<PAGE>
As filed with the Securities and Exchange Commission on October 8, 1999
Registration No. 333-86421
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
AMENDMENT NO. 1
To
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
HEADWAY TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
----------------
<TABLE>
<S> <C> <C>
Delaware 3572 94-3259145
(State or other jurisdiction
of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
678 South Hillview Drive
Milpitas, California 95035
(408) 934-5300
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
----------------
Thomas A. Surran
Chief Financial Officer
Headway Technologies, Inc.
678 South Hillview Drive
Milpitas, California 95035
(408) 934-5300
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
----------------
Copies to:
<TABLE>
<S> <C>
Jeffrey D. Saper, Esq. Gavin B. Grover, Esq.
Kurt J. Berney, Esq. Susan Hamilton MacCormac, Esq.
H. Jack Helfand, Esq. Matthew Burns, Esq.
Ava M. Hahn, Esq. Charles C. Kim, Esq.
Wilson Sonsini Goodrich & Rosati Morrison & Foerster llp
Professional Corporation 425 Market Street
650 Page Mill Road San Francisco, CA 94105
Palo Alto, CA 94304 (415) 268-7000
(650) 493-9300
</TABLE>
----------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration Statement.
----------------
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 145 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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<TABLE>
<CAPTION>
Title of Each Class of Proposed Maximum
Securities to be Amount to be Aggregate Offering Amount of
Registered Registered(1) Price(1) Registration Fee(2)
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Common Stock, $.001 par
value................. 4,830,000 33,810,000 $9,591
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</TABLE>
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(1) Includes up to 630,000 shares of common stock which may be purchased by the
Underwriters to cover over-allotments, if any.
(2) Initially estimated and paid pursuant to Rule 457(o) solely for the purpose
of calculating the registration fee.
----------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
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<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. We may not sell these securities until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+prospectus is not an offer to sell these securities and we are not soliciting +
+an offer to buy these securities in any state where the offer or sale is not +
+permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED OCTOBER 8, 1999
PROSPECTUS
4,200,000 Shares
Headway Technologies, Inc.
Common Stock
This is an initial public offering of common stock by Headway Technologies,
Inc. We are selling shares of common stock. The estimated initial public
offering price is between $5 and $7 per share.
------------
We intend to list our shares of common stock on the Nasdaq National Market
under the symbol "HWTI."
------------
<TABLE>
<CAPTION>
Per
Share Total
------ ------
<S> <C> <C>
Initial public offering price.................................... $ $
Underwriting discounts and commissions........................... $ $
Proceeds to Headway Technologies, Inc., before expenses.......... $ $
</TABLE>
We have granted the underwriters an option for a period of 30 days to
purchase up to 630,000 shares of common stock.
------------
Investing in the common stock involves a high degree of risk.
See "Risk Factors" beginning on page 7.
------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is
a criminal offense.
Hambrecht & Quist
Banc of America Securities LLC
, 1999
<PAGE>
[PLACE HOLDER FOR ARTWORK]
Headway Technologies Photograph Photograph
provides recording of of
head products Operator Wafer
designed for use in
server, desktop and
mobile disk drives.
Our products have
been incorporated
into industry-
leading drives by
Seagate, Maxtor and
Toshiba. With our
highly efficient
outsourcing business
model and a research
and development team
which boasts more
than 50 Ph.D.s,
Headway Technologies
is strategically
positioned to play a
key role in the
storage industry of
the future.
Photograph
Photograph of
of Disk Drive
Recording Head
Photograph
Photograph of
of Head Gimbal
Server Disk Drive Assembly
Photograph Photograph
of of
a Slider Final
Inspection
[Swirl logo] Headway Technologies
2
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................................................... 4
Risk Factors.......................................................... 7
Forward-Looking Statements............................................ 18
How We Intend to Use the Proceeds from this Offering.................. 19
Dividend Policy....................................................... 19
Capitalization........................................................ 20
Dilution.............................................................. 21
Selected Consolidated Financial Data.................................. 22
Management's Discussion and Analysis of Financial Condition and
Results of Operations ............................................... 24
Business.............................................................. 35
Management............................................................ 45
Related Party Transactions............................................ 53
Principal Stockholders................................................ 56
Description of Capital Stock.......................................... 58
Shares Eligible for Future Sale....................................... 60
Underwriting.......................................................... 62
Legal Matters......................................................... 64
Experts............................................................... 64
Where You Can Find Additional Information............................. 64
Index to Consolidated Financial Statements............................ F-1
</TABLE>
----------------
All brand names and trademarks appearing in this prospectus are the property
of their respective holders.
This prospectus contains projections of third parties including International
Data Corporation and Trend Focus. These projections incorporate a number of
assumptions concerning the computer industry, the data storage industry and
sales prices and sales volumes in the various segments of the computer hard
disk drive industry. There can be no assurance that any of these projections
will be achieved or that the underlying assumptions are correct.
3
<PAGE>
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this
prospectus. This summary does not contain all of the information that you
should consider before investing in our common stock. You should read the
entire prospectus carefully, including "Risk Factors" and our consolidated
financial statements and related notes before making an investment decision.
Headway Technologies, Inc.
We provide recording head products to the computer hard disk drive industry.
Our volume sales have included recording head sales to Seagate Technologies,
Inc. for use in its industry leading server disk drives, Toshiba Corporation
for use in its mobile disk drives and SAE Magnetics, Ltd. for incorporation
into Maxtor Corporation's desktop disk drives.
