net of unamortized debt issuance costs of $0.4 million). In the first half of fiscal 2003, the Company repurchased 43¤4% Notes with a book value of $120.4 million for an aggregate price of $116.3 million, resulting in a gain on extinguishment of debt of $3.3 million (net of unamortized debt issuance costs of $0.8 million). The gain (loss) on extinguishment of debt has been included in “Interest and other income” in the Company’s Unaudited Condensed Consolidated Statement of Operations (Note 11).


 

16




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

9. Stock Plans

ESPP

During the second quarter of fiscal 2004, the Company’s stockholders amended the 1986 ESPP to increase the number of shares reserved for issuance thereunder by 5,000,000 shares to a total of 15,600,000 authorized shares.

Eurologic Stock Option Plan

In connection with the acquisition of Eurologic in the first quarter of fiscal 2004 (Note 4), each outstanding stock option under the Eurologic Stock Option Plan was converted into an option to purchase shares of the Company’s common stock at a ratio of 0.3472. As a result, outstanding options to purchase 498,789 shares of the Company’s common stock were assumed. No further options may be granted under the Eurologic Stock Option Plan.


10. Guarantees

 Intellectual Property Indemnification Obligations

The Company has entered into agreements with customers and suppliers that include limited intellectual property indemnification obligations that are customary in the industry. These guarantees generally require the Company to compensate the other party for certain damages and costs incurred as a result of third party intellectual property claims arising from these transactions. The nature of the intellectual property indemnification obligations prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to its customers and suppliers. Historically, the Company has not incurred significant costs to defend lawsuits or settle claims related to such agreements and no amount has been accrued in the accompanying consolidated financial statements with respect to these indemnification guarantees.

Product Warranty

The Company provides an accrual for estimated future warranty costs based upon the historical relationship of warranty costs to sales. The estimated future warranty obligations related to product sales are recorded in the period in which the related revenue is recognized. The estimated future warranty obligations are affected by product failure rates, material usage and replacement costs incurred in correcting a product failure. If actual product failure rates, material usage or replacement costs differ from the Company’s estimates, revisions to the estimated warranty obligations would be required; however the Company made no adjustments to pre-existing warranty accruals in the first quarter of fiscal 2004. The Company has received communications from a customer alleging that the Company is in breach of certain contractual obligations related to product support and warranty matters. Please refer to Note 14 for further discussion of this matter.

17




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

10. Guarantees (Continued)

A reconciliation of the changes to the Company’s warranty accrual for the first half of fiscal 2004 and 2003 was as follows:

 

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands)

 

Balance at beginning of period

 

 

$

1,343

 

 

 

$

1,516

 

 

Warranties assumed

 

 

120

 

 

 

 

 

Warranties provided

 

 

1,987

 

 

 

1,933

 

 

Actual costs incurred

 

 

(2,091

)

 

 

(1,605

)

 

Balance at end of period

 

 

$

1,359

 

 

 

$

1,844

 

 



11. Interest and Other Income

The components of interest and other income for the second quarter and first half of fiscal 2004 and 2003, were as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands)

 

Interest income

 

 

$

4,105

 

 

 

$

7,587

 

 

 

$

10,679

 

 

 

$

15,679

 

 

Gain on settlement with former president of DPT

 

 

 

 

 

 

 

 

49,256

 

 

 

 

 

Gain (loss) on extinguishment of debt

 

 

 

 

 

2,197

 

 

 

(790

)

 

 

3,297

 

 

Foreign currency transaction gains (losses)

 

 

147

 

 

 

(151

)

 

 

842

 

 

 

(508

)

 

Gain on investments

 

 

 

 

 

 

 

 

324

 

 

 

 

 

Total

 

 

$

4,252

 

 

 

$

9,633

 

 

 

$

60,311

 

 

 

$

18,468

 

 

 

