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, 2006 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

 

94-2748530

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

 

 

 

691 S. MILPITAS BLVD., MILPITAS, CALIFORNIA

 

95035

(Address of principal executive offices)

 

(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 o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer o              Accelerated Filer x              Non-Accelerated Filer o

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

The number of shares of Adaptec’s common stock outstanding as of November 2, 2006 was 117,454,763.

 




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

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

6

 

 

Item 2.

 

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

 

22

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

31

 

 

Item 4.

 

Controls and Procedures

 

32

Part II.

 

Other Information

 

 

 

 

Item 1.

 

Legal Proceedings

 

33

 

 

Item 1A.

 

Risk Factors

 

33

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

43

 

 

Item 6.

 

Exhibits

 

43

 

 

Signatures

 

44

 

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,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

73,553

 

$

92,588

 

$

142,624

 

$

176,401

 

Cost of revenues

 

47,010

 

62,459

 

93,811

 

122,184

 

Gross profit

 

26,543

 

30,129

 

48,813

 

54,217

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

13,560

 

17,856

 

30,854

 

36,236

 

Selling, marketing and administrative

 

15,693

 

19,239

 

31,087

 

37,700

 

Amortization of acquisition-related intangible assets

 

1,470

 

2,800

 

3,056

 

5,856

 

Restructuring charges

 

1,085

 

478

 

4,096

 

518

 

Goodwill impairment

 

 

90,602

 

 

90,602

 

Other charges

 

 

 

13,942

 

 

Total operating expenses

 

31,808

 

130,975

 

83,035

 

170,912

 

Loss from continuing operations

 

(5,265

)

(100,846

)

(34,222

)

(116,695

)

Interest and other income

 

5,825

 

4,523

 

11,728

 

8,131

 

Interest expense

 

(883

)

(867

)

(1,759

)

(1,840

)

Loss from continuing operations before income taxes

 

(323

)

(97,190

)

(24,253

)

(110,404

)

Provision for (benefit from) income taxes

 

(49,080

)

2,672

 

(48,186

)

3,518

 

Income (loss) from continuing operations

 

48,757

 

(99,862

)

23,933

 

(113,922

)

Discontinued operations, net of taxes

 

 

 

 

 

 

 

 

 

Income (loss) from discontinued operations, net of taxes

 

(132

)

1,032

 

132

 

(20,881

)

Income (loss) from disposal of discontinued operations, net of taxes

 

2,440

 

(6,976

)

3,730

 

(6,976

)

Income (loss) from discontinued operations

 

2,308

 

(5,944

)

3,862

 

(27,857

)

Net income (loss)

 

$

51,065

 

$

(105,806

)

$

27,795

 

$

(141,779

)

 

 

 

 

 

 

 

 

 

 

Income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.42

 

$

(0.88

)

$

0.21

 

$

(1.01

)

Discontinued operations

 

$

0.02

 

$

(0.05

)

$

0.03

 

$

(0.25

)

Net income (loss)

 

$

0.44

 

$

(0.94

)

$

0.24

 

$

(1.26

)

Diluted

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.36

 

$

(0.88

)

$

0.19

 

$

(1.01

)

Discontinued operations

 

$

0.02

 

$

(0.05

)

$

0.03

 

$

(0.25

)

Net income (loss)

 

$

0.38

 

$

(0.94

)

$

0.22

 

$

(1.26

)

 

 

 

 

 

 

 

 

 

 

Shares used in computing income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

116,325

 

112,965

 

115,967

 

112,705

 

Diluted

 

136,735

 

112,965

 

135,991

 

112,705

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

3




ADAPTEC, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)

 

 

September 30, 2006

 

March 31, 2006

 

 

 

(in thousands)

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

86,588

 

$

131,373

 

Marketable securities

 

468,884

 

425,179

 

Restricted cash and marketable securities

 

1,680

 

1,663

 

Accounts receivable, net

 

41,393

 

47,876

 

Inventories

 

36,459

 

28,259

 

Prepaid expenses and other current assets

 

25,885

 

26,294

 

Total current assets

 

660,889

 

660,644

 

Property and equipment, net

 

28,887

 

30,665

 

Restricted marketable securities, less current portion

 

2,328

 

3,086

 

Other intangible assets, net

 

13,108

 

32,524

 

Other long-term assets

 

18,143

 

10,480

 

Total assets

 

$

723,355

 

$

737,399

 

 

 

 

 

 Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

35,724

 

$

40,246

 

Accrued liabilities

 

39,244

 

87,722

 

3% Convertible Subordinated Notes

 

10,637

 

10,637

 

Total current liabilities

 

85,605

 

138,605

 

3/4% Convertible Senior Subordinated Notes

 

225,000

 

225,000

 

Other long-term liabilities

 

3,048

 

4,349

 

Commitments and contingencies (Note 12)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

117

 

115

 

Additional paid-in capital

 

183,165

 

174,648

 

Deferred stock-based compensation

 

 

(319

)

Accumulated other comprehensive income (loss), net of taxes

 

843

 

(2,781

)

Retained earnings

 

225,577

 

197,782

 

Total stockholders’ equity

 

409,702

 

369,445

 

Total liabilities and stockholders’ equity

 

$

723,355

 

$

737,399

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

4




                                                                                               

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

 

 

Six-Month Period Ended

 

 

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands)

 

Cash Flows From Operating Activities:

 

 

 

 

 

Net income (loss)

 

$

27,795

 

$

(141,779

)

Less: Income (loss) from discontinued operations

 

3,862

 

(27,857

)

Income (loss) from continuing operations

 

23,933

 

(113,922

)

Adjustments to reconcile income (loss) from continuing operations to net cash used for operating activities:

 

 

 

 

 

Impairment of intangible assets

 

13,203

 

 

Impairment of goodwill

 

 

90,602

 

Non-cash effect of tax settlement

 

(45,955

)

 

Stock-based compensation

 

4,566

 

351

 

Loss on extinguishment of debt

 

 

102

 

Depreciation and amortization

 

9,299

 

14,434

 

Other non-cash items

 

681

 

(129

)

Changes in assets and liabilities

 

(15,397

)

(5,679

)

 

 

 

 

 

 

Net Cash Used for Operating Activities of Continuing Operations

 

(9,670

)

(14,241

)

Net Cash Provided by Operating Activities of Discontinued Operations

 

2,564

 

2,916

 

Net Cash Used for Operating Activities

 

$

(7,106

)

$

(11,325

)

 

 

 

 

 

 

Cash Flows From Investing Activities:

 

 

 

 

 

Maturities of restricted marketable securities

 

844

 

844

 

Payment of holdback in connection with acquisition of Platys

 

(1,507

)

 

Purchases of property and equipment

 

(1,845

)

(5,416

)

Proceeds from the sale of property and equipment

 

 

2,684

 

Purchases of marketable securities

 

(165,839

)

(438,060

)

Sales of marketable securities

 

111,337

 

107,141

 

Maturities of marketable securities

 

14,029

 

4,511

 

Net Cash Used for Investing Activities of Continuing Operations

 

(42,981

)

(328,296

)

Net Cash Used for Investing Activities of Discontinued Operations

 

 

(1,655

)

Net Cash Used for Investing Activities

 

(42,981

)

(329,951

)

Cash Flows From Financing Activities:

 

 

 

 

 

Repurchases and redemption of long-term debt

 

 

(22,988

)

Proceeds from issuance of common stock

 

4,272

 

2,554

 

Net Cash Provided by (Used for) Financing Activities

 

4,272

 

(20,434

)

Effect of Foreign Currency Translation on Cash and Cash Equivalents

 

1,030

 

(853

)

Net Decrease in Cash and Cash Equivalents

 

(44,785

)

(362,563

)

Cash and Cash Equivalents at Beginning of Period

 

131,373

 

441,588

 

Cash and Cash Equivalents at End of Period

 

$

86,588

 

$

79,025

 

 

See accompanying Notes to Unaudited 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, 2006 audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary to fairly state 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 accounting principles generally accepted in the United States of America. 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, 2006, which was filed with the SEC on June 14, 2006. The second quarters of fiscal 2007 and 2006 ended September 29, 2006 and September 30, 2005, respectively. For presentation purposes, the accompanying financial statements have been shown as ending on September 30. The results of operations for the second quarter of fiscal 2007 are not necessarily indicative of the results to be expected for the entire fiscal year.