Our Opportunity
The demand for data storage is rapidly increasing and hard disk drives are
the primary means of data storage for most computer systems. To meet the
growing demand for data storage and retrieval, disk drive manufacturers must
continue to offer hard disk drives with greater capacity at lower prices.
Recording heads are a key component of hard disk drives and a primary
determinant of hard disk drive performance and storage capacity. To date, the
rate of technology advancement in recording heads has provided the ability to
annually double storage capacity at a constant cost. To effectively compete in
this environment, a recording head manufacturer must have an in-depth
understanding of the fundamental physics and magnetic properties of data
storage and have the ability to develop manufacturing processes capable of
producing state of the art recording heads.
Our Approach and Strategy
We develop products designed to provide our customers with significant
performance advantages and faster time-to-volume production. Our team includes
a number of storage industry pioneers who are expert in the underlying
sciences, technologies and manufacturing processes required for the design and
production of increasingly advanced recording heads. Our team's depth and
expertise recently enabled us to transition to the latest recording head
technology in approximately nine months. Key components of our strategy
include:
. providing targeted solutions to the server, mobile and desktop segments
of the hard disk drive industry;
. leveraging our extensive experience in the server and mobile segments to
address the largest segment of the disk drive market--the desktop
segment;
. outsourcing the lower margin, labor and equipment intensive back-end
manufacturing processes and focusing our research and development efforts
on the higher value-added wafer design and production processes; and
. forging strong collaborative relationships with leading disk drive
manufacturers and other disk drive component manufacturers to develop
compatible products which can be effectively incorporated into leading-
edge disk drives.
We were incorporated in Delaware in December 1996. Our consolidated
subsidiary, Headway Technologies, Inc. (California), was incorporated in
California in April 1994. Our principal executive offices are located at 678
South Hillview Drive, Milpitas, California 95035, and our telephone number at
that address is (408) 934-5300.
4
<PAGE>
THE OFFERING
<TABLE>
<C> <S>
Common stock offered by us........................ 4,200,000 shares
Common stock to be outstanding after this
offering......................................... shares
Use of proceeds................................... . repayment of
approximately $12.4
million in notes
payable;
. capital expenditures;
and
. general corporate
purposes, including
working capital.
Nasdaq National Market Symbol..................... HWTI
</TABLE>
----------------
The number of outstanding shares after this offering is based on the number
of shares outstanding at July 3, 1999. The number of outstanding shares
excludes:
. 5,304,953 shares of common stock issuable upon the exercise of
outstanding options as of July 3, 1999 at an average exercise price of
$1.15 per share;
. 56,161 shares of common stock issuable upon the exercise of options
granted, net of cancellations, between July 3, 1999 and August 19, 1999
at an average exercise price of $4.50 per share; and
. 1,029,946 shares of common stock issuable upon the exercise of options
granted on August 19, 1999 at an exercise price of $5.00 per share.
As of August 19, 1999, we reserved 3,456,903 shares of common stock for
future issuance under our stock option plan, director option plan and employee
stock purchase plan.
----------------
Unless otherwise noted, all information in this prospectus assumes:
. the public offering price is $6.00 per share;
. the underwriters will not exercise their option to purchase additional
shares of our common stock to cover over-allotments;
. the conversion of all outstanding shares of preferred stock into common
stock upon the closing of this offering; and
. the amendment of our Amended and Restated Certificate of Incorporation to
increase our authorized common stock from 25,000,000 to 75,000,000 and to
authorize 5,000,000 shares of undesignated preferred stock.
5
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL DATA
The following summary consolidated financial data should be read in
conjunction with our consolidated financial statements and their related notes
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this prospectus. We have prepared this information
using our consolidated financial statements. For a discussion of the
computation of pro forma diluted net income per share, you should review Note 1
to our consolidated financial statements. The unaudited consolidated financial
statements include all adjustments, consisting of normal recurring accruals,
which we consider necessary for a fair presentation of the financial position
and the results of operations for these periods. The adjusted consolidated
balance sheet data summarized below reflects the sale of 4,200,000 shares of
common stock offered by us in this offering, at an assumed initial public
offering price of $6.00 per share, after deducting the estimated underwriting
discount and estimated offering expenses, and the application of the net
proceeds therefrom, including the repayment of $12.4 million of notes payable.