In December 1999, the Company purchased Distributed Processing Technology Corporation (“DPT”). As part of the purchase agreement, $18.5 million of the purchase price was held back (“Holdback Amount”), from former DPT stockholders, for unknown liabilities that may have existed as of the acquisition date. The Holdback Amount was included in “Accrued liabilities” in the Consolidated Balance Sheets at March 31, 2003. Subsequent to the date of purchase, the Company determined that certain representations and warranties made by the DPT stockholders were incomplete or inaccurate, which caused the Company to lose revenues and incur additional expenses. In addition, certain DPT products were found to be defective. In December 2000, the Company filed a claim against the DPT stockholders for the entire Holdback Amount of $18.5 million. In January 2001, the DPT stockholders notified the Company as to their objection of its claim. Under the terms of the purchase agreement, the Company’s claim was submitted to arbitration. Thereafter, the Company also initiated arbitration proceedings against Steven Goldman, the principal shareholder and former president of DPT alleging causes of action for, amongst others, fraud, fraudulent inducement, and negligent misrepresentation. In April 2003, the arbitrator issued a partial decision in the Company’s favor for $50.0 million, including the remaining balance of the Holdback Amount, related to the Company’s claim of negligent

18




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

11. Interest and Other Income (Continued)

misrepresentation. In May 2003, the Company entered into a written settlement and a mutual general release agreement with Steven Goldman, on his own and on behalf of all the selling shareholders of DPT, pursuant to which it was agreed that the Company would retain the Holdback Amount and additionally, Steven Goldman would pay the Company $31.0 million. The Company received the $31.0 million payment in May 2003 and recorded a gain of approximately $49.3 million in the first quarter of fiscal 2004. The cash received from the DPT settlement of $31.0 million was included in cash provided from operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows.


12. Restructuring Charges

During the second quarter of fiscal 2004, the Company recorded restructuring charges of $1.5 million as follows:

In the second quarter of fiscal 2004, the Company initiated certain actions related primarily to its DSG segment. These actions included the consolidation of research and development resources, the involuntary termination of certain marketing and administrative personnel, the shutdown of the DSG’s Hudson, Wisconsin facility, and asset impairments associated with the identification of duplicative assets and facilities. In addition, the Company took actions to streamline its SSG segment by reducing headcount and related costs. The Company expects to incur approximately $2.0 million for these restructuring plans, of which the Company recorded approximately $1.6 million in the second quarter of fiscal 2004. Of this amount, $1.5 million was associated with severance and benefits from terminating approximately 33 employees and $0.1 million related to the write-down of certain assets taken out of service. The remaining costs of approximately $0.4 million are associated with the Hudson facility and will be recorded in the third quarter of fiscal 2004 when the facility is completely vacated. Of the total restructuring expense incurred, approximately $0.6 million and $1.0 million related to the SSG and DSG segments, respectively.

Additionally, in the second quarter of fiscal 2004, the Company recorded a net reduction of $0.1 million to restructuring charges. This consisted of a reduction of $0.1 million to the second quarter and fourth quarter of fiscal 2003 restructuring provisions and $0.1 million to the fourth quarter of fiscal 2002 restructuring provision as severance and benefits were lower than originally anticipated. This was offset by an increase of $0.1 million to the fiscal 2001 restructuring provision due to additional lease costs.

During the first quarter of fiscal 2004, the Company recorded adjustments of $0.4 million to prior years restructuring plans consisting of a net adjustment of $0.1 million to the second quarter of fiscal 2003 restructuring provision and an adjustment of $0.3 million to the first quarter of fiscal 2002 restructuring provision.

The adjustment to the second quarter of fiscal 2003 restructuring provision included an additional accrual for lease costs offset by a reduction to severance and benefits, as actual benefit costs were lower than originally anticipated. The adjustment to the first quarter of fiscal 2002 restructuring provision consisted of additional lease costs. The additional lease costs pertained to a sublease arrangement entered in the first quarter of fiscal 2004 with a third party where the sublease payments through the end of the lease term are insufficient to cover the Company’s obligations on the facility by approximately $0.4 million.