As discussed in Note 4, in September 2005, the Company sold its IBM i/p Series RAID component business (“IBM i/p Series RAID Business”) to International Business Machines (“IBM”) and the Company’s Board of Directors approved management’s recommendation to divest its systems business. Accordingly, the Company reclassified the financial statements and related disclosures for all periods presented to reflect the results of IBM i/p Series RAID Business and the systems business as discontinued operations.  In January 2006, the Company sold the block-based portion of its systems business to Sanmina-SCI Corporation and its wholly owned subsidiary, Sanmina-SCI USA, Incorporated. In July 2006, and effective for the end of the first quarter of fiscal 2007, the Company’s Board of Directors decided to retain the Snap Server portion of the systems business and management terminated its ongoing efforts to sell this business. Accordingly, the Company has reclassified the financial statements and related disclosures for all periods presented to reflect the Snap Server portion of its systems business as continuing operations.

Unless otherwise indicated, the Notes to the Unaudited Condensed Consolidated Financial Statements relate to the discussion of the Company’s continuing operations.

The glossary of key acronyms used in the Company’s industry and accounting rules and regulations referred to within this Quarterly Report on Form 10-Q is listed in alphabetical order in Note 16.

2. Recent Accounting Pronouncements

In June 2006, the FASB issued FIN No. 48, which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS No. 109. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective beginning with the Company’s fiscal year 2008.  The Company is currently assessing the impact, if any, of FIN No. 48 on its financial position and results of operations.

In September 2006, the SEC issued SAB 108 in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements:  the “roll-over” method and the “iron curtain” method.  The “roll-over” method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior period misstatements; but its use can lead to the accumulation of misstatements in the balance sheet.  The “iron-curtain” method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior period errors on the income statement.  The Company currently uses the “roll-over” method for quantifying identified financial statement misstatements.  In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the Company’s financial statements and the related financial statement disclosures.  This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the “iron curtain” and the “roll-over” methods. SAB 108 permits existing public companies to initially apply its provisions either by (i) restating prior financial statements as if the “dual approach” had always been used or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of April 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings.  Use of the “cumulative effect” transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment and how and when it arose. The Company will initially apply the provisions of SAB 108 using the “cumulative effect” transition method in connection with the preparation of its annual financial statements for the year ending March 31, 2007.  The Company is currently evaluating the impact of SAB 108 on its financial position and results of operations.

6




In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of SFAS No. 157 on its results of operations and financial position.

3. Stock Benefit Plans and Stock-Based Compensation

Stock Benefit Plans

The Company grants stock options and other stock awards to employees, directors and consultants under two equity incentive plans.  The Company also has an employee stock purchase plan for all eligible employees. These plans are described in further detail below.

Employee Stock Purchase Plan:    The Company has authorized 15,600,000 shares of common stock for issuance under the 1986 ESPP. Eligible employees may authorize payroll deductions of up to 10% of their salary to purchase shares of the Company’s common stock at the lower of 85% of the market value of the common stock at the beginning of the 24 month offering period or at the end of each applicable six month purchase period. The Company issued 0.6 million shares under the ESPP in the second quarter and first half of fiscal 2007. As of September 30, 2006, 3.5 million shares remained available for issuance. As of September 30, 2006, the total unamortized stock-based compensation expense related to shares issuable under the ESPP was $1.1 million, and this expense is expected to be recognized over a remaining weighted-average period of 0.96 years.

Equity Incentive Plans, including the 2004 Equity Incentive Plan, the 2000 Nonstatutory Stock Option Plan, 1999 Stock Option Plan and 1990 Stock Option:   In August 2004, the Company’s Board of Directors and its stockholders approved the Company’s 2004 Equity Incentive Plan and reserved for issuance thereunder 10,000,000 shares of the Company’s common stock plus shares reserved but not issued under the Company’s 2000 Nonstatutory Stock Option Plan, 1999 Stock Option Plan and 1990 Stock Option Plan. The 2004 Equity Incentive Plan provides for the granting of incentive stock options, nonstatutory stock options, restricted stock, stock awards, restricted stock units and stock appreciation rights to employees, employee directors and consultants. Stock options are subject to terms and conditions as determined by the Compensation Committee of the Company’s Board of Directors. Twenty-five percent of stock options for new hires generally vest and become exercisable one year from the date of grant and then vest quarterly thereafter for the next three years. Stock options expire seven years from the date of grant. As of September 30, 2006, the Company had an aggregate of 31.1 million shares of its common stock reserved for issuance under its 2004 Equity Incentive Plan, of which 15.3 million shares are subject to outstanding options and 15.8 million shares are available for future grants of options and other stock awards.

Director Stock Option Plans, including the 2006 Director Stock Option Plan, 2000 Director Stock Option Plan and 1990 Directors’ Stock Option Plan:   In September 2006, the Company’s Board of Directors and its stockholders approved the Company’s 2006 Director Plan and reserved for issuance thereunder 1,200,000 shares of the Company’s common stock plus shares reserved but not issued under the Company’s 2000 Director Stock Option Plan and the 1990 Directors’ Stock Option Plan. The 2006 Director Plan provides for the granting of non-qualified stock options, restricted stock, restricted stock units and stock appreciation rights to non-employee directors. Although grants made under the 2006 Director Plan are discretionary, the Company expects that (1) new non-employee directors will receive an option to purchase 32,500 shares of the Company’s common stock, in which 25% of these stock options will vest and become exercisable one year from the date of grant and quarterly thereafter for the next three years, (2) existing non-employee directors will receive an option to purchase 12,500 shares of the Company’s common stock on May 31st of each year, with such option vesting quarterly over one year, (3) a new non-employee director will receive 16,250 shares of restricted stock and (4) existing non-employee directors will receive 6,250 shares of restricted stock on May 31st of each year. The restricted stock will fully vest one year after the date of grant. Stock options expire ten years from the date of grant. As of September 30, 2006, the Company had an aggregate of 2.2 million shares of its common stock reserved for issuance under its 2006 Director Plan, of which 0.9 million shares are subject to outstanding options and 1.3 million shares are available for future grants.

Assumed Stock Option Plans:   The Company assumed the stock option plans and the outstanding stock options of certain acquired companies, which include Snap Appliance, Inc. in fiscal 2005, Eurologic Systems Group Limited in fiscal 2004, Platys Communications, Inc. in fiscal 2002 and Distributed Processing Technology Corporation in fiscal 1999. No further options may be granted under these assumed plans. However, options that were outstanding under these plans will continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the option term. As of September 30, 2006, the Company had 0.2 million shares of common stock reserved that are subject to outstanding options under these assumed plans.

7




Stock-Based Compensation

On April 1, 2006, the Company adopted SFAS No. 123(R) using the modified prospective transition method, which requires the Company to measure and recognize compensation expense for all stock-based awards made to its employees and directors, including employee stock options, employee stock purchase plans, and other stock-based awards, based on estimated fair values. Accordingly, the Condensed Consolidated Statements of Operations for the second quarter and first half of fiscal 2007 reflect the impact of adopting SFAS No. 123(R) and prior periods have not been restated.

Stock-based compensation expense recognized in the second quarter and first half of fiscal 2007 includes (a) stock-based award payments 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, as adjusted for estimated forfeitures and (b) stock-based award payments granted subsequent to April 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). The Company recognized the stock-based compensation costs for all stock-based awards using a straight-line amortization method over the respective requisite service period of the awards and adjusted it for estimated forfeitures.

