On July 30, 1996, Atari Corporation ("Atari") was merged
with and into JTS Corporation ("JTS") 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 owns approximately 62% of the equity of the merged
company. Therefore, for accounting
purposes, the merger was accounted for as a purchase
of JTS by Atari. See Note 2.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. Accordingly, the Company's current fiscal
year commenced on January 29, 1996
and the current quarter ended on October 27, 1996.
The unaudited condensed consolidated statement of
operations for the nine months ended
October 27, 1996 reflects the results of Atari's
operations from January 29, 1996 through October 27, 1996
and of JTS' operations from July 30,
1996 (the merger date) through October 27, 1996. The
financial statements for the transition periods from
January 1, 1996 to January 28, 1996 and
July 1, 1996 to July 28, 1996 are included also.Due to this fiscal year change, the end of the
quarter does not coincide with the end of the quarter of
the previous year. The Company did not recast
the financial information for the prior fiscal year
as management believes that financial statements for the
quarters of the preceding year are nearly
comparable to the quarters in the newly adopted
fiscal year and that there are no seasonal factors and
other factors that could affect the comparability
of the information or trends reflected.Note 2. Merger With JTS Corporation ("JTS")
The following unaudited proforma financial
information shows the results of operations for the three
and nine months ended October 27, 1996 and for
the three and nine months ended October 30, 1995 as
if the JTS acquisition had occurred at the beginning of
each period presented and at the
purchase price established on July 30, 1996. The
results are not necessarily indicative of what would have
occurred had the acquisition actually been
made at the beginning of each of the respective
periods presented or of future operations of the combined
companies. The proforma results for 1996
combine Atari's and JTS' results for the three and
nine months ended October 27, 1996. The proforma results
for 1995 combine Atari's results for the
three and nine months ended September 30, 1995 with
JTS' three and nine months ended October 30, 1995. The
following unaudited proforma results
include the straight-line amortization of
intangibles over periods ranging from three years to
seven years.The purchase price was allocated as follows:
(in thousands)
Inventory, trade accounts receivables and other current assets
$ 24,697Equipment and tooling
$20,600In-process research and development
$110,012Existing technology
$23,542Goodwill
$17,956Liabilities assumed
(84,308)Net assets acquired
$112,499Prior to the merger with JTS discussed above, Atari
had made a $30 million loan to JTS and upon consummation
of the merger the loan was cancelled.
The merger was accounted for as a purchase of JTS by
Atari and accordingly, the operating results of JTS from
July 30, 1996, the date of the merger
forward was combined with Atari's operating results
and reported as JTS. The aggregate purchase price of
$112.5 million has been allocated to the
acquired assets and liabilities of JTS. The
allocation resulted in $133.5 million allocated to
purchased technology, $110 million of which represented
in-process research and development. The $110
million was expensed in the accompanying statements of
operations for the three and nine months
ended October 27, 1996, as the technology had not
yet reached technological feasibility and does not have
alternative future uses.
(in the thousands)
Quarter Ended Revenue
1996 $33,265
1995 $6,187
1996 $68,821
1995 $17,826
MANAGEMENT
DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION
AND RESULTS OF OPERATIONSOn July 30, 1996, Atari Corporation ("Atari") was
merged into JTS Corporation ("JTS" or the "Company") and
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 nine months in the prior year and
for the periods in the current year prior to the three
months ended October 27, 1996, include Atari
only. In addition, due to the change in year end
Atari's balance sheets for the end of each transition
period, January 28, 1996 and July 28, 1996, are
included herein, as are Atari's operating results
for the one month periods ended on each of these dates.The unaudited pro forma condensed combined
statements of operations included in footnote two to the
financial statements give effect to the merger as
if the acquisition were completed at the beginning
of the periods presented. The following discussion and
analysis is based on these pro forma
condensed combined statements for the prior year
which combine the historical results of operations of
Atari for the three month and nine month
periods ended September 30, 1995 with the JTS
unaudited pro forma combined results of operations for
the three month and nine month periods
ended October 28, 1995 and for the current year
which reflects the actual results of the merged company
for the three month period ended October
28, 1996 and unaudited pro forma financials that
combine the historical results of operation of Atari and
JTS for the nine month period ended October
27, 1996. The liquidity and capital resources
discussion and analysis is based on the unaudited balance
sheet of the merged company as of October 27,
1996. Throughout this discussion, "fiscal 1997"
refers to the fiscal year ending February 2, 1997.