<TABLE>
<CAPTION>
Period from
April 4, 1994 Years Ended Six Months Ended
(inception) ----------------------------------------------- ----------------
to January 1, Dec. 28, Jan. 2, June 27, July 3,
1995 Dec. 31, 1995 Dec. 29, 1996 1997 1999 1998 1999
------------- ------------- ------------- --------- -------- -------- -------
(predecessor) (predecessor) (predecessor) (unaudited)
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Total revenue......... $ 556 $19,801 $26,792 $ 54,369 $179,419 $92,600 $72,786
Gross (loss) profit... (608) 1,957 4,176 13,147 42,418 23,543 21,858
Operating (loss)
income............... (5,876) (7,118) (4,308) (18,338) 10,342 8,429 2,398
Net (loss) income..... (5,838) (7,018) (4,967) (19,404) 6,735 6,123 620
Historical basic net
income (loss) per
share................ $(4.50) $(1.92) $(1.38) $(441.00) $ 12.36 $ 14.31 $ 0.68
======= ======= ======= ========= ======== ======= =======
Historical diluted net
income (loss) per
share................ $(4.50) $(1.92) $(1.38) $(441.00) $ 0.33 $ 0.30 $ 0.03
======= ======= ======= ========= ======== ======= =======
Pro forma diluted net
income per share..... $ 0.33 $ 0.30 $ 0.03
======== ======= =======
</TABLE>
<TABLE>
<CAPTION>
July 3, 1999
-----------------
Actual Adjusted
------- --------
(unaudited)
<S> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents................................... $22,083 $ 32,292
Working capital (deficit)................................... (4,697) 17,905
Total assets................................................ 90,328 100,537
Current portion of notes payable and capital leases......... 24,871 12,478
Notes payable and capital leases, less current portion...... 23,529 23,529
Stockholders' equity........................................ 25,990 48,592
</TABLE>
<TABLE>
<S> <C>
[E & Y Insert historical basic & diluted EPS]
</TABLE>
6
<PAGE>
RISK FACTORS
You should carefully consider the following risk factors and all other
information contained in this prospectus before purchasing our common stock.
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially harm our business, operating results and
financial condition and could result in a complete loss of your investment.
Our operating results are likely to fluctuate significantly which may cause the
market price of our stock to fall
Factors likely to cause quarterly fluctuations in our revenues and operating
results include:
. market acceptance of our new products, particularly products based on our
giant magneto-resistive technology;
. increased production and engineering costs associated with the
introduction of new products;
. delayed product introductions;
. order cancellations, modifications or quantity adjustments, or
rescheduling of orders by customers;
. manufacturing capacity constraints;
. changing product manufacturing yields;
. decreased demand for our products;
. changes in product pricing by us or our competitors;
. timing of product announcements and product transitions by us, our
customers or our competitors;
. increased operating costs or unit costs associated with an increase in
production capacity or under-utilization of capacity;
. our inability to qualify for customer programs;
. changes in product mix, especially because wafers containing thousands of
recording head candidates and the disk drive recording head gimbal
assemblies which involve significant further manufacturing, have
different revenue and gross margin contributions;
. disruptions in our operations or the operations of our subcontractors;
and
. increased material costs and material or equipment unavailability.
We generally sell our products pursuant to purchase orders. These purchase
orders are subject to cancellation, modification, quantity reduction or
rescheduling by our customers on short notice and without significant
penalties. Therefore, our backlog as of any particular date is not indicative
of sales for any future period. These changes made by our customers in the
past have caused, and in the future could cause, our total revenue to fall
below expected levels. Net income, if any, and gross profit may be
disproportionately affected by a reduction in total revenue as a substantial
portion of our costs are fixed and do not vary with revenues. Additionally,
changes to products or cancellations of orders could result in under-
utilization of production capacity.
Future revenue, expenses and operating results are likely to vary
significantly between quarters. As a result, quarter-to-quarter comparisons of
operating results are not necessarily meaningful or indicative of future
performance. It is likely that in some future quarters our operating results
will be below the expectations of public market analysts or investors, which
would cause the market price of our common stock to fall.
7
<PAGE>
If our giant magneto-resistive products do not receive widespread adoption, our
business will be harmed
Our long-term success depends on the broad market adoption of our products,
particularly our recently introduced giant magneto-resistive products. Prior
to 1999, almost all of our revenues have been generated through the sale of our
DSMR products. DSMR is our brand name for the specialized recording head
products that we developed and manufactured prior to development of our giant
magneto-resistive technology. We do not expect sales of our DSMR products to be
significant after the first half of 2000. Our giant magneto-resistive
recording heads may not meet the requirements of our customers and may not be
broadly adopted by the market. Broad market adoption depends on the
performance relative to price for our products. We recently began volume
shipments of our giant magneto-resistive recording heads to a single customer.
If our giant magneto-resistive product line is not broadly adopted by the hard
disk drive industry, our business would be materially harmed.
We must continue to introduce new products that satisfy customer demand because
substantially all of our revenue is derived from a limited number of products
At any one time, we typically supply products in volume to a limited number
of disk drive manufacturers to be included in a limited number of disk drive
products. These disk drive products have short life cycles. Due to the rapid
technological change and constant development of new disk drive products, it is
common for our relative mix of customers and products to change quickly from
one quarter to the next. We typically offer three or four products in any
given quarter. Therefore, it is essential we consistently introduce new
products in a timely manner that are designed into customers' disk drive
products.
Because we depend on a limited number of customers, the loss of any one
customer could harm our business
The loss of any customer, a significant decrease in orders from one or more
customers, the failure to qualify for a new program with an existing customer
or the failure of program volumes to achieve expectations could materially harm
our business. We sell our products to leading manufacturers in each of the
server, mobile and desktop segments of the disk drive market. During 1998 and
the first six months of 1999, 26.9% and 48.8%, respectively, of our total
revenues were to Seagate for the server market and 67.2% and 45.6%,
respectively, of our total revenues were to Toshiba for the mobile market. We
expect our dependence on a limited number of customers to continue given the
limited number of disk drive manufacturers who require an independent source of
recording heads.
In addition, the disk drive industry has recently experienced significant
consolidation. Any further consolidation could significantly reduce the number
of our actual or potential customers. If any of our customers experience a
change of ownership, particularly to a company with its own recording head
capabilities, that customer might stop purchasing our products.
