<Picture>
JTS CORP (AMEX:JTS) files SEC Form 10-K
EDGAR Online, Friday, May 02, 1997 at 17:35
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
This document includes "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. All statements other than statements of historical fact
included in this Prospectus, including without limitation, statements regarding
the Company's financial position, business strategy, budgets and the plans and
objectives of management for future operations, including plans and objectives
relating to the Company's products, are forward-looking statements. Although the
Company believes that assumptions underlying such forward-looking statements are
reasonable, it can give no assurance that such assumptions will prove to have
been correct. The Company's actual results may differ significantly from the
results discussed in the forward-looking statements. Important cautionary
factors that could cause actual results to differ materially from the Company's
expectations include, but are not limited to, those disclosed under "Risk
Factors", "Business", and elsewhere in this 10-K. All written and oral
forward-looking statements attributable to the Company, or persons acting on its
behalf, are expressly qualified in their entirety by these cautionary
statements. Prospective investors should consider carefully the information
discussed under "Risk Factors", "Business", and elsewhere in this 10-K.
JTS AND ATARI BACKGROUND
On July 30, 1996, Atari was merged into JTS (the "Merger") and the separate
existence of Atari ceased. Although the business combination resulted in Atari
merging into the JTS legal entity, the substance of the transaction was that
Atari, as a public company with substantially greater operating history and net
worth, owned approximately 62% of the equity of the merged company. The
acquisition was accounted for as a purchase of JTS by Atari and, accordingly,
the operating results of JTS from July 30, 1996 forward were combined with
Atari's operating results and reported as JTS' operating results. The aggregate
purchase price of $112.3 million was allocated to the acquired assets and
liabilities of JTS.
Subsequent to the Merger the Company changed its fiscal year from a 52/53
week fiscal year ending on the Saturday closest to December 31 to a 52/53 week
fiscal year ending on the Sunday closest to January 31. The Merger was accounted
for as a purchase of JTS by Atari, and, as such, the historical balance sheets
and the statements of operations for the prior years include Atari only. In
addition, due to the change in year end, Atari's balance sheet for the end of
transition period as of January 28, 1996 is included herein, as are Atari's
operating results for the one month period then ended.
Throughout this discussion, "fiscal 1997" refers to the fiscal year ended
February 2, 1997.
Prior to the merger with JTS, Atari significantly downsized its video game
operations due primarily to lack of market acceptance of its video game console,
Jaguar. This downsizing resulted in significant reductions in Atari's workforce
and significant curtailment of research and development and sales and marketing
activities for Jaguar and related products. Despite the introduction of four
additional game titles in the first quarter of 1996, sales of Jaguar and related
software remained disappointing. As a result, management revised estimates and
wrote-down inventory by $5.0 million in the first quarter of 1996 and by an
additional $3.3 million during July 1996. The prior business of Atari is now
conducted through the Company's Atari division; however, the Atari division is
not expected to represent a significant portion of the Company's business going
forward.
The major portion of the Company's business today is its disk drive
division acquired in the merger with JTS, which designs, manufactures and
markets hard disk drives for use in notebook computers and desktop personal
computers. JTS was incorporated in February 1994 and remained in the development
stage until October 1995, when it began shipping its 3.5-inch "Palladium" disk
drives to customers in the United States and Europe. The Company currently has
three disk drive product families in production, the 3-inch form factor "Nordic"
family for notebook computers and the 3.5-inch form factor "Champ" and
"Champion" families for desktop personal computers. During the first quarter of
fiscal 1998, the Company introduced into production its higher performance
"Champion" family for desktop personal computers. During the second quarter of
fiscal 1998, the Champion drives are expected to entirely replace the Champ
drives.
23
Through fiscal 1997, the Company had shipped over 800,000 disk drives,
consisting primarily of 3.5-inch drives. JTS began shipment of Nordic disk
drives to Compaq in the second quarter of fiscal 1997; however, to date volume
shipments of 3.0-inch drives have not occurred. The Company markets its disk
drives to computer companies and systems integrators for incorporation into
their computer systems and subsystems and to OEMs. The Company sells its
products through a direct sales force operating throughout the United States,
Europe and Asia, as well as through distributors in the United States, Europe,
Latin America and Canada.