Total compensation expense for the Company’s stock-based awards in the second quarter and first half of 2007 was $2.0 million and $4.6 million, respectively. The following table summarizes the impact of the adoption of SFAS No. 123(R) on stock-based compensation expense included in the Condensed Consolidated Statements of Operations for the second quarter and first half of fiscal 2007:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2006

 

September 30, 2006

 

 

 

(in thousands)

 

 

 

 

 

Stock-based compensation expense by caption:

 

 

 

 

 

Cost of revenues

 

$

141

 

$

329

 

Research and development

 

865

 

2,090

 

Selling, marketing and administrative

 

1,017

 

2,147

 

Stock-based compensation expense effect on income from continuing operations, net of taxes

 

2,023

 

4,566

 

 

 

 

 

 

 

Stock-based compensation expense by type of award:

 

 

 

 

 

Stock options

 

$

1,642

 

$

3,546

 

Restricted stock awards and restricted stock units

 

263

 

306

 

Employee stock purchase plan

 

118

 

714

 

Stock-based compensation expense effect on income from continuing operations, net of taxes

 

2,023

 

4,566

 

 

Stock-based compensation expense in the above table does not reflect any significant income taxes, which is consistent with the Company’s treatment of income or loss from its U.S. operations. As a result of adopting SFAS No. 123(R) on April 1, 2006, the Company’s net income for the second quarter and first half of fiscal 2007 was lower by $2.0 million and $4.6 million, respectively, than if the Company had continued to account for share-based compensation under APB Opinion No. 25. In addition, prior to adopting SFAS No. 123(R), the Company presented the tax benefits of stock option exercises as operating cash flows in the Condensed Consolidated Statements of Cash Flows; however, there was no income tax benefit realized for the tax deductions from option exercises of the share-based payment arrangements for the first halves of fiscal 2007 and 2006. Therefore, no amounts were classified from operating to financing cash flows for the first half of fiscal 2006. In addition, there was no stock-based compensation costs capitalized as part of an asset in the second quarter and first halves of fiscal 2007 and during fiscal 2006.

Prior to April 1, 2006, the Company accounted for stock-based compensation in accordance with APB Opinion No. 25 as interpreted by FIN No. 44, and complied with the disclosure provisions of SFAS No. 148, an amendment of SFAS No. 123. Under APB Opinion No. 25, compensation expense was recognized on the measurement date based on the excess, if any, of the fair value of the Company’s common stock over the amount an employee must pay to acquire the common stock.  Compensation costs related to restricted stock awards and assumed unvested acquisition-related stock options, determined to be the fair market value of the shares at the date of grant, have been recognized as compensation expense ratably over the respective vesting period. In addition, the employee stock purchase plan was deemed noncompensatory under APB Opinion No. 25; therefore, no compensation cost was recorded in relation to the discount offered to employees for purchases made under the employee stock purchase plan. The following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, as amended, to account for stock-based compensation for the second quarter and first half of fiscal 2006:

8




 

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2005

 

September 30, 2005

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

Net loss, as reported

 

$

(105,806

)

$

(141,779

)

Add: Stock-based compensation expense previously determined under intrinsic value method, net of taxes

 

1,029

 

1,303

 

Deduct: Stock-based compensation expense determined under fair value-based method, net of taxes

 

(2,884

)

(6,380

)

Pro forma net loss

 

$

(107,661

)

$

(146,856

)

 

 

 

 

Basic net loss per share:

 

 

 

 

 

As reported

 

$

(0.94

)

$

(1.26

)

Pro forma

 

$

(0.95

)

$

(1.30

)

Diluted net loss per share:

 

 

 

 

 

As reported

 

$

(0.94

)

$

(1.26

)

Pro forma

 

$

(0.95

)

$

(1.30

)

 

Valuation Assumptions

                Upon adoption of SFAS No. 123(R), the Company selected the Black-Scholes option pricing model as the most appropriate model for determining the estimated fair value for stock-based awards. The use of the Black-Scholes model requires the use of extensive actual exercise behavior data and the use of a number of complex assumptions including expected volatility, risk-free interest rate, expected term, and expected dividends.

Beginning April 1, 2006, the Company estimated the volatility of its stock using historical volatility as well as the implied volatility in market-traded options on its common stock in accordance with guidance in SFAS No. 123(R) and SAB 107. Management determined that a blend of implied volatility and historical volatility is more reflective of market conditions and a better indicator of expected volatility than using purely historical volatility. The Company will continue to monitor these and other relevant factors used to measure expected volatility for future option grants. Prior to the adoption of SFAS No. 123(R), the Company used its historical common stock price volatility in accordance with SFAS No. 123 for purposes of pro forma information disclosed in the notes to its consolidated financial statements for prior periods.

The risk-free interest rate assumption is based upon observed interest rates using the implied yield currently available on U.S. Treasury zero-coupon issues that is appropriate for the term of the Company’s stock options. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts.  The Company has historically not paid dividends and has no foreseeable plans to issue dividends as it is the Company’s current policy to reinvest earnings for its business.

The expected term of stock options represents the weighted-average period that the stock options are expected to remain outstanding. The Company derived the expected term assumption based on its historical settlement experience, while giving consideration to options that have life cycles less than the contractual terms and vesting schedules in accordance with guidance in SFAS No. 123(R) and SAB 107. Prior to the adoption of SFAS No. 123(R), the Company used its historical settlement experience to derive the expected term for the purposes of pro forma information under SFAS No. 123, as disclosed in the notes to its consolidated financial statements for the related periods.

 The fair value of the Company’s outstanding stock options was estimated using the following weighted-average assumptions:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2006

 

September 30, 2005

 

September 30, 2006

 

September 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Equity Incentive Plans:

 

 

 

 

 

 

 

 

 

Expected life (in years)

 

3.87 – 4.22

 

2.5

 

3.87 – 4.22

 

2.5

 

Risk-free interest rates

 

4.60 – 4.89

%

4.2

%

4.60 – 5.11

%

4.1

%

Expected volatility

 

44

%

39

%

44

%

38

%

Dividend yield

 

 

 

 

 

Weighted average fair value

 

$

2.38

 

$

0.97

 

$

2.65

 

$

0.98

 

 

 

 

 

 

 

 

 

 

 

ESPP:

 

 

 

 

 

 

 

 

 

Expected life (in years)

 

1.00 – 1.25

 

1.1

 

1.00 – 1.25

 

1.1

 

Risk-free interest rates

 

5.07 – 5.11

%

3.8

%

5.07 – 5.11

%

3.8

%

Expected volatility

 

44

%

39

%

44

%

39

%

Dividend yield

 

 

 

 

 

Weighted average fair value

 

$

1.11

 

$

1.12

 

$

1.11

 

$

1.12

 

 

9




Stock Benefit Plans Activities

Equity Incentive Plans:  A summary of option activity under all of the Company’s equity incentive plans as of September 30, 2006, and changes during the first half of fiscal 2007 is presented below:

 

 

 

 

 

 

Weighted Average

 

 

 

 

 

 

 

 

 

Remaining

 

 

 

 

 

 

 

Weighted Average

 

Contractual Term

 

Aggregate Intrinsic

 

 

 

Shares

 

Exercise Price

 

(Years)

 

Value

 

 

 

(in thousands except exercise price and contractual term)

 

 

 

 

 

Outstanding at March 31, 2006

 

19,942

 

$

8.90

 

 

 

 

 

Granted

 

1,283

 

4.39

 

 

 

 

 

Exercised

 

(754

)

3.53

 

 

 

 

 

Forfeited and cancelled

 

(4,164

)

9.65

 

 

 

 

 

Outstanding at September 30, 2006

 

16,307

 

$

8.60

 

3.88

 

$

4,499

 

Options vested and expected to vest at September 30, 2006

 

15,359

 

$

8.80

 

3.76

 

$

4,265

 

Options exercisable at September 30, 2006

 

11,733

 

$

9.89

 

3.38

 

$

2,917

 

 

 

 

 

 

 

 

 

 

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for the 5.7 million options that were in-the-money at September 30, 2006. During the second quarters of fiscal 2007 and 2006, the aggregate intrinsic value of options exercised under the Company’s equity incentive plans was $0.3 million and $0.0 million, respectively, determined as of the date of option exercise.   During the first halves of fiscal 2007 and 2006, the aggregate intrinsic value of options exercised under the Company’s equity incentive plans was $0.7 million and $0.5 million, respectively, determined as of the date of option exercise.