We may incur significant inventory related charges that could reduce our net
income and harm our business
Our manufacturing processes are complex and involve a long cycle time. As a
result, our inventory is subject to a number of risks, some of which are beyond
our control, and we may incur inventory related charges due to, among other
factors:
. our inability to obtain necessary product qualifications;
. the cyclical nature of, and rapid technological change in, the hard disk
drive industry;
. changes to product specifications or manufacturing processes;
8
<PAGE>
. our dependence on a few customers and the limited number of product
programs for each customer;
. the magnitude of the inventory commitments we must make to qualify our
products with our customers and to support our customers' time to market
needs; and
. our limited remedies in the event of program cancellations, changes in
specifications or reductions in demand.
We may be unable to mitigate or avoid these risks in which case we could incur
significant losses from reduction in the value of inventory, missed customer
shipments and damage to customer relationships.
If we are unable to anticipate emerging recording head product technologies or
if our technology is made obsolete by the emergence of new storage technology
our business will be harmed
The recording head industry has been characterized by rapid technological
development and short product life cycles. Product life cycles typically range
from six to 12 months. As a result, we must continually anticipate product
transitions and develop new products to meet the demand for increased storage
capacity. We may be unable to anticipate technological advances in disk drives
and develop products incorporating these advances in a timely manner or compete
effectively against our competitors' new products.
We must also anticipate and address the obsolescence of existing technologies
and the emergence of new technologies. Some industry participants have
suggested that advances in recording and storage devices strictly reliant on
magnetic principles are subject to technological limitations. In addition,
other companies are developing alternative data storage technologies which may
reduce the demand for our products or make our products obsolete. These
alternative data storage technologies include solid-state flash memory, digital
versatile disks, or DVDs, holographic memory and optically-assisted magneto
disk drives.
Because we are directly impacted by the business cycles and trends of the hard
disk drive industry, adverse conditions affecting the industry will harm our
business
The hard disk drive industry is highly cyclical and historically has
experienced periods of increased demand and rapid growth followed by oversupply
and reduced production levels. This results in significantly reduced demand
and average selling prices for recording heads. The effect of these cycles on
component suppliers has been magnified by the practice of hard disk drive
manufacturers ordering components, including recording heads, in excess of
their needs during periods of rapid growth. This practice increases the
severity of the drop in the demand for components during periods of reduced
growth or contraction. In addition, the disk drive industry continues to
experience a significant and prolonged decline in average selling prices. As a
result, component suppliers are facing extreme pressure to lower their prices.
To lower their costs, disk drive manufacturers have taken advantage of
increasing areal densities to reduce the total number of recording heads in
their drives. This has reduced the demand for recording heads.
In recent years, the hard disk drive industry has experienced significant
unit growth and we have expanded our capacity. This growth in the hard disk
drive industry may not continue, the level of demand for our products may
decline and future demand for our products may not be sufficient to utilize our
capacity.
The market for recording heads is intensely competitive and we expect increased
competition which may result in lower revenues from the sale of our products or
may otherwise harm our business
The market for our products is highly competitive, and we expect to
experience increased competition in the future. Substantially all of our
principal competitors have significantly greater financial, marketing and
9
<PAGE>
other resources than we do. We compete with other independent recording head
suppliers, such as ALPS, Applied Magnetics, Read-Rite, TDK and its wholly-owned
subsidiary SAE, and Yamaha. In addition, we compete with the captive recording
head manufacturing operations of disk drive companies. Captive producers who
produce some or all of their recording heads for internal use include Fujitsu,
Hitachi, IBM and Seagate.
Other potential competitors or competitive threats which could harm our
business include:
. captive recording head manufacturers that, similar to IBM, may seek to
market their recording head products to other disk drive manufacturers;
. captive recording head manufacturers, such as Seagate, who to date have
elected to purchase a portion of their recording heads from third-party
suppliers, but may cease to do so in the future; and
. non-vertically integrated disk drive manufacturers who may seek to
acquire or develop their own recording head production capabilities.
In addition, the announcement or implementation of any of the following by
our competitors could materially harm our business:
. changes in pricing;
. product introductions;
. increases in production capacity; and
. changes in product mix and technological innovation.
We have experienced pricing pressures in the past and will likely experience
increased price competition in the future. Pricing pressures have included,
and may continue to include, demands for discounts, long-term supply
commitments and extended payment terms. In addition, other recording head
manufacturers, in light of their significant fixed costs, may be inclined to
sell products with little or no gross profit in order to cover a portion of
their fixed costs. Any increase in price competition could materially harm our
business.
If we are unable to manage the numerous complex operations associated with our
manufacturing processes, our net income could be reduced because of increased
costs and our business could otherwise be harmed
Minor deviations or disruptions in our manufacturing processes could cause
substantial manufacturing yield losses, increased cycle time, increased product
returns, loss of work-in-process inventory and, in some cases, suspension of
production. During our plant expansion in 1998, we experienced a significant
increase in cycle time, due, in part, to the relocation of equipment. The
complexity of the manufacturing processes is susceptible to manufacturing
defects, which may result in a loss of work-in-process, product returns or
missed customer shipment dates. A significant percentage of potential defects
can only be detected at the end of our four to eight week manufacturing
process. In addition, our complex manufacturing processes require continual
equipment maintenance. Should some portion of our production or testing
equipment become unavailable for a significant period of time, our business
could be materially harmed.