JTS and Atari Background
The most significant portion of the Company's
business today is its disk drive division which designs,
manufactures and markets hard disk drives for use
in notebook computers and desktop personal
computers. The Company currently has two disk drive
product families in production, the 3-inch form
factor "Nordic" family for notebook computers and
the 3.5-inch form factor "Palladium" family for desktop
personal computers. Total disk drives
shipped to date have primarily consisted of 3.5-inch
Palladium drives. While shipment of Nordic disk drives to
Compaq began in the second quarter of
fiscal 1997, volume shipments to Compaq have not yet
commenced. The Company markets its disk drives to
original equipment manufacturers
("OEMs"), computer companies and second-tier systems
integrators for incorporation into their computer systems
and subsystems. 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.JTS was incorporated in February 1994 and remained
in the development stage until October 1995, when it
began shipping its Palladium disk drives to
customers in the United States and Europe. All of
JTS' products are manufactured in Madras, India by its
subsidiary, JTS Technology Ltd. (formerly
Modular Electronics (India) Pvt. Ltd.), which was
acquired in April 1996 and employs over 5,000
individuals. Since its inception, JTS has incurred
significant losses which have resulted from the
substantial costs associated with the design, development
and marketing of new products, the
establishment of manufacturing operations and the
development of a supplier base. JTS has yet to generate
significant revenue from its disk drive
business and cannot assure that any level of future
revenues will be attained or that JTS will achieve or
maintain successful operations in the future. Such
factors have raised substantial doubt about the
ability of JTS to continue its operations without
achieving successful future operations or obtaining
financing to meet its working capital needs, neither
of which can be assured. The fiscal year 1996 report of
independent public accountants of JTS'
financial statements includes an explanatory
paragraph describing uncertainties concerning the ability
of JTS to continue as a going concern.Due primarily to lack of market acceptance of its
video game console, Jaguar, Atari, prior to acquiring
JTS, decided to significantly downsize its video
game operations. 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 have remained
disappointing due to uncertainty about Atari's commitment
to the Jaguar platform, increased price
competition and competitive product introductions.
As a result of continued disappointing sales, management
revised estimates and wrote- down
inventory by $5.0 million in the first quarter of
1996. During July the company wrote-down an additional
$3.3 million in inventory. 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.Results of Operations For the Three Months
ended October 27, 1996 Compared to the JTS and Atari Pro
Forma Combined
Results of Operations for the Three Months
ended October 30, 1995.For the three months ended October 27, 1996, results
of operations on a proforma basis reflect a net loss of
$125.2 million compared to a net loss of
$27.7 million on a pro forma basis for the same
period in the prior year. This loss includes a $110.0
million expense for in-process research and
development. This $110 million expense represents
the one time charge for in process research and
development which had not yet reached
technological feasibility and had no alternative
future use. The net loss incurred by the disk drive
division's operations to $11.0 million for the third
quarter ended October 27, 1996 compared to a net
loss of $11.3 million incurred by the disk drive division
during the same quarter in the previous
year. The Atari division's portion of the net loss
for the three month period ended October 27 1996 amounted
to $4.1 million and compares to a net
loss of $13.5 million incurred during the three
month period ended September 30, 1995. The $4.1 million
loss for the current quarter included
approximately $3 million of amortization expense
resulting from the merger.Revenues for the three months ended October 27, 1996
were $33.3 million. Revenues from the disk drive division
increased from $1.0 million for the
same quarter in the prior year to $32.1 million for
the current quarter. Such revenues increase reflects
progress achieved since the Company initiated
shipment of disk drives in October 1995. During the
quarter ended October 27, 1996 the Company shipped
230,000 disk drives, which primarily
consisting of the 3.5-inch Palladium drives, in
capacities ranging from 1 gigabyte to 1.6 gigabytes.