All of JTS' products are manufactured in Madras, India by its subsidiary,
JTS Technology (formerly Moduler Electronics (India) Pvt. Ltd.), which was
acquired in April 1996 and employed approximately 6,270 individuals at February
2, 1997.
Since its inception, JTS has incurred significant losses which have
resulted from the substantial costs associated with the design and development
of its products, the establishment of manufacturing operations, the development
of a supplier base, and the marketing of its new products and the ramp up of
production volumes. JTS has yet to generate profits from its disk drive business
and cannot assure that it will achieve or maintain successful operations in the
future.
YEAR ENDED FEBRUARY 2, 1997 COMPARED TO THE ATARI YEAR ENDED DECEMBER 31, 1995
The year ended February 2, 1997 operating results include only Atari for
the two quarters prior to the merger date, and for the two quarters after the
merger date the operations of both companies are included. For fiscal 1997, the
Company incurred a net loss of $152.5 million, including a one time charge of
$110 million, compared to a net loss for Atari for 1995 of $49.6 million.
Total revenues for the Company for fiscal 1997 were $90.5 million compared
to $14.6 million for Atari for 1995. Included in the $90.5 million are $86.0
million in revenues derived from the sales of disk drive products during the
second half of fiscal 1997 on shipments of approximately 600,000 units. For the
entire fiscal year including the two quarters prior to the merger with Atari,
approximately 820,000 disk drives were shipped which generated revenues of
$119.1 million.
The prior year's revenues of $14.6 million are entirely attributed to the
sale of Atari games, and sales of the Jaguar video game console represented 68%
of the total revenue for 1995.
The gross margin deficit for fiscal 1997 was $9.8 million compared to $29.6
million for 1995. The fiscal 1997 gross margin deficit includes $3.7 million
attributed to the disk drive division for the six-month period after the merger
and $1.1 million is attributed to the Atari operations for the entire year. The
fiscal 1997 gross margin deficit includes approximately $3.3 million of
inventory write-offs related to Atari games, and a provision of approximately
$2.8 million for inventory allowances related to the disk drive operation. The
principal reasons for these allowances are obsolete and unsalable inventory and
costs associated with the repair of defective product. JTS anticipates recording
future inventory allowances, the level of which will depend upon a number of
factors including manufacturing yields, new product introductions, maturity or
obsolescence of product designs, inventory levels and competitive pressures. The
portion of the gross margin deficit attributed to the disk drive division also
included amounts provided for potential product returns and distributor price
protection of $2.8 million.
The hard disk drive industry has been characterized by ongoing rapid price
erosion and resulting pressure on gross margins. JTS expects that hard disk
drive prices will continue to decline in the future and that competitors will
offer products which meet or exceed the performance capabilities of JTS
products. Due to such pricing pressures, JTS future gross margins will be
substantially dependent upon its ability to control manufacturing costs, improve
manufacturing yields and introduce new products on a timely basis.
The $110 million one time charge represented that portion of the purchase
price which was attributed to in-process research and development and was
expensed in Atari's July operations as the technology had not yet reached
technological feasibility and did not have alternative future uses.
Research and development expenses for JTS for 1997 were $12.8 million
compared to $5.4 million for Atari for 1995. The prior year's research and
development expenses reflect that of the video game business
24
only, which had begun to downsize. In the fourth quarter of 1995, Atari entirely
eliminated its internal Jaguar development teams and other development staff as
titles for Jaguar were completed. The fiscal 1997 research and development
expenses include six months of research and development expenses of the disk
drive division. The 1997 research and development expenses reflect amounts
significantly greater than the expenses incurred in the prior year due primarily
to salaries and benefits for staffing required for the design of disk drives and
the development of manufacturing processes as well as $1.9 million of expense
for amortization of purchased technology acquired at the time of the Merger.
Going forward, the company expects that research and development expenses will
continue to increase in the next fiscal year in absolute dollars but will
decline as a percent of revenues.
Selling, general and administrative expenses for 1997 were $13.7 million
compared to $18.6 million for 1995. The decrease in such expenses was primarily
a result of the Atari division's staff reductions, reduced rent, reduced legal
fees and other operating costs. The Company expects selling, general and
administrative expenses will increase in the next fiscal year in absolute
dollars primarily to support the expansion of the disk drive marketing and sales
efforts, but will decline as a percent of revenues.