If we experience small variations in manufacturing yields and productivity, our
operating results and profitability could be harmed
Manufacturing yields tend to be lower in the early stages of product life
cycles and increase as the product matures and manufacturing volumes increase.
Our pricing reflects this assumption of improving manufacturing yields. As a
result, material variances between projected and actual manufacturing yields
have a direct effect on our profitability. Forecasting manufacturing yields
accurately becomes increasingly
10
<PAGE>
difficult as manufacturing processes increase in complexity. The compression of
product life cycles also requires us to bring new products on line faster and
for shorter periods, while maintaining acceptable manufacturing yields and
quality. These compressed product life cycles often eliminate the lengthy
periods of high volume manufacturing conducive to higher manufacturing yields
and declining unit costs.
Because our long sales cycle makes it difficult for us to predict if or when a
sale will occur, we may expend substantial financial and human resources
without generating related product sales
Qualifying recording head products for incorporation into a new disk drive
product requires us to work extensively with the customer and the customer's
other suppliers to meet product specifications. Customers often require a
significant number of product presentations and demonstrations, as well as
substantial interaction with our senior management, before making a purchasing
decision. Accordingly, our products typically have a lengthy sales cycle,
which can range from three to 18 months, during which we may expend substantial
financial resources and management, engineering and sales time and effort with
no assurance that future product sales will result.
If we do not maintain high utilization of our manufacturing capacity, we may
not achieve our profit targets
The term "capacity utilization" means the actual number of wafers we are
manufacturing in relation to the total number of wafers we have the capacity to
process. Because a significant portion of our operating costs, such as plant
and equipment related costs and expenses, cannot be reduced or eliminated
quickly in response to changing conditions, operating below capacity has a
significant negative effect on our profitability. Some of the factors
affecting our capacity utilization rates are overall industry conditions,
operating efficiencies, the level of customer orders, mechanical failures,
disruption of operations due to expansion of operations or relocation of
equipment, fire or natural disaster.
If hard disk drive manufacturers do not incorporate our products into new disk
drive products, our business will be harmed
Component suppliers must demonstrate to their customers an ability to deliver
the specified product significantly in advance of volume production. This
qualification process is lengthy and costly for the disk drive manufacturer.
Therefore, if a component supplier fails in the pre-production qualification
process, it will generally be unable to participate in the program, resulting
in lost revenue opportunities, creating the potential for under-utilization of
manufacturing capacity and making it more difficult for the supplier to
participate in subsequent customer programs. In some instances, a component
supplier may be allowed to qualify in a program after production volumes have
commenced. The revenues and margins associated with participation later in
programs, however, tend to be lower.
If our customers choose to incorporate recording heads products from other
providers, our business will be harmed
In 1996, Hewlett-Packard Co., or HP, at the time our largest shareholder and
primary customer, accounting for substantially all of our product sales, made a
strategic decision to exit the disk drive business. This departure had a
severe and adverse effect on our operating results. Some hard disk drive
manufacturers enter into arrangements with component suppliers to supply
technology and products for future disk drives. If these arrangements include
recording head technologies that compete with our products, they may make it
more difficult for us to maintain our relationships with existing customers or
to attract new customers. For example, in June 1998, Western Digital
Corporation and IBM established a strategic relationship whereby IBM agreed to
provide giant magneto-resistive disk drive technology and designs to Western
Digital for incorporation into desktop disk drive programs. In exchange,
Western Digital agreed to purchase a significant percentage of its material
requirements, including recording heads, from IBM.
11
<PAGE>
If parties who license our technology use the licensed technology to
manufacture recording heads for themselves or third parties, our business may
be harmed
We sell products to customers who also manufacture, directly or indirectly,
products for their own use. For example, Seagate, a significant customer, is
one of the world's largest manufacturers of recording heads. In addition, we
have in the past licensed, and in the future may license, our technology to
entities who use the licensed technology to satisfy their own or third-party
product demand. For example, we have licensed our DSMR wafer production
technology to Seagate. We expect that Seagate will continue to use the
licensed DSMR technology to manufacture a significant portion of its future
DSMR wafer demand.
In July 1999, we entered into a patent license agreement and a technology
transfer agreement with IBM under which, among other things, we licensed to IBM
all existing and future patents that are filed by us through December 31, 2002
for the life of the patents. These agreements may allow IBM to compete more
effectively against us. Increased production of recording heads by third
parties pursuant to a technology license from us could materially harm our
business.
To achieve significant revenue growth, we must become a significant supplier to
the desktop market
Our development efforts and volume sales have historically been focused on
the server and mobile markets. These markets tend to be less price competitive
than the desktop market, but they also typically have smaller program volumes.
The desktop market is characterized by large program volumes, rapid product
transitions, severe price competition and a lower emphasis on technological
differentiation. We have limited experience providing recording head products
to the desktop market and cannot be sure that we will be able to significantly
penetrate this market.
We may be unable to meet customer demand in a timely manner because we
currently rely on a single source for the production of our sliders and head
gimbal assemblies
We currently subcontract, and expect to continue to subcontract, all of our
slider and head gimbal assembly manufacturing to a limited number of offshore
manufacturers, except for limited volumes for prototype and research and
development. Currently, our only subcontractor is SAE, a wholly-owned
subsidiary of TDK who performs these services in China. Pursuant to an
agreement with us, SAE has agreed to manufacture sliders and head gimbal
assemblies through the year 2002. SAE also provides similar subcontract
services to some of our competition, including ALPS and IBM. If SAE ceases to
provide subcontracting services or elects not to dedicate available capacity to
us when faced with either increased demand or limited production capacity, we
would then be required to secure an alternative subcontract manufacturer.