Sales to the top five customers for the three months
ended October 27, 1996 were 63% of net sales and one
customer had sales greater than 10% of total net sales
for the three month period. The Atari
division revenues for the current quarter amounted
to $1.2 million. Pro forma combined revenues for the
third quarter in the previous year totaled $6.1
million and included approximately $6.0 million of
Atari revenues recorded for the three month period ended
September 30, 1995.The gross margin for the three month period ended
October 27, 1996 was a deficit of $1.6 million compared
to a $11.9 million deficit on a pro forma
basis for the third quarter in the prior year. The
portion of the current quarter's deficit attributable to
the disk drive division was $1.7 million compared
to a deficit of $3.9 million incurred by the disk
drive division in the three month period ended October
28, 1995. The decline in the gross margin deficit
percent results principally from the greater
absorption of fixed costs due to increased production
volumes. The gross margin for the Atari division for
the current quarter ended October 27, 1996 was $.1
million compared to a deficit of $8.0 million for the
three month period ended September 30,
1995. The decline in the deficit results from the
decrease in sales of the Jaguar product to approximately
$.8 million during the current quarter.Research and development expense for the three
months ended October 27, 1996 were 5.7 million compared
to research and development expenses
on a pro forma basis of $6.5 million for the third
quarter in the prior year. The quarter over quarter
increase for the disk drive division was 900,000,
due to the increase in salaries and benefits
resulting from the significant increase in staffing
required for product design and the development of
manufacturing processes. The Atari division
experienced a quarter over quarter decline in research
and development expenses of $1.6 million due to
the elimination of the game development team as well
as other development staff reductions which took place in
the fourth quarter of 1995. The
Company expects that research and development
expenses will continue to increase throughout fiscal 1997
in absolute dollars but that such expenses
will decline as a percent of revenues.Selling, general and administrative expenses for the
third quarter in the current year were $3.9 million,
including $2.7 million from the disk drive division,
compared to $6.1 million pro forma selling, general
administrative expenses incurred during the third quarter
of the previous year which included $2.1
million from the disk drive division. The $600,000
increase incurred by the disk drive division resulted
primarily from increases in salaries and benefits
of administrative and marketing and sales employees
and professional fees required to support the expansion
of JTS' operations and the
commencement of marketing and sales efforts.
Selling, general and administrative expenses for the
Atari division declined $2.8 million as a result of staff
reductions, reduced rent and other reductions in
operating costs for the division. JTS expects that
selling, general and administrative expenses will
increase throughout fiscal 1997 in absolute dollars
but that such expenses will decline as a percentage of
revenues.JTS and Atari Pro Forma Combined Results of
Operations for the Nine Months ended October 27, 1996 and
the Nine Months
ended October 28, 1995.For the nine months ended October 27, 1996 pro forma
combined results of operations reflect a net loss of
$167.3 million compared to a net loss of
$47.0 for the nine months ended October 28, 1995.
Such loss includes the write of in-prcess research and
developemnt discussed above.Total pro forma revenues for the nine month period
ended October 27, 1996 amounted to $68.8 million compared
to pro forma revenues of $17.8
million for the same nine month period in the
previous year. For the nine month period ended October
27, 1996, the disk drive division shipped
approximately 462,000 drives and recognized revenues
of $65.8 million compared to revenues for the same period
in the prior year of $5.9 million.
Revenues for the Atari division amounted to $2.9
million for the nine-month period ended October 27, 1996
compared to the $11.8 million recognized
by the division for the nine month period ended
September 30, 1995.The pro forma gross margin deficit for the nine
months ended October 27, 1996 was $15.0 million compared
to a pro forma deficit of $10.2 million for
the nine months ended October 28, 1995. The gross
margin deficit incurred by the disk drive division for
the nine months ended October 27, 1996 was
$12.7 million compared to a $3.5 million deficit
incurred by the division for the same period in the
previous year. The Company first shipped disk
drives in October 1995 and has not yet reached
production volumes which fully absorb all fixed
production costs. The gross margin deficit for the Atari
division was $2.3 million for the nine months ended
October 27, 1996 compared to a deficit of $6.7 million
for the nine months ended September 30,
1995. Such reduction in the amount of the deficit
reflects lower sales volumes and includes inventory
write-downs of $5.4 million and $8.0 million.In order for JTS to realize positive gross margins
in the future, the Company will, among other things, have
to control manufacturing costs, further
improve manufacturing yields and successfully
introduce new products on a timely basis, none of which
can be assured.Research and development expenses for the nine
months ended October 27, 1996 were $20.7 million compared
to research and development
expenses of $13.2 million for the third quarter in
the prior year, on a pro forma basis. Research and
development expenses for the disk drive division
increased from $8.5 for the nine months in the prior
year to $20.1 for the nine month period in the current
year and the $11.6 million increase is
principally due a significant increase in the number
of employees in research and development required to meet
demand for timely product design.