Other income and expense for 1997 was a net expense of $2.8 million and
consisted primarily of $2.7 million of losses from disposal of obsolete
equipment, approximately $3.5 million of interest expense and approximately $3.9
million of realized gain from the sale of marketable securities. For 1995, other
income of $3.5 million was primarily due to realized gains of approximately $6.0
million from the sale of Dixon PLC holdings, which was offset by approximately
$2.0 million of interest expense on the $42 million of the Company's 5 1/4%
convertible debentures.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR ENDED DECEMBER 31, 1994
Total revenues for Atari for 1995 were $14.6 million compared to $38.7
million for 1994. Sales of Jaguar and related products represented 68% and 76%
of total revenues for 1995 and 1994, respectively, and sales of other products
and royalties represented the balance of revenues in each such year. The
reduction in revenues was primarily the result of lower unit volumes of Jaguar
products and lower average selling prices of Jaguar and certain of its software
titles. In the first quarter of 1995, Atari reduced the suggested retail price
of Jaguar from its original price of $249.99 to $149.99. As a result of the
Jaguar price reductions, the substantial curtailment of sales and marketing
activities for Jaguar and the substantial curtailment of efforts by Atari and
independent software developers to develop additional software titles for
Jaguar, Atari expected sales of Jaguar and related products to decline
substantially in 1996 and thereafter.
Cost of revenues for 1995 was $44.2 million compared to $35.2 million for
1994. Included in cost of revenues for 1995 were accelerated amortization and
write-offs of capitalized game software development costs of $16.6 million and
inventory write-downs of $12.6 million primarily relating to Jaguar products. As
a result of these charges and lower selling prices for Jaguar products and
provisions for returns and allowances and price protection, gross margin for the
year was a loss of $29.6 million. For 1994, gross margin was $3.5 million, or
9.2% of revenues. Included in cost of revenues for 1994 were write-downs of
inventory of $3.6 million and amortization and the write-off of capitalized game
software development costs of $1.5 million. As of December 31, 1995, Atari had
approximately 100,000 units of the Jaguar console in inventory which was
subsequently written off in 1996.
Research and development expenses for 1995 were $5.4 million compared to
$5.8 million for 1994. During 1995 and 1994, a significant number of Atari
employees and consultants were devoted to developing hardware and software for
the Jaguar, and Atari contracted with third-party software developers to develop
Jaguar software titles. As a result of Jaguar's poor sales performance, in the
third and fourth quarters of 1995, Atari accelerated its amortization of
contracted software development which resulted in charges in those quarters of
$6.0 million and $10.6 million, respectively. At December 31, 1995 and 1994,
Atari had capitalized software development costs of $758,000 and $5.1 million,
respectively. In the fourth quarter of 1995, Atari eliminated its internal
Jaguar development teams and other development staff as titles for Jaguar were
completed.
25
Marketing and distribution expenses for 1995 were $12.7 million compared to
$14.7 million for 1994. Such costs included television and print media,
promotions and other activities to promote Jaguar.
General and administrative expenses for 1995 were $5.9 million compared to
$7.2 million for 1994. The decrease in such expenses was primarily a result of
staff reductions, reduced legal fees and other operating costs.
Atari experienced a gain on foreign currency exchange of $13,000 for 1995
compared to a gain of $1.2 million for 1994. These changes were a result of
lower foreign asset exposure and a greater percentage of sales made in U.S.
dollars which further reduced exposure to foreign currency transaction
fluctuations.
In 1994, Atari received $2.2 million in connection with the settlement of
litigation between Atari, Atari Games Corporation and Nintendo. In 1994, Atari
also reached an agreement with Sega, which resulted in a gain of $29.8 million,
after contingent legal fees, and the sale of 4,705,883 shares of Atari Common
Stock to Sega at $8.50 per share for an aggregate of $40.0 million.
During 1995, Atari sold a portion of its holdings in Dixon PLC, a retailer
in England, and realized a gain of $2.4 million, of which $1.8 million was
realized in the fourth quarter of 1995. In the first quarter of 1996, Atari sold
the remaining portion of its holdings and realized a gain of $6.1 million. The
1995 gain of $2.4 million together with other income items resulted in a total
other income of $2.7 million compared to $484,000 for 1994.