The following table summarizes information about the Company’s equity incentive plans as of September 30, 2006:

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of Exercise Prices

 

Number
Outstanding
at 9/30/06

 

Weighted Average
Remaining
Contractual Life

 

Weighted
Average
Exercise Price

 

Number
Exercisable
at 9/30/06

 

Weighted
Average
Exercise Price

 

 

 

(in thousands except weighted average exercise price and contractual life)

 

 

 

 

 

$0.18 – $0.18

 

52

 

4.37

 

$

0.18

 

52

 

$

0.18

 

$0.35 – $3.45

 

3,494

 

4.05

 

3.41

 

2,297

 

3.40

 

$0.35 – $4.24

 

2,072

 

5.72

 

4.03

 

786

 

3.94

 

$4.26 – $6.25

 

1,690

 

5.44

 

5.26

 

835

 

4.93

 

$6.30 – $7.66

 

2,192

 

3.69

 

7.10

 

1,361

 

6.94

 

$7.70 – $11.94

 

1,797

 

4.27

 

10.05

 

1,454

 

10.28

 

$12.20 – $14.60

 

1,657

 

2.42

 

13.08

 

1,598

 

13.11

 

$14.68 – $14.90

 

310

 

3.73

 

14.89

 

307

 

14.89

 

$15.29 – $15.29

 

2,609

 

2.24

 

15.29

 

2,609

 

15.29

 

$15.97 – $3,473.67

 

434

 

2.62

 

25.88

 

434

 

25.88

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

16,307

 

3.88

 

$

8.60

 

11,733

 

$

9.89

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2006, the total unamortized stock-based compensation expense related to non-vested stock options, net of estimated forfeitures, was $6.4 million, and this expense is expected to be recognized over a remaining weighted-average period of 2.05 years. Compensation expenses for all stock-based awards granted are recognized using the straight-line amortization method.

10




Restricted Stock Awards and Restricted Stock Units:   Restricted stock awards and restricted stock units were granted under the Company’s 2004 Equity Incentive Plan and 2006 Director Plan. The restricted stock units are converted into shares of the Company’s common stock upon vesting.  As of September 30, 2006, there were 0.6 million shares of service-based restricted stock awards and 0.1 million shares of restricted stock units outstanding, all of which are subject to forfeiture if employment terminates prior to the release of restrictions.  Restrictions lapse 50% one year from the date of grant and the remainder at the second anniversary for restricted stock awards and restricted stock units granted under the 2004 Equity Incentive Plan. Restrictions lapse one year from the date of grant for restricted stock awards and restricted stock units granted under the 2006 Director Plan. The cost of these awards, determined to be the fair market value of the shares at the date of grant, is expensed ratably over the period the restrictions lapse.

A summary of activity for restricted stock awards as of September 30, 2006, and changes during the first half of fiscal 2007 is as follows:

 

 

Shares

 

Weighted Average
Grant-Date Fair
Value

 

 

 

(in thousands except weighted average
grant-date fair value)

 

 

 

 

 

 

 

Nonvested stock at March 31,2006

 

 

$

 

Granted

 

627

 

4.27

 

Vested

 

 

 

Forfeited

 

(32

)

4.24

 

Nonvested stock at September 30, 2006

 

595

 

$

4.27

 

 

 

 

 

 

 

As of September 30, 2006, the total unrecognized compensation expense related to non-vested restricted stock awards that is expected to vest, net of estimated forfeitures, was $1.6 million.  This expense is expected to be recognized over a remaining weighted-average period of 1.50 years.

A summary of activity for restricted stock units as of September 30, 2006, and changes during the first half of fiscal 2007 is as follows:

 

 

 

 

 

 

Weighted Average

 

 

 

 

 

 

 

 

 

Remaining 

 

 

 

 

 

 

 

Weighted Average

 

Contractual Term

 

Aggregate Intrinsic

 

 

 

Shares

 

Purchase Price

 

(Years)

 

Value

 

 

 

(in thousands except purchase price and contractual term)

 

 

 

 

 

 

 

 

 

 

 

Nonvested units at March 31, 2006

 

 

$

 

 

 

 

 

Granted

 

65

 

0.001

 

 

 

 

 

Vested

 

 

 

 

 

 

 

Forfeited and cancelled

 

(3

)

0.001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonvested units at September 30, 2006

 

62

 

$

0.001

 

1.21

 

$

269

 

Units vested and expected to vest at September 30, 2006

 

46

 

$

0.001

 

1.15

 

$

205

 

 

 

 

 

 

 

 

 

 

 

As of September 30, 2006, the total unrecognized compensation expense related to non-vested restricted stock units that is expected to vest, net of estimated forfeitures, was $0.2 million.  This expense is expected to be recognized over a remaining weighted-average period of 1.21 years.

4. Business Dispositions

IBM i/p Series RAID: On June 29, 2004, the Company completed the acquisition of the IBM i/p Series RAID Business.

On September 30, 2005, the Company entered into a series of arrangements with IBM pursuant to which the Company sold its IBM i/p Series RAID Business to IBM for approximately $22.0 million plus $1.3 million for certain fixed assets. In addition, IBM

11




purchased certain related inventory at the Company’s net book value of $0.8 million. Expenses incurred in the transaction primarily included costs of approximately $0.5 million for legal and accounting fees. In addition, the Company accrued $0.3 million for lease obligations. Under the terms of the agreements, the Company granted IBM a nonexclusive license to certain intellectual property and sold to IBM substantially all of the assets dedicated to the engineering and manufacturing of RAID controllers and connectivity products for the IBM i/p Series RAID Business. Under the terms of the nonexclusive license, IBM will pay royalties to the Company for the sale of its board-level products on a quarterly basis through March 31, 2007, which will be recognized as contingent consideration in discontinued operations as earned. In fiscal 2006, the Company received royalties, net of taxes of $5.6 million, which the Company recorded in “Income (loss) from disposal of discontinued operations, net of taxes,” in its Consolidated Statements of Operations.  Additional royalties, net of taxes of $2.4 million and $3.7 million, were recorded in the second quarter and first half of fiscal 2007, respectively.  Through September 30, 2006, the Company has recognized a cumulative gain of $1.4 million on the disposal of the IBM i/p Series RAID Business.

Net revenues and the components of income (loss) related to the IBM i/p Series RAID Business included in discontinued operations, which were previously included in the Company’s DPS segment, were as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2005

 

September 30, 2005

 

 

 

(in thousands)

 

 

 

 

 

Net revenues

 

$

15,357

 

$

19,809

 

Income (loss) from discontinued operations before income taxes

 

3,694

 

(14,663

)

Benefit from income taxes

 

(833

)

(642

)

Income (loss) from discontinued operations

 

$

4,527

 

$

(14,021

)

Systems Business:  On September 29, 2005, the Company’s Board of Directors approved management’s recommendation to divest its systems business, including substantially all of the operating assets and cash flows that were obtained through the Snap Appliance acquisition in July 2004. Accordingly, the Company had classified the systems business as a discontinued operation in its consolidated financial statements for the three-year period ended March 31, 2006 and began pursuing a sale of the systems business.

On January 31, 2006, the Company sold the block-based portion of its systems business to Sanmina-SCI Corporation and its wholly owned subsidiary, Sanmina-SCI USA, Inc., for $14.5 million, of which $5.0 million will be received over the two years following the transaction. In addition, Sanmina-SCI USA agreed to pay the Company contingent consideration of up to an additional $12.0 million if certain revenue levels are achieved over a three-year period. The Company recorded a gain of $12.1 million on the disposal of the OEM block-based systems business in the fourth quarter of fiscal 2006.