Research and development expenses for the Atari
division declined from $4.6 million for the nine months
in 1995 to $700,000 for the nine month
period in the current years as a result of staff
reductions in development which took place in the fourth
quarter of 1995.On a pro forma basis selling, general and
administrative expenses for the nine months ended October
27, 1996 totaled $15.4 million, a $3.7 million
decline from the nine month period in the prior
year. A decline of $9.6 million was attributed to the
Atari division and was due to reductions in staff and
other operating costs for the division. Selling,
general and administrative expenses for the disk drive
division increased $5.9 million to $9.5 million for
the nine month period ending October 27, 1996 as a
result of the expansion of JTS operations and the
commencement of marketing and sales efforts.
JTS expects that selling, general and administrative
expenses will increase throughout fiscal 1997 in absolute
dollars but that such expenses will decline
as a percentage of revenues.
Liquidity and Capital Resources
At October 27, 1996, JTS had cash and cash
equivalents of $10.6 million, a working capital deficit
of $11.8 million and a net worth of $300,000.At October 27, 1996, total debt, including bank
credit lines and notes payable was $64.0 million. JTS has
a $5.0 million revolving Line of Credit with
Silicon Valley Bank which bears interest at the
bank's prime rate plus .75% and became due and payable on
November 30, 1996. JTS is presently in
negotiations with Silicon Valley Bank to extend the
term of the line of credit. As of October 27, 1996, all
amounts available under this line were drawn.
JTS also had equipment lease financing of $4.2
million at October 27, 1996. There were $5.5 million of
working capital loans outstanding between JTS
Technology and three Indian banks at interest rates
ranging from 13% to 15% as of October 27, 1996 as well as
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 $12.5 million at interest rates of LIBOR plus
2.75% and LIBOR plus 4%, respectively. At October 27,
1996, JTS Technology's borrowings under
these term loan facilities were $_______ million,
which is 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 are contingent on the
Company's ability to comply with stringent financial
covenants. In this regard, certain debt and/or
equity capital was not obtained as required under
one loan agreement. JTS has informed the lender that it
intends to provide such capital during the
fourth quarter of fiscal 1997. In addition, certain
agreements require the lender's consent to a merger and
similar transactions, which could be
interpreted to require the consent of the lending
institution to the acquisition of 90% of the capital
stock of JTS' Indian subsidiary by JTS on April 4,
1996. Such consents were not obtained, but the
lending institution has continued to transact business
with the Company. JTS believes that such matters
regarding the agreements will not have a material
adverse effect on JTS' business, operating results or
financial condition. However, there can be no
assurance that JTS will be able to renew or maintain
its current financing facilities which would have a
material adverse effect on JTS' business.At October 27, 1996, the Company had $42.3 million
of 5 1/4% convertible subordinated debentures due April
29, 2002, which had been issued in
1987.JTS has yet to generate significant revenues and
cannot assure that any level of future revenues 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.The Company will need significant additional
financing resources over the next several years for
facilities expansion, capital expenditures, working
capital, research and development and vendor
tooling. For example, the Company expects to spend
approximately $7 million for vendor tooling and
equipment to expand manufacturing capacity for the
remainder of fiscal 1997. In fiscal year 1998, the
Company plans approximately $45 million in
capital expenditures related primarily to equipment
and facilities required to increase drive production
volumes. In addition, significant cash resources
will be required to fund purchases of inventory
needed to achieve anticipated sales levels. Failure to
receive such cash resources will negatively impact
the Company's ability to manufacture its products at
required levels.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