The Company also implemented restructuring plans in fiscal 2003, 2002, and 2001. For a complete discussion of all restructuring actions implemented in fiscal 2003, 2002 and 2001, please refer to the notes

19




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

12. Restructuring Charges (Continued)

included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2003. The activity in the accrued restructuring reserves related to all of the plans, excluding acquisition-related plans (Note 4) was as follows for the first half of fiscal 2004:

 

 

Severance And
Benefits

 

Other Charges

 

Total

 

 

 

(in thousands)

 

Reserve balance at March 31, 2003

 

 

$

3,251

 

 

 

$

2,005

 

 

$

5,256

 

Provision adjustment

 

 

(50

)

 

 

398

 

 

348

 

Cash paid

 

 

(2,691

)

 

 

(272

)

 

(2,963

)

Reserve balance at June 30, 2003

 

 

510

 

 

 

2,131

 

 

2,641

 

Q2’04 restructuring plan

 

 

1,486

 

 

 

86

 

 

1,572

 

Provision adjustment

 

 

(124

)

 

 

30

 

 

(94

)

Cash paid

 

 

(457

)

 

 

(247

)

 

(704

)

Non-cash charges

 

 

 

 

 

(66

)

 

(66

)

Reserve balance at September 30, 2003

 

 

1,415

 

 

 

1,934

 

 

3,349

 

 

The Company anticipates that the remaining restructuring reserve balance of $3.3 million will be substantially paid by the first quarter of fiscal 2009. The longer term payments relate to lease obligations and are reflected in “Other long-term liabilities” in the Unaudited Condensed Consolidated Balance Sheet, with the remaining restructuring reserve balance included in “Accrued liabilities.”

13. Other Charges

Other charges consisted of asset impairment charges. The Company holds minority investments in non-public companies. The Company regularly monitors these minority investments for impairment and records reductions in the carrying values when necessary. Circumstances that indicate an other-than-temporary decline include the valuation ascribed to the issuing company in subsequent financing rounds, decreases in quoted market price and declines in operations of the issuer. The Company recorded an impairment charge of $0.5 million in the second quarter of fiscal 2003 related to a decline in the value of a minority investment deemed to be other-than-temporary.


14. Commitments and Contingencies

The Company has received communications from a customer alleging that the Company is in breach of certain contractual obligations that it assumed in conjunction with its purchase of DPT. The obligations extend to product support and warranty matters. The Company has taken steps to remedy the issues and has been in negotiations with the customer in an effort to reach an amicable resolution of the matter. However, the Company cannot predict with certainty how this matter will be resolved.

On December 15, 2000, the Company received a statutory notice of deficiency from the IRS with respect to its Federal income tax return for fiscal 1997. The Company filed a Petition with the United States Tax Court on March 14, 2001, contesting the asserted deficiencies. Settlement agreements have been filed with the United States Tax Court on all but one issue. The Company believes that the final outcome of all issues will not have a material adverse impact on its financial position or results of operations, as it believes that it has meritorious defenses against the asserted deficiencies and any

20




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
(unaudited)

14. Commitments and Contingencies (Continued)

proposed adjustments and has made sufficient tax provisions. However, the Company cannot predict with certainty how these matters will be resolved and whether it will be required to make additional payments.

In addition, the IRS is currently auditing the Company’s Federal income tax returns for fiscal 1998 through fiscal 2001. The Company believes that it has provided sufficient tax provisions for these years and the ultimate outcome of the IRS audits will not have a material adverse impact on its financial position or results of operations. However, the Company cannot predict with certainty how these matters will be resolved and whether it will be required to make additional tax payments.

The Company is a party to other litigation matters and claims which are normal in the course of its operations, and while the results of such litigation matters and claims cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a material adverse impact on its financial position or results of operations.