The Company received offers from prospective buyers for the Snap Server portion of its systems business; however, management concluded that the potential value from retaining the operations outweighed the offers received for the business.  As a result, on July 6, 2006, and effective for the end of the first quarter of fiscal 2007, the Company’s Board of Directors decided  to retain the Snap Server portion of the systems business, and management terminated its ongoing efforts to sell this business. As a result, the  Company has reclassified the financial statements and related disclosures for all periods presented to reflect the Snap Server portion of its systems business as continuing operations.  In addition, the Company recorded asset impairment charges of $13.2 million related to certain acquisition-related intangible assets (Note 6) and $0.7 million of legal and consulting fees incurred in connection with its efforts that had been undertaken to sell the Snap Server portion of its systems business, which was recorded in “Other charges” in the Condensed Consolidated Statements of Operations in the first half of fiscal 2007.

Net revenues and the components of income (loss) related to the block-based portion of its systems business included in discontinued operations, were as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2006

 

September 30, 2005

 

September 30, 2006

 

September 30, 2005

 

 

 

(in thousands)

 

 

 

 

 

Net revenues

 

$

418

 

$

7,112

 

$

2,036

 

$

17,245

 

Income (loss) from discontinued operations before income taxes

 

(181

)

(3,568

)

149

 

(6,865

)

Provision for (benefit from) income taxes

 

(49

)

(73

)

17

 

(5

)

Income (loss) from discontinued operations

 

$

(132

)

$

(3,495

)

$

132

 

$

(6,860

)

 

12




5. Balance Sheets Details

Inventories:

 

 

September 30, 2006

 

March 31, 2006

 

 

 

(in thousands)

 

 

 

 

 

Raw materials

 

$

4,166

 

$

4,258

 

Work-in-process

 

4,281

 

4,732

 

Finished goods

 

28,012

 

19,269

 

Total

 

$

36,459

 

$

28,259

 

Accrued Liabilities:

 

 

September 30, 2006

 

March 31, 2006

 

 

 

(in thousands)

 

 

 

 

 

Tax related

 

$

10,646

 

$

46,704

 

Acquisition related

 

2,146

 

3,635

 

Accrued compensation and related taxes

 

11,610

 

16,235

 

Other

 

14,842

 

21,148

 

Total

 

$

39,244

 

$

87,722

 

 

6. Goodwill and Other Intangible Assets

Goodwill:   Goodwill is not amortized, but instead is reviewed annually and whenever events or circumstances occur which indicate that goodwill might be impaired. In connection with the reorganization of the Company’s segments in fiscal 2006, in which the organization managed its segments at the product level as opposed to a set of customer-focused products, an assessment of the recoverability of goodwill was performed.  Impairment of goodwill is tested at the Company’s reporting unit level, which is its operating segment level, by comparing each segment’s carrying amount, including goodwill, to the fair value of that segment. To determine fair value, the Company’s review process uses the income or discounted cash flows approach and the market approach. In performing its analysis, the Company used the best information available under the circumstances, including reasonable and supportable assumptions and projections. If the carrying amount of the segment exceeds its implied fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. As a result of this review, the Company wrote-off the entire balance of goodwill of $90.6 million in the second quarter of fiscal 2006.  Factors that led to this conclusion included, but were not limited to, industry technology changes experienced in the first half of fiscal 2006 such as the shift from parallel to serial technology and the migration of core functionality to server chipsets; required increased investments that eventually led the Company to sell the IBM i/p Series RAID Business in the second quarter of fiscal 2006 and the decision to sell the systems business; continued losses associated with the sales of systems products to IBM; and general market conditions.

Other Intangible Assets:

 

 

 

September 30, 2006

 

March 31, 2006

 

 

 

Gross Carrying

 

Accumulated

 

Gross Carrying

 

Accumulated

 

 

 

Amount

 

Amortization

 

Amount

 

Amortization

 

 

 

(in thousands)

 

 

 

 

 

Acquisition-related intangible assets:

 

 

 

 

 

 

 

 

 

Patents, core and existing technologies

 

$

43,545

 

$

(35,797

)

$

43,545

 

$

(24,218

)

Customer relationships

 

1,047

 

(904

)

1,047

 

(773

)

Trade name

 

10,774

 

(10,407

)

10,774

 

(5,858

)

Subtotal

 

55,366

 

(47,108

)

55,366

 

(30,849

)

Intellectual property assets and warrants

 

40,242

 

(35,392

)

40,242

 

(32,235

)

Total

 

$

95,608

 

$

(82,500

)

$

95,608

 

$

(63,084

)

 

Amortization of other intangible assets was $3.0 million and $4.5 million in the second quarters of fiscal 2007 and 2006, respectively.  Amortization of other intangible assets was $6.2 million and $9.2 million in the first halves of fiscal 2007 and 2006, respectively.  The other intangible assets related to the Snap Server portion of the systems business have been reclassified from discontinued operations to continuing operations and are included in the numbers above.

13




The Company regularly performs reviews to determine if facts or circumstances are present, either internal or external, which would indicate that the carrying values of its long-lived assets are impaired. If an asset is determined to be impaired, the loss is measured based on the difference between the asset’s fair value and its carrying value. The estimate of fair value of the assets is based on discounting estimated future cash flows using a discount rate commensurate with the risks inherent in the Company’s current business model. The estimation of the impairment involves numerous assumptions that require judgment by the Company, including, but not limited to, future use of the assets for Company operations versus sale or disposal of the assets and future selling prices for the Company’s products. During the first quarter of fiscal 2007, as a result of the decision to retain and operate the Snap Server portion of the systems business, the Company performed an impairment analysis that indicated that the carrying amount of the long-lived assets exceeded their estimated fair value. This was due in part to the limited cash flows of the business and a number of uncertainties, which included the significant research and development expenditures necessary to grow the revenue of the Snap Server portion of the systems business and the significant uncertainties associated with achieving such growth in revenue. This resulted in an impairment charge of $13.2 million in “Other charges” in the in the Condensed  Consolidated Statements of Operations, of which $5.6 million, $3.1 million and $4.5 million related to the Company’s intangible assets for existing technology, core technology, and trademarks, respectively.

The annual amortization expense of the other intangible assets that existed as of September 30, 2006 is expected to be as follows:

 

 

Estimated Amortization Expense

 

 

 

Acquisition-related
intangible assets

 

Intellectual
property assets

 

 

 

(in thousands)

 

Fiscal years:

 

 

 

 

 

2007 (remaining six months)

 

$

2,938

 

$

3,159

 

2008

 

2,892

 

1,691

 

2009

 

2,395

 

 

2010

 

33

 

 

2011 and thereafter

 

 

 

Total

 

$

8,258

 

$

4,850

 

 

7. Interest and Other Income

The components of interest and other income for the second quarters and first halves of fiscal 2007 and 2006, were as follows:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2006

 

September 30, 2005

 

September 30, 2006

 

September 30, 2005

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

5,813

 

$

3,969

 

$

11,506

 

$

7,543

 

Loss on redemption of debt

 

 

(16

)

 

(102

)

Transaction gains (losses)

 

(45

)

(63

)

134

 

(380

)

Other

 

57

 

633

 

88

 

1,070

 

Total

 

$

5,825

 

$

4,523

 

$

11,728

 

$

8,131

 

 

 

 

 

 

 

In the second quarter of fiscal 2006, the Company repurchased $3.4 million in aggregate principal amount of its 3% Convertible Subordinated Notes (“3% Notes”) on the open market for an aggregate price of $3.4 million, resulting in an immaterial loss.  In the first half of fiscal 2006, the Company repurchased $23.2 million in aggregate principal amount of its 3% Notes on the open market for an aggregate price of $23.1 million, resulting in an immaterial loss.  The loss on extinguishment of debt has been included in “Interest and other income” in the Company’s Condensed Consolidated Statements of Operations.