Assuming additional capacity is available from other qualified subcontract
manufacturers on commercially acceptable terms, the process of qualifying these
subcontractors with our customers could be lengthy and could create delays in
product shipments. An inability to secure subcontract manufacturing on
acceptable terms on a timely basis, or at all, would adversely impact our
ability to sell products, which in turn could materially harm our business.
We may be unable to meet customer demand in a timely manner because we rely on
a limited number of component suppliers
Components necessary for the manufacture of our products are frequently
obtained from a single supplier or a limited group of preferred suppliers. We
currently have 12 single source materials suppliers, however, we do not
maintain any long-term agreements with any of our component suppliers. In the
future, these single or limited source suppliers may be unable to meet our
requirements on a timely basis or on acceptable terms. A shortage of any key
component could materially harm our business. If a component supplier raises
its prices, we may be unable to obtain substitute components at acceptable
costs and we may not be able to pass these increased costs along to our
customers.
12
<PAGE>
In addition, our component suppliers must be qualified with our customers.
Depending on the supplier, this qualification process may be complex and time
consuming. Because the purchase of key components may involve long lead times,
if there is an unanticipated increase in demand for our products or a supplier
is unable to meet our orders, we could be unable to manufacture some of our
products in a quantity sufficient to meet demand. Several pieces of equipment
used in the manufacture of our products can only be obtained from sole or
limited source suppliers. Replacing this equipment or acquiring new equipment
in connection with any plant expansion would involve long lead times. This
equipment may not be delivered, installed and operational in a timely manner.
If we cannot attract and maintain key personnel in the future, our business
will be harmed
Our success depends to a significant extent upon a limited number of our
senior management and other key employees. The loss of one or more senior
managers or key employees could materially harm our business. We do not
maintain any key-man life insurance policies on any of our key personnel and do
not have employment agreements with any of our executive officers. In
addition, we believe our future success will depend, in part, on our ability to
attract and retain highly skilled technical and managerial personnel.
Competition for these personnel is intense in the technology industry,
particularly in Silicon Valley, where our facilities are located. Moreover,
there are a limited number of individuals with appropriate recording head
industry experience, making the competition for these individuals even more
intense. We may not be successful in attracting and retaining such personnel,
and the failure to do so could materially harm our business.
If we are unable to protect our proprietary technology, we may be unable to
successfully compete and our business could be harmed
Although we attempt to protect our intellectual property rights through
patents, copyrights, trade secrets and other measures, we may not be able to
protect our technology adequately and competitors may be able to develop
similar technology independently. We have 12 issued patents in the United
States and have 31 additional United States patent applications pending. We
may not be able to obtain patents on all aspects of our technology relating to
our recording head technology. Any patents issued to us may not be
sufficiently broad to protect our technology. The status of computer-related
patents involves complex legal and factual questions and the breadth of claims
allowed is uncertain. Accordingly, patent applications filed by us may not
result in patents being issued. Further, our existing patents, and any patents
which may be issued to us in the future, may not afford protection against
competitors with similar technology. Patents issued to us may be infringed
upon or designed around by others and others may possess or obtain patents that
we would need to license or design around. Further, we have only limited
patent rights outside the U.S. and the laws of certain foreign countries may
not protect our intellectual property rights to the same extent as do the laws
of the U.S.
In the past, we have been notified that we may be infringing patents owned by
others. We may receive additional infringement claims in the future. If it
appears necessary or desirable, we may seek licenses under patents which we are
allegedly infringing. If existing or future patents containing broad claims
are upheld by the courts, the holders of these patents might be in a position
to require companies, including us, to obtain licenses. Licenses which might
be required for us to avoid infringement of these patents may not be available
on reasonable terms, if at all, and we may not be able to avoid infringement of
these patents. The failure to obtain a key patent license from a third party
could cause us to incur substantial liabilities and to suspend the manufacture
of the products utilizing the patented invention.
Litigation may be necessary to enforce our patents, copyrights or other
intellectual property rights, to protect our trade secrets, to determine the
validity and scope of the proprietary rights of others or to defend against
claims of infringement or claims for indemnification resulting from
infringement claims by third parties. This litigation, regardless of the
outcome, could result in substantial costs and diversion of resources and could
materially harm our business.
13
<PAGE>
Because we rely on a single manufacturing facility, product production and
shipment interruptions could harm our business
Our Milpitas, California manufacturing facility, which currently accounts
for, and is expected to account for, all of our wafer fabrication capacity, is
located near major earthquake faults. Disruption of operations for any reason,
including power failures, work stoppages or natural disasters such as fires,
floods or earthquakes would cause delays in, or an interruption of, production
and shipment of products, which would materially harm our business.
If we underestimate or overestimate our manufacturing capacity requirements,
our business will be harmed because of an inability to meet customer demand or
to reduce costs
We must anticipate demand for our products and the path of new technologies
so that we will have sufficient production capacity to meet our customers'
requirements. Accurate capacity planning is complicated by the pace of
technological change, unpredictable demand variations, fluctuating
manufacturing yields and long lead times associated with the acquisition of
plant and equipment. These planning difficulties are exacerbated by the
lengthy sales cycle for our products. Our underestimation or overestimation of
our capacity requirements, or inability to successfully and timely develop and
implement the proper technologies, would materially harm our business.