15. Income Taxes

Income tax provisions for interim periods are based on the Company’s estimated annual income tax rate. In the second quarter of fiscal 2004, the Company recorded an income tax benefit of $2.4 million on a pre-tax loss of $2.2 million. The estimated annual tax rate differs from the combined United States Federal and state statutory income tax rate of 40%, due to the tax treatment allowed for certain transactions that differ from financial statement reporting. For tax purposes, the gain on settlement with the former president of DPT of $49.3 million is treated as an adjustment to the tax basis of the DPT common stock acquired and does not result in taxable income. The tax rate benefit derived from the differing treatment of the DPT settlement was partially offset by the amortization of acquisition related intangible assets, excluding goodwill, that are not fully deductible for tax purposes.

16. Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share gives effect to all potentially dilutive common shares outstanding during the period. In computing diluted net income (loss) per share, the average stock price for the period is used in determining the number of shares assumed to be purchased upon the exercise of stock options.

21



ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

16. Net Income (Loss) Per Share  (Continued)

A reconciliation of the numerator and denominator of the basic and diluted net income (loss) per share computations are as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands, except per share amounts)

 

Numerators:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

 

$

261

 

 

 

$

(10,820

)

 

 

$

41,063

 

 

 

$

(8,266

)

 

Adjustment for interest expense on 3% Convertible Subordinated Notes, net of taxes

 

 

 

 

 

 

 

 

2,800

 

 

 

 

 

Adjusted net income
(loss)

 

 

$

261

 

 

 

$

(10,820

)

 

 

$

43,863

 

 

 

$

(8,266

)

 

Denominators:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—basic

 

 

108,411

 

 

 

106,550

 

 

 

108,183

 

 

 

106,264

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Employee stock
options

 

 

1,808

 

 

 

 

 

 

1,890

 

 

 

 

 

3% Convertible Subordinated
Notes

 

 

 

 

 

 

 

 

16,327

 

 

 

 

 

Weighted average shares and potentially dilutive common shares outstanding—diluted

 

 

110,219

 

 

 

106,550

 

 

 

126,400

 

 

 

106,264

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

$

0.00

 

 

 

$

(0.10

)

 

 

$

0.38

 

 

 

$

(0.08

)

 

Diluted

 

 

$

0.00

 

 

 

$

(0.10

)

 

 

$

0.35

 

 

 

$

(0.08

)

 

 

22




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

16. Net Income (Loss) Per Share  (Continued)

Certain instruments potentially convertible into common stock were excluded from the diluted computation for the second quarter of fiscal 2003 and the first half of fiscal 2003 because they were anti-dilutive as the Company was in a net loss position. Certain instruments potentially convertible into common stock were excluded from the diluted computation for the second quarter of fiscal 2004 and the first half of fiscal 2004 because their exercise prices were greater than the average market price of the common shares and their inclusion would have been anti-dilutive. The items excluded for the second quarter and first half of fiscal 2004 and 2003 were as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands)

 

Outstanding employee stock options

 

 

14,508

 

 

 

18,441

 

 

 

14,798

 

 

 

18,791

 

 

Warrants

 

 

1,310

 

 

 

1,310

 

 

 

1,310

 

 

 

1,310

 

 

43¤4% Convertible Subordinated Notes

 

 

 

 

 

3,022

 

 

 

810

 

 

 

3,552

 

 

3% Convertible Subordinated Notes

 

 

16,327

 

 

 

16,327

 

 

 

 

 

 

16,327

 

 

 

17. Comprehensive Income (loss)

The Company’s comprehensive income (loss) consisted of net income (loss) and the changes in net unrealized gains (losses) on marketable securities, net of taxes and foreign currency translation adjustments, net of taxes, as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands)

 

Net income (loss)

 

 

$

261

 

 

 

$

(10,820

)

 

 

$

41,063

 

 

 

$

(8,266

)

 

Net unrealized gains (losses) on marketable securities, net of taxes

 

 

1,085

 

 

 

1,968

 

 

 

(63

)

 

 

2,624

 