8. Restructuring Charges

In the first and second quarters of fiscal 2007, management approved and initiated plans to restructure the operations of the Company by simplifying its infrastructure.  The first quarter of fiscal 2007 restructuring plan eliminated certain duplicative resources in all functions of the organization worldwide, due to consolidating certain processes and vacating redundant facilities in order to reduce the Company’s cost structure, resulting in a restructuring charge of $3.0 million. The second quarter of fiscal 2007 restructuring plan vacated another redundant facility and involuntarily terminated employees primarily related to research and development activities, resulting in a restructuring charge of $0.9 million.

14




The Company also recorded provision adjustments of $0.2 million in the second quarter and first half of fiscal 2007 related primarily to additional lease costs based on the estimated loss on facilities that the Company subleased and asset impairments associated with the identification of duplicative assets. This was partially offset by severance and benefits as actual costs were lower than anticipated. These provision adjustments pertained to the restructuring plans that the Company implemented in the first quarter of fiscal 2007, and restructuring plans that it implemented in fiscal 2006, fiscal 2003, fiscal 2002 and fiscal 2001. All expenses, including adjustments, associated with the Company’s restructuring plans are included in “Restructuring charges” in the Condensed Consolidated Statements of Operations and are not allocated to segments but rather managed at the corporate level.  For a complete discussion of all restructuring actions that were implemented prior to fiscal 2007, please refer to the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2006.

The activity in the accrued restructuring reserves, excluding acquisition-related restructuring, was as follows for the first half of fiscal 2007:

 

 

Severance And

 

 

 

 

 

 

 

Benefits

 

Other Charges

 

Total

 

 

 

(in thousands)

 

 

 

 

 

Reserve balance at March 31, 2006

 

$

1,185

 

$

1,586

 

$

2,771

 

Q1’07 Restructuring Plan

 

2,927

 

101

 

3,028

 

Q2’07 Restructuring Plan

 

881

 

 

881

 

Provision adjustments

 

(101

)

288

 

187

 

Non-cash charges

 

 

(225

)

(225

)

Cash paid

 

(4,334

)

(540

)

(4,874

)

Reserve balance at September 30, 2006

 

$

558

 

$

1,210

 

$

1,768

 

 

 

 

 

 

 

 

 

The Company anticipates that the remaining restructuring severance and benefits balance of $0.6 million will be substantially paid out by the third quarter of fiscal 2007 while the remaining restructuring other charges balance of $1.2 million , relating primarily to long term leases, will be paid out through fiscal 2009.  The remaining restructuring reserve balance is reflected both in “Accrued liabilities” and “Other long-term liabilities” in the Condensed Consolidated Balance Sheets.

Acquisition-Related Restructuring:    During the first quarter of fiscal 2006, the Company finalized its Snap Appliance integration plan to eliminate certain duplicative resources, including severance and benefits in connection with the involuntary termination of approximately 24 employees, exiting duplicative facilities and disposing of duplicative assets. The acquisition-related restructuring liabilities were accounted for under EITF No. 95-3 and therefore were included in the purchase price allocation. The Company recorded a total liability of $6.7 million for these activities, of which the original estimate of $6.0 million was recorded in the second quarter of fiscal 2005 and adjustments were recorded in each subsequent quarter through the first quarter of fiscal 2006 totaling $0.7 million. Any further changes to the Company’s finalized plan will be accounted for under SFAS No. 146 and will be recorded in “Restructuring charges” in the Condensed Consolidated Statements of Operations. In the third quarter of fiscal 2006, the Company recorded additional adjustments of $0.2 million due to additional lease costs related to the estimated loss of facilities that the Company subleased. As of September 30, 2006, the Company had utilized $4.5 million of these charges. The Company anticipates that the remaining restructuring reserve balance of $2.4 million will be paid out by the third quarter of fiscal 2012, primarily related to long-term facility leases.

The activity in the accrued restructuring reserve related to the Snap Appliance acquisition-related restructuring plan was as follows for the first half of fiscal 2007:

 

 

 

Severance And

 

 

 

 

 

 

 

Benefits

 

Other Charges

 

Total

 

 

 

(in thousands)

 

 

 

 

 

Snap Appliance Acquisition-Related Restructuring Plan:

 

 

 

 

 

 

 

Reserve balance at March 31, 2006

 

$

46

 

$

2,489

 

$

2,535

 

Cash paid

 

 

(170

)

(170

)

Reserve balance at September 30, 2006

 

$

46

 

$

2,319

 

$

2,365

 

 

15




9.  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, which include certain stock options and warrants, calculated using the treasury stock method, and convertible notes which are potentially dilutive at certain earnings levels, and are computed using the if-converted method.

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

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30, 2006

 

September 30, 2005

 

September 30, 2006

 

September 30, 2005

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

Numerators:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations—basic

 

$

48,757

 

$

(99,862

)

$

23,933

 

$

(113,922

)

Income (loss) from discontinued operations—basic

 

2,308

 

(5,944

)

3,862

 

(27,857

)

Net income (loss)—basic

 

$

51,065

 

$

(105,806

)

$

27,795

 

$

(141,779

)

 

 

 

 

 

 

 

 

 

 

Adjustments:

 

 

 

 

 

 

 

 

 

Adjustment for interest expense on ¾% Convertible Senior Subordinated Notes (“¾% Notes”) , net of taxes

 

$

762

 

$

 

$

1,524

 

$

 

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

 

100

 

 

 

 

Total adjustments for interest expense on convertible notes, net of taxes

 

$

862

 

$

 

$

1,524

 

$

 

 

 

 

 

 

 

 

 

 

 

Adjusted income (loss) from continuing operations—diluted

 

$

49,619

 

$

(99,862

)

$

25,457

 

$

(113,922

)

Adjusted income (loss) from discontinued operations—diluted

 

2,308

 

(5,944

)

3,862

 

(27,857

)

Adjusted net income (loss)—diluted

 

$

51,927

 

$

(105,806

)

$

29,319

 

$

(141,779

)

 

 

 

 

 

 

 

 

 

 

Denominators:

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—basic

 

116,325

 

112,965

 

115,967

 

112,705

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options

 

491

 

 

800

 

 

¾% Notes

 

19,224

 

 

19,224

 

 

3% Notes

 

695

 

 

 

 

Weighted average shares and potentially dilutive common shares outstanding—diluted

 

136,735

 

112,965

 

135,991

 

112,705

 

 

 

 

 

 

 

 

 

 

 

Income (loss) per share:

 

 

 

 

 

 

 

 

 

Basic

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.42

 

$

(0.88

)

$

0.21

 

$

(1.01

)

Discontinued operations

 

$

0.02

 

$

(0.05

)

$

0.03

 

$

(0.25

)

Net income (loss)

 

$

0.44

 

$

(0.94

)

$

0.24

 

$

(1.26

)

Diluted

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.36

 

$

(0.88

)

$

0.19

 

$

(1.01

)

Discontinued operations

 

$

0.02

 

$

(0.05

)

$

0.03

 

$

(0.25

)

Net income (loss)

 

$

0.38

 

$

(0.94

)

$

0.22

 

$

(1.26

)

 

Certain potential common shares were excluded from the diluted computation from continuing operations, discontinued operations and net income for the second quarter and first half of fiscal 2007 because their inclusion would have been anti-dilutive. In addition, diluted loss per share from continuing operations, discontinued operations and net loss for the second quarter and first half of fiscal 2006 was based only on the weighted-average number of shares outstanding during these periods, as the inclusion of any common stock equivalents would have been anti-dilutive. The items excluded for the second quarters and first halves of fiscal 2007 and 2006 were as follows:

 

16




 

 

 

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands)

 

Outstanding employee stock options

 

12,552

 

19,461

 

12,825

 

19,820

 

Outstanding restricted stock awards and units

 

8

 

 

4

 

 

Warrants(1)

 

19,874

 

19,874

 

19,874

 

19,874

 

¾% Notes

 

 

19,224

 

 

19,224

 

3% Notes

 

 

880

 

695

 

1,154

 


(1) In connection with the issuance of its ¾% Notes due 2023, the Company entered into a derivative financial instrument to repurchase up to 19,224,000 shares of its common stock, at the Company’s option, at specified prices in the future to mitigate any potential dilution as a result of the conversion of the ¾% Notes. For further discussion on this derivative financial instrument, please refer to Note 6 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended March 31, 2006.