For each of 1995 and 1994, interest expense was approximately $2.3 million
on the Atari Debentures. In 1995, Atari repurchased a portion of the Atari
Debentures and realized a gain of $582,000. As of December 31, 1995, the
outstanding balance of these debentures was $42.4 million.
Interest income for 1995 and 1994 was $3.1 million and $2.0 million,
respectively. The increase in interest income was primarily attributable to
higher average cash balances in 1995.
As a result of Atari's operating losses, there was no provision for income
taxes in 1995.
As a result of the factors discussed above, Atari reported a net loss for
1995 of $49.6 million compared to net income of $9.4 million in 1994.
LIQUIDITY AND CAPITAL RESOURCES
As of February 2, 1997, the Company had cash and cash equivalents of $24.8
million, working capital of $1.8 million and a net worth of $12.4 million.
At February 2, 1997, total debt, including bank credit lines and notes
payable, was $64.4 million. The Company had a $5.0 million revolving line of
credit with Silicon Valley Bank which bore interest at the bank's prime rate
plus .75%. As of February 2, 1997, all amounts available under this line were
drawn. The principal amount was replaced by a factoring arrangement of the same
amount which the Company entered into with Silicon Valley Bank in April 1997.
During 1997 the Company also entered into an agreement with a European bank to
finance certain of the Company's European accounts receivable. At February 2,
1997, $3.0 million was outstanding under this agreement. The Company also had
equipment lease financing of $4.2 million at February 2, 1997. There were $5.5
million of working capital loans outstanding between JTS Technology and two
Indian banks at interest rates ranging from 13% to 15% as of February 2, 1997,
as well as borrowing under term loan facilities with the Industrial Credit and
Investment Corporation of India Limited (ICICI) and the Shipping Credit and
Investment Corporation of India Limited (SICI) in the amount of $11.0 million at
interest rates of LIBOR plus 2.75% and LIBOR plus 4%, respectively. The term
loans are due in 2000 through 2002. Amounts borrowed under these loan agreements
have been used for working capital purposes, tooling, facilities expansion and
purchases of capital equipment.
Certain sources of financing in India require the Company to comply with
stringent financial covenants. In this regard, certain unsecured debt and equity
required under one loan agreement has not been obtained. However, management
believes that the lender is unlikely to require JTS to immediately repay
advances outstanding for non-compliance with debt covenants. JTS believes that
such matter will not have a material
26
adverse effect on JTS' business, operating results or financial condition.
However, JTS may not be able to renew or maintain its current Indian financing
facilities and its failure to do so would have a material adverse effect on JTS'
business, operating results and financial condition.
At February 2, 1997, the Company had $42.3 million of 5 1/4% convertible
subordinated debentures due April 29, 2002, which had originally been issued by
Atari in 1987.
JTS has yet to generate profits and cannot assure that profits will be
attained or that JTS will achieve or maintain successful operations in the
future. The Company's accounts receivable are heavily concentrated with a small
number of customers. If any large customer of the Company became unable to pay
its debts to the Company, liquidity would be adversely affected. In the event
the Company is unable to increase sales or maintain production yields at
acceptable levels there would be a significant adverse impact on liquidity. This
would require the Company to either obtain additional capital from external
sources or to curtail its capital, research and development and working capital
expenditures. Such curtailment could adversely affect the Company's operations
and competitive position. Due to delays in the receipt of additional financing,
the Company took action in September 1996 to conserve its cash resources by
reducing the production of drives planned for the third and fourth quarters of
fiscal 1997.
In September 1996, the Company sold certain of its real estate acquired
from Atari in the Merger to one of its board members for $10 million. The
property was sold at fair value, and the Company has an option to repurchase the
property one year from the date of sale for $10 million. Also, in early November
1996, the Company completed a $15 million private financing involving the sale
of its Series B Preferred Stock. In January 1996, the Company completed a $25
million private financing involving the sale of its Series C Preferred Stock.