If we cannot secure additional capital on commercially acceptable terms, we may
not be able to stay competitive in our industry
The manufacturing of recording heads is capital intensive. In 1998, we
deployed $66.0 million in equipment and facilities, including $31.4 million of
operating leases. We believe we will need significant additional financial
resources over the next several years for capital expenditures and working
capital in order to remain competitive. The advancement of recording head
technology is tightly coupled with the introduction of new manufacturing
processes. The capital equipment required to deploy these new processes is
expensive. In addition, our customers prefer suppliers which can provide a
substantial portion of their volume requirements. Therefore, in order to be
considered an acceptable supplier, we must be able to quickly purchase new
capital equipment required by new manufacturing processes and to expand our
manufacturing capacity in order to meet customers' requirements and remain
competitive.
To meet anticipated future capital requirements, including capital
expenditures, we may need additional sources of capital. Additional funds may
not be available to us or, if available, these funds may not be available to us
upon terms and conditions acceptable to us. If we are unable to obtain
sufficient capital, we would need to curtail our operating and capital
expenditures, which would harm our business. The failure of actual demand for
our products to meet anticipated demand could result in under-utilization of
our capacity which, in turn, could materially harm our business.
If we do not properly manage international operations, our business may be
harmed
Our product sales to foreign corporations and their U.S. subsidiaries
represented 73.0% and 51.0% of total revenue in 1998 and the six months ended
July 3, 1999, respectively. Our subcontract manufacturing occurs offshore.
International sales and manufacturing are subject to a number of risks,
including:
. changes in foreign government regulations and standards;
. export license requirements;
. tariffs, taxes and other trade barriers;
. fluctuations in currency exchange rates;
. difficulty in collecting accounts receivable;
14
<PAGE>
. loss in shipment; and
. difficulties of enforcing contracts and judgments against third parties.
Although international sales and cost commitments are typically denominated
in U.S. dollars, fluctuations in currency exchange rates could cause our
products to become relatively more expensive to customers in a particular
country, leading to a reduction in sales or profitability in that country. In
particular, several Asian countries have experienced significant economic
downturns and significant declines in the value of their currencies relative to
the U.S. dollar. Further, payment cycles for international customers may be
longer than those for our U.S. customers. We are also subject to geopolitical
risks, such as political, social and economic instability, potential
hostilities and changes in diplomatic and trade relationships, in connection
with international operations. We are unable to predict what effect, if any,
these factors will have on our ability to maintain or increase our product
sales or to manufacture products in these markets, or what economic effects
these factors will have upon general economic conditions, the disk drive
industry, our customers or our operations.
We must properly manage our growth or our business will be harmed
In the last 12 months, we have added significant manufacturing capacity.
This growth has resulted in new and increased responsibilities for management
personnel and continues to place a significant strain upon our management,
operating and financial resources. This offering and our status as a public
company are expected to place additional demands on our management team. Our
executive officers have limited or no experience in serving as executive
officers of a public company. Our ability to manage our expanded operations
effectively will require us to improve all aspects of our operations, including
our operational and financial systems, and to train, motivate and manage our
employees.
Subsequent to the offering, we may replace our current financial and
accounting software with an enterprise resource planning software system
system. This system is complex, time consuming to install and require
extensive training of personnel. Our inability to effectively implement this
system may materially harm our business.
To manage our operations, we must continuously evaluate the adequacy of our
management structure and our existing procedures, including our financial and
internal controls. Management may not adequately anticipate all of the
changing demands that growth may impose on our procedures and structure. Our
inability to adequately anticipate and respond to such changing demands could
materially harm our business.
Capital expenditures may increase and we may experience unexpected production
delays if we convert our manufacturing from square to round recording head
wafers
Currently, we manufacture square recording head wafers. We may change our
manufacturing methods to incorporate round wafers in the event that we
determine that round wafers allow us to better take advantage of advances in
complex technologies and processes developed for use in the semi-conductor
industry. A conversion to round wafers will likely require us to significantly
modify our existing capital equipment and/or to acquire additional capital
equipment. We can not currently estimate when or if a conversion to round
wafers will occur or the cost of any such conversion. In addition, a conversion
to round wafers will result in modified manufacturing processes and possibly
manufacturing delays and reduced product yields, particularly immediately after
the conversion. Any of these could materially harm our business.
Our manufacturing processes use hazardous chemicals which subject us to
government environmental regulations and potential fines
The operation of our Milpitas manufacturing facility requires that we comply
with a number of environmental regulations and that we have the necessary
environmental, fire, waste neutralization, air
15
<PAGE>
abatement, building and use permits. We must comply with a variety of
environmental regulations relating to the use, storage, discharge and disposal
of hazardous chemicals used during our wafer manufacturing processes. For the
past several months, we have been in negotiations with the San Francisco Bay
Area Air Quality Management District, or the BAAQMD, regarding certain alleged
permit limitations infractions resulting from the use of two volatile organic
compounds in our manufacturing processes. We have actively pursued a
settlement of this matter and have been working in a cooperative manner with
the BAAQMD. Counsel for us and the BAAQMD are currently negotiating a
Stipulated Settlement Agreement and Conditional Order for Abatement under the
terms of which, if approved, we would agree to pay a $12,500 fine to BAAQMD and
install approximately $1.0 million of air abatement devices over a pre-
determined time period. The terms of the agreement also are subject to the
approval of the BAAQMD Hearing Board and there can be no assurance that
approval will be granted or that the final settlement will be the same. Our
inability to reach an agreement with the BAAQMD, to obtain or comply with this
settlement agreement or our inability to materially comply with applicable
environmental regulations and to obtain required permits on a timely basis
could subject us to potential liabilities or result in the suspension of
production. Some of our permits require annual renewals, which we may not be
able to obtain. Environmental regulations could also restrict our ability to
expand our facilities or could require us to acquire costly equipment or incur
other significant expense to comply with these regulations. In addition,
certain of our permits require the purchase and installation of additional
capital equipment for waste neutralization and air abatement in the event our
production volumes substantially change. In connection with our plant
expansion completed in 1998, we were required to, among other things, replace
several pieces of manufacturing equipment and significantly upgrade our waste
water treatment system.