10. Comprehensive Income (Loss)

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

 

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands)

 

Net income (loss)

 

$

51,065

 

$

(105,806

)

$

27,795

 

$

(141,779

)

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

 

3,222

 

(1,231

)

2,569

 

(810

)

Foreign currency translation adjustment, net of taxes

 

182

 

(157

)

1,055

 

(962

)

Comprehensive income (loss), net of taxes

 

$

54,469

 

$

(107,194

)

$

31,419

 

$

(143,551

)

 

The components of accumulated other comprehensive income (loss) were as follows:

 

 

 

September 30,
2006

 

March 31,
2006

 

 

 

(in thousands)

 

Unrealized losses on marketable securities

 

$

(669

)

$

(3,233

)

Foreign currency translation

 

1,512

 

452

 

Total

 

$

843

 

$

(2,781

)

 

11. Income Taxes

Income tax provisions for interim periods are based on the Company’s estimated annual income tax rate. The estimated annual tax for fiscal 2007 includes foreign taxes related to the Company’s foreign subsidiaries, certain state minimum taxes, interest accrued on prior years’ tax disputes and the tax allocation between the Company’s continuing and discontinued operations. This resulted in a tax benefit of $3.1 million for the second quarter of fiscal 2007. In addition, the Company settled certain tax disputes with the U.S. and Singapore taxing authorities, including the resolution of the Company’s fiscal 1997 U.S. Tax Court Litigation, which resulted in a discrete tax benefit of $46.0 million that was recorded in the second quarter of fiscal 2007. The estimated annual tax for fiscal 2006 consists of foreign taxes related to the Company’s foreign subsidiaries, certain state minimum taxes and interest accrued on prior years’ tax disputes. A portion of those disputes was resolved in fiscal 2007. The Company currently has a full valuation allowance on its net U.S. deferred tax assets. The Company is in ongoing negotiations with the U.S. and Singapore taxing authorities with regard to its various tax disputes. The Company’s tax rate for the period in which a settlement is reached is impacted if the settlement materially differs from the amounts previously accrued.

17




 

12. Commitments and Contingencies

The Company has been, or is, subject to IRS audits for its fiscal years 1994 through 2003. The fiscal 1994 through fiscal 1996 cycle and fiscal 1997 cycle, which are docketed in the United States Tax Court, were resolved in December 2001 and September 2006, respectively. The outcome of the fiscal 1994 through fiscal 1996 cycle did not have a material adverse effect on the Company’s financial position or results of operations, as sufficient tax provisions had been made. The outcome of the fiscal 1997 cycle resulted in the release of tax reserves in September 2006. The final Tax Court stipulations will be filed when the subsequent audit cycles are completed. Tax credits that were generated but not used in subsequent years may be carried back to the respective fiscal 1994 through 1996 and fiscal 1997 audit cycles. In addition, in fiscal 2005, the Company resolved all issues for fiscal 1998 through fiscal 2001 audit cycles, other than the tax credits that were generated but not used in subsequent years that may be carried back. The IRS is currently auditing the Company’s Federal income tax returns for the fiscal 2002 and 2003 audit cycle. 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 in future periods. 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, including those related to intellectual property, 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. However, because of the nature and inherent uncertainties of litigation, should the outcome of these actions be unfavorable, the Company’s business, financial condition, results of operations and cash flows could be materially and adversely affected.

In connection with the Company’s acquisitions of Snap Appliance, Eurologic, Elipsan Limited (“Elipsan”), and Platys Communications, Inc. (“Platys”), portions of the purchase price and other future payments totaling $6.7 million, $3.8 million, $2.0 million and $15.0 million, respectively, were held back (the “Holdbacks”) for unknown liabilities that may have existed as of the acquisition dates. As of September 30, 2006, the Company has asserted claims against the Snap Appliance and Eurologic Holdbacks totaling $3.0 million and $1.5 million, respectively. The remainder of the Platys Holdback of $0.7 million was paid in the second quarter of fiscal 2007. The Elipsan Holdback of $2.0 million was paid in the second quarter of fiscal 2006.

13. Guarantees

Intellectual Property Indemnification Obligations

The Company has entered into agreements with customers and suppliers that include intellectual property indemnification obligations. These indemnification obligations 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. In each of these circumstances, payment by the Company is conditional on the other party making a claim pursuant to the procedures specified in the particular contract, which procedures typically allow the Company to challenge the other party’s claims. Further, the Company’s obligations under these agreements may be limited in terms of time and/or amount, and in some instances, the Company may have recourse against third parties for certain payments made by it under these agreements. It is not possible to make a reasonable estimate of the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. 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 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 second quarters and first halves of fiscal 2007 and 2006.

18




 

A reconciliation of the changes to the Company’s warranty accrual for the first halves of fiscal 2007 and 2006 was as follows:

 

 

Six-Month Period Ended

 

 

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands)

 

Balance at beginning of period(1)

 

$

2,051

 

$

2,084

 

Warranties provided

 

2,086

 

2,745

 

Actual costs incurred

 

(2,561

)

(2,880

)

Warranties classified as liabilities held for sale(1)

 

 

(183

)

Balance at end of period(1)

 

$

1,576

 

$

1,766

 


(1)  The table presented above has been updated to reflect the decision to retain and operate the Snap Server portion of the systems business. As a result, the Company has reclassified the financial statements and related disclosures to reflect the Snap Server portion of its systems business as continuing operations.

14. Segment Reporting

During the first quarter of fiscal 2007, as a result of retaining the Snap Server portion of the systems business, the Company reorganized its segments by adding an additional segment. For the period ended September 30, 2006, the Company operated in three reportable segments: DPS, DSG and SSG. A description of the types of customers or products and services provided by each reportable segment is as follows:

DPS provides storage products and currently sells all of its storage technologies in various form factors, such as board-level products, ASICs and stand-alone software. The Company sells these products directly to OEMs, ODMs that supply OEMs, VARs and end users through its network of distribution and reseller customers.

DSG provides high-performance I/O connectivity and digital media products for personal computing platforms, including notebook and desktop PCs. The Company sells these products to retailers, OEMs and distributors.

SSG primarily provides Snap Server products, including NAS hardware and related software. The Company sells these products to VARs and end users through its network of distribution and reseller channels.

The unallocated corporate income and expenses, which are in the “Other” category, include amortization of acquisition-related intangible assets, restructuring charges, goodwill impairment, other charges, interest and other income, interest expense, all administrative expenses and certain research and development, selling and marketing expenses.