The Company will need significant additional financing resources over the
next several years for working capital, facilities expansion and capital
equipment. In fiscal year 1998, the Company plans approximately $17 million in
capital expenditures related primarily to equipment and facilities required to
increase drive production volumes in its Madras, India facility. In addition,
significant cash resources will be required to fund purchases of inventory
needed to achieve anticipated sales levels. Failure to obtain such cash
resources will negatively impact the Company's ability to manufacture its
products at required levels. The Company is currently pursuing working capital
and equipment financing options and, in April 1997, received commitments for a
$30 million revolving line of credit, a $25 million accounts receivable line and
a $5 million equipment lease line from three financial institutions.
The precise amount and timing of the Company's funding needs beyond these
amounts cannot be determined at this time and will depend upon a number of
factors, including the market demand for its products, the progress of the
Company's product development efforts and the Company's inventory and accounts
receivable management. The Company currently expects that it would seek to
obtain such funds from additional borrowing arrangements and/or public offering
of debt and equity securities. There can be no assurance that funds required by
the Company in the future will be available on terms satisfactory to the Company
or at all.
As of February 2, 1997, the Company had Federal net operating losses
("NOLs") and tax credit carryforwards in the amount of approximately $245
million and $2 million, respectively. Under the Internal Revenue Code of 1986,
as amended (the "Code"), certain changes in the ownership or business of a
corporation that has NOLs or tax credit carryforwards will result in the
inability to use or the imposition of significant restrictions on the use of
such NOLs or tax credit carryforwards to offset future income and tax
liabilities of the Company. The merger between Atari and JTS constituted a
change in ownership with respect to JTS and, accordingly, restricts the use of
JTS' pre-merger NOLs against post-merger income of the Company to the maximum of
$12.5 million per year, unless previously expired. In addition, subsequent
events may result in the imposition of restrictions on the ability of the
Company to utilize its NOLs and tax credit carryforwards. There can be no
assurance that the Company will be able to utilize all or any of its NOLs or tax
credit carryforwards.
27
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Independent Auditors' Reports....................................................... 29, 30
Consolidated Balance Sheets
February 2, 1997; January 28, 1996 and December 31, 1995.......................... 31
Consolidated Statements of Operations for the year ended February 2, 1997; the
one-month period ended January 28, 1996; and the years ended December 31, 1995 and
1994.............................................................................. 32
Consolidated Statements of Shareholders' Equity for the year ended February 2, 1997;
the one-month period ended January 28, 1996; and the years ended December 31, 1995
and 1994.......................................................................... 33
Consolidated Statements of Cash Flows for the year ended February 2, 1997; the
one-month period ended January 28, 1996; and the years ended December 31, 1995 and
1994.............................................................................. 34
Notes to Consolidated Financial Statements.......................................... 35
II Valuations and Qualifying Accounts.............................................. 50
28
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors
of JTS Corporation:
We have audited the accompanying consolidated balance sheets of JTS
Corporation (formerly Atari Corporation) and subsidiaries as of February 2, 1997
and January 28, 1996, and the related consolidated statements of operations,
shareholders' equity, and cash flows for the year ended February 2, 1997 and the
one month ended January 28, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. These standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of JTS Corporation and
subsidiaries as of February 2, 1997 and January 28, 1996 and the results of
their operations and their cash flows for the year ended February 2, 1997 and
the one month period ended January 28, 1996 in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
San Jose, California
April 21, 1997
29
REPORT OF DELOITTE & TOUCHE LLP
To the Shareholders and Board of Directors
of Atari Corporation:
We have audited the accompanying consolidated balance sheet of Atari
Corporation and subsidiaries as of December 31, 1995, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
the two years in the period ended December 31, 1995. Our audits also included
the financial statement schedule for the two years in the period ended December
31, 1995 listed in the Index at Item 14. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Atari Corporation and
subsidiaries at December 31, 1995 and the results of their operations and their
cash flows for each of the two years in the period ended December 31, 1995 in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California
March 1, 1996
30
JTS CORPORATION (FORMERLY ATARI CORPORATION)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
FEBRUARY 2, JANUARY 28, DECEMBER 31,
1997 1996 1995
----------- ----------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (including $1,800, $700 and $700
held as restricted balances in 1997, 1996, and 1995,
respectively)............................. |