 

Foreign currency translation adjustment, net of taxes

 

 

101

 

 

 

133

 

 

 

52

 

 

 

298

 

 

Comprehensive income
(loss)

 

 

$

1,447

 

 

 

$

(8,719

)

 

 

$

41,052

 

 

 

$

(5,344

)

 

 

23




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

17. Comprehensive Income (loss)  (Continued)

The components of accumulated other comprehensive income, net of income taxes, were as follows:

 

 

September 30, 2003

 

March 31, 2003

 

 

 

(in thousands)

 

Unrealized gain on marketable securities, net of tax provision of $2,554 at September 30, 2003 and $2,596 at March 31, 2003

 

 

$

3,831

 

 

 

$

3,894

 

 

Foreign currency translation, net of tax benefit of $33 at September 30, 2003 and $69 at March 31, 2003

 

 

(52

)

 

 

(104

)

 

Total

 

 

$

3,779

 

 

 

$

3,790

 

 

 

18. Segment Reporting

SSG provides interface products that enable the movement, storage and protection of data across a range of server platforms, direct attached storage devices, SANs, NAS devices, and external storage systems. These products bring Host I/O technology, including SCSI and RAID solutions to storage applications. SSG is also investing in Serial ATA and Serial Attached SCSI technologies.

DSG provides high-performance I/O connectivity and digital media solutions for personal computing platforms, including notebook and desktop PCs sold to consumers and small and midsize businesses.

SNG provides storage connectivity solutions for servers, storage devices, fabric switches and NAS devices. SNG’s products incorporate iSCSI, TOE functionality, fibre channel and multi-port ethernet technologies. SNG has recently announced the availability of its iSCSI HBAs and TOE NACs through its distribution channel partners and continues to work with major OEM customers on testing and integration of iSCSI and TOE NAC products.

Unallocated corporate income and expenses includes restructuring charges, other charges, interest and certain other income and interest expense.

24




ADAPTEC, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(unaudited)

18. Segment Reporting  (Continued)

Summarized financial information on the Company’s reportable segments is shown in the following table. There were no inter-segment revenues for the periods shown below. The Company does not separately track assets or depreciation by operating segments nor are the segments evaluated under these criteria. Segment income (loss) represents income (loss) before interest and taxes.

 

 

SSG

 

DSG

 

SNG

 

Other

 

Total

 

 

 

(in thousands)

 

Three-Month Period Ended September 30, 2003:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

98,240

 

$

9,610

 

$

1,342

 

$

 

$

109,192

 

Segment income (loss)

 

10,690

 

(2,394

)

(10,898

)

421

 

(2,181

)

Three-Month Period Ended September 30, 2002:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

70,939

 

$

12,082

 

$

2,688

 

$

 

$

85,709

 

Segment income (loss)

 

7,471

 

(2,128

)

(16,292

)

(1,290

)

(12,239

)

Six-Month Period Ended September 30, 2003:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

192,060

 

$

21,520

 

$

2,905

 

$

 

$

216,485

 

Segment income (loss)

 

65,105

 

(4,157

)

(23,360

)

3,823

 

41,411

 

Six-Month Period Ended September 30, 2002:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

158,713

 

$

28,426

 

$

6,416

 

$

 

$

193,555

 

Segment income (loss)

 

24,694

 

(1,581

)

(33,167

)

3,025

 

(7,029

)

 

The following table presents the details of unallocated corporate income and expenses for the second quarter and first half of fiscal 2004 and 2003:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2003

 

September 30, 2002

 

September 30, 2003

 

September 30, 2002

 

 

 

(in thousands)

 

Unallocated corporate expenses, net

 

 

$

137

 

 

 

$

755

 

 

 

$

282

 

 

 

$

1,409

 

 

Restructuring charges

 

 

(1,478

)

 

 

(7,139

)

 

 

(1,826

)

 

 

(7,139

)

 

Other charges

 

 

 

 

 

(528

)