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 all tangible assets or depreciation by operating segments nor are the segments evaluated under these criteria. Segment financial information is summarized as follows for the second quarters and first halves of fiscal 2007 and 2006:

 

 

 

DPS

 

DSG

 

SSG

 

Other

 

Total

 

 

 

(in thousands)

 

Three-Month Period Ended September 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

62,945

 

$

4,534

 

$

6,074

 

$

 

$

73,553

 

Segment income (loss)

 

16,861

 

697

 

(3,604

)

(14,277

)

(323

)

Three-Month Period Ended September 30, 2005:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

73,813

 

$

11,124

 

$

7,651

 

$

 

$

92,588

 

Segment income (loss)

 

16,766

 

(1,094

)

(993

)

(111,869

)

(97,190

)

Six-Month Period Ended September 30, 2006:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

119,053

 

$

9,737

 

$

13,834

 

$

 

$

142,624

 

Segment income (loss)

 

24,131

 

1,616

 

(4,698

)

(45,302

)

(24,253

)

Six-Month Period Ended September 30, 2005:

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

138,984

 

$

19,916

 

$

17,501

 

$

 

$

176,401

 

Segment income (loss)

 

26,016

 

(1,472

)

(1,479

)

(133,469

)

(110,404

)

 

19




The following table presents the details of unallocated corporate income and expenses for the second quarters and first halves of fiscal 2007 and 2006:

 

 

Three-Month Period Ended

 

Six-Month Period Ended

 

 

 

September 30,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands)

 

Unallocated corporate expenses, net

 

$

(18,134

)

$

(24,445

)

$

(37,233

)

$

(48,640

)

Restructuring charges

 

(1,085

)

(478

)

(4,096

)

(518

)

Goodwill impairment

 

 

(90,602

)

 

(90,602

)

Other charges

 

 

 

(13,942

)

 

Interest and other income

 

5,825

 

4,523

 

11,728

 

8,131

 

Interest expense

 

(883

)

(867

)

(1,759

)

(1,840

)

 Total

 

$

(14,277

)

$

(111,869

)

$

(45,302

)

$

(133,469

)

 

15. Supplemental Disclosure of Cash Flows

 

 

Six-Month Period Ended

 

 

 

September 30,
2006

 

September 30,
2005

 

 

 

(in thousands)

 

Non-cash investing and financial activities:

 

 

 

 

 

Adjustment for deferred stock-based compensation

 

$

 

$

414

 

Unrealized loss on available-for-sale securities

 

2,569

 

(810

)

 

16. Glossary

The following is a list of business related acronyms that are contained within this Quarterly Report on Form 10-Q. They are listed in alphabetical order.

·                  ASIC: Application Specific Integrated Circuit

·                  ATA: Advanced Technology Attachment

·                  DPS: Data Protection Solutions

·                  DSG: Desktop Solutions Group

·                  ESPP: Employee Stock Purchase Plan

·                  I/O: Input/Output

·                  IP: Internet Protocol

·                  IPsec: Internet Protocol Security

·                  IRS: Internal Revenue Service

·                  iSCSI: Internet Protocol SCSI

·                  NAS: Network Attached Storage

·                  ODM: Original Design Manufacturer

·                  OEM: Original Equipment Manufacturer

·                  PC: Personal Computer

·                  PCI: Peripheral Component Interconnect

·                  RAID: Redundant Array of Independent Disks

·                  ROC: RAID on a Chip

·                  SAS: Serial Attached SCSI

·                  SATA: Serial Advanced Technology Attachment

·                  SCSI: Small Computer System Interface

·                  SMI-S: Storage Management Initiative Specification

·                  SSG: Storage Solutions Group

·                  Ultra DMA: Ultra Direct Memory Access

·                  USB: Universal Serial Bus

·                  VAR: Value Added Reseller

20




 

The following is a list of accounting rules and regulations and related regulatory bodies referred to within this Quarterly Report on Form 10-Q. They are listed in alphabetical order.

·                  APB: Accounting Principles Board

·                  APB Opinion No. 25: Accounting for Stock Issued to Employees

·                  ARB: Accounting Research Bulletin

·                  EITF: Emerging Issues Task Force

·                  EITF No. 95-3: Recognition of Liabilities in Connection with Purchase Business Combinations

·                  FASB: Financial Accounting Standards Board

·                  FIN: FASB Interpretation Number

·                  FIN No. 44: Accounting for Certain Transactions involving Stock Compensation — an interpretation of APB Opinion No. 25

·                  FIN No. 48: Accounting for Uncertainty in Income Taxes

·                  SAB: Staff Accounting Bulletin

·                  SAB 107: Share Based Payment

·                  SAB 108: Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements

·                  SEC: Securities Exchange Commission

·                  SFAS: Statement of Financial Accounting Standards

·                  SFAS No. 109: Accounting for Income Taxes

·                  SFAS No. 123: Accounting for Stock-Based Compensation

·                  SFAS No. 123(R): Share Based Payment

·      SFAS No. 146: Accounting for Costs Associated with Exit or Disposal Activities

·                  SFAS No. 148: Accounting for Stock-Based Compensation — Transition and Disclosure

·                  SFAS No.157: Fair Value Measurements

 

21




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. The statements contained in this document that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding our business, including, but not limited to, our expected reduction in annual intrastructure expenses, expected revenues from our DSG segment, our plans to migrate certain foreign operations from Singapore to the Republic of Ireland and the Cayman Islands during the second half of fiscal 2007 and our liquidity in future periods. We may identify these statements by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and other similar expressions. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements, except as may otherwise be required by law.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in the “Risk Factors” section and elsewhere in this document. In evaluating our business, current and prospective investors should consider carefully these factors in addition to the other information set forth in this report.

While management believes that the discussion and analysis in this report is adequate for a fair presentation of the information presented, we recommend that you read this discussion and analysis in conjunction with our Annual Report on Form 10-K for the year ended March 31, 2006.

For your convenience, we have included, in Note 16 to the Notes to the Unaudited Condensed Consolidated Financial Statements, a Glossary that contains a list of (1) key acronyms commonly used in our industry that are used in this Quarterly Report and (2) accounting rules and regulations that are also referred to in this report. These key acronyms and accounting rules and regulations are listed in alphabetical order.

Recent Developments

On September 29, 2005, our Board of Directors approved management’s recommendation to divest our systems business, which includes substantially all of the operating assets and cash flows that were obtained through our acquisitions of Snap Appliance Inc., and Eurologic Systems Group Limited in fiscal 2004, as well as internally developed hardware and software. In connection with this action, we classified the systems business as a discontinued operation in our condensed consolidated financial statements in September 2005, and sold the block-based portion of the systems business in January 2006.

On July 6, 2006, our Board of Directors decided to retain the Snap Server portion of the systems business, and management terminated its ongoing efforts to sell this business.  As a result of the decision to retain the Snap Server portion of the systems business, we reclassified the financial statements and related disclosures for all periods presented to reflect the Snap Server portion of our systems business as continuing operations in the first quarter of fiscal 2007. In addition, we reorganized our segments in the first quarter of fiscal 2007, adding the SSG segment to our previous DPS and DSG segments.  Our SSG segment primarily provides Snap Server products, including NAS hardware and related software.  We sell these products to VARs and end users through our network of distribution and reseller channels.

Results of Operations

Overview

In the second quarter of fiscal 2007, our revenues decreased 21% as compared to the second quarter of fiscal 2006 due primarily to slower adoption of our newer generation of serial products as compared to the declining revenue base of our parallel products.  In the second quarter of fiscal 2007, IBM and Dell accounted for 29% and 15% of our net revenues, respectively, compared with 26% and 13%, respectively for IBM and Dell in the second quarter of fiscal 2006.   In addition, Hewlett-Packard accounted for 10% of our net revenues in the second quarter of fiscal 2006. The improvement in gross margin in the second quarter of fiscal 2007 compared to the second quarter of fiscal 2006 was primarily due to changes in our product and customer mix, which included obtaining favorable pricing negotiations with certain of our customers. Operating expenses also decreased in the second quarter of fiscal 2007 as compared to the second quarter of fiscal 2006 as a result of cost reductions and restructuring efforts.

Our future revenue growth remains largely dependent on the success of our new products addressing serial technologies (for example., SAS, SATA and iSCSI), new OEM design wins, channel growth and our ability to develop new products in other markets.

 

22




The following table sets forth the items in the Unaudited Condensed Consolidated Statements of Operations as a percentage of net revenues (references to notes in the footnotes to this table are to the Notes to Unaudited Condensed Consolidated Financial Statements appearing in this report):

 

 

Three-Month Period Ended (1)

 

Six-Month Period Ended (2)

 

 

 

September 30,
2006

 

September 30,
2005

 

September 30,
2006

 

September 30,
2005

 

Net revenues

 

100

%

100

%

100

%

100

%

Cost of revenues

 

64

 

67

 

66

 

69

 

Gross margin

 

36

 

33

 

34

 

31

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

18

 

19

 

21

 

21

 

Selling, marketing and administrative

 

21

 

21

 

22