Our inability and the inability of our key suppliers and customers to be Year
2000 compliant could harm our business
The "Year 2000" issue causes many computer systems and software products to
incorrectly recognize date information starting on January 1, 2000. We rely on
systems and applications in operating and monitoring all major aspects of our
business, including financial systems, customer services, infrastructure,
embedded computer chips, networks and telecommunications equipment. We are in
the process of upgrading our software to address the "Year 2000" issue. We
currently estimate that the costs associated with making our internal systems
and business operations "Year 2000" compliant, and the consequences of
incomplete or untimely resolution of making our systems and operations
compliant, will not materially harm our business. We also directly and
indirectly exchange data with customers, suppliers, creditors, financial
organizations and governmental entities. Therefore, even if our internal
systems are not materially affected by the "Year 2000" issue, we could be
affected through disruptions in the operation of the enterprises with which we
interact. This impact may result in disruption of our business and may
materially harm our business.
Substantial sales of our common stock could significantly reduce our stock
price
Sales of a substantial number of shares of our common stock after this
offering could adversely affect the market price of our common stock. The
introduction of a large number of shares of our common stock into a market in
which our common stock price is already volatile, could drive down our common
stock price. In addition, the sale of these shares could impair our ability to
raise capital through the sale of additional equity securities. Based on
shares outstanding as of July 3, 1999, upon completion of this offering, we
will have 21,177,679 shares of common stock outstanding, or 21,807,679 shares
if the underwriters' over-allotment option is exercised in full. Our
directors, executive officers and current stockholders have executed lock-up
agreements that limit their ability to sell shares of our common stock. These
stockholders have agreed, subject to limited exceptions, not to sell or
otherwise dispose of any shares of our common stock for a period of at least
180 days after the date of this prospectus without the prior written approval
of Hambrecht & Quist LLC. When these lock-up agreements expire, these shares
and the shares of common stock underlying any options held by these individuals
will become eligible for sale, in some cases pursuant only to the volume,
manner of sale and notice requirements of Rule 144.
16
<PAGE>
Our stock price may be volatile
Prior to this offering, you could not buy or sell our common stock publicly.
An active public market for our common stock may not develop or be sustained
after this offering. The market for technology stocks has been extremely
volatile. The following factors could cause the market price of our common
stock to fluctuate significantly from the price paid by investors in this
offering:
. variations in our quarterly operating results;
. announcements by us or our competitors of significant contracts, new
products or purchase orders, or strategic arrangements;
. conditions and trends in the disk drive and recording head industries;
. adoption of new accounting standards affecting the disk drive component
industry;
. changes in financial estimates by securities analysts; and
. fluctuations in stock market prices and volumes.
Control by existing stockholders may limit your ability to influence the
outcome of director elections and certain transactions
Upon completion of this offering, our executive officers, directors and
principal stockholders and their affiliates will beneficially own approximately
81.8% of our outstanding common stock (79.5% if the underwriters' over-
allotment option is exercised in full). These stockholders, if acting
together, would be able to significantly influence all matters requiring
approval by our stockholders, including the election of directors and the
approval of mergers or other business combination transactions.
Anti-takeover provisions in our charter documents and Delaware law could
prevent or delay a change in control of our company
Provisions in our bylaws and in our certificate of incorporation, both as
amended and restated upon the closing of this offering, may have the effect of
delaying or preventing a change of control or changes in management of our
company. These provisions include the:
. establishment of a classified board of directors;
. stipulation that a special meeting of stockholders may only be called by
stockholders owning at least 50% in the aggregate of our outstanding
shares;
. ability of our board of directors to issue preferred stock without
stockholder approval; and
. right of our board of directors to elect a director to fill a vacancy
created by the expansion of the board of directors.
Furthermore, we are subject to the provisions of Section 203 of the Delaware
General Corporation Law. These provisions prohibit a stockholder who owns 15%
or more of our outstanding voting stock from consummating a merger or
combination with us unless this stockholder receives board approval for the
transaction or unless 66 2/3% of the outstanding shares of our voting stock not
owned by this stockholder approve the merger or combination.
Investors will experience immediate dilution
The initial public offering price of our common stock is expected to be
substantially higher than the book value per share of our outstanding common
stock immediately after this offering. Accordingly, if you purchase our common
stock in this offering, you will incur immediate dilution of approximately
$4.19 in the book value per share of our common stock from the price you pay
for our common stock. This calculation assumes that you purchased our common
stock for $6.00 per share.
17
<PAGE>
FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that involve risks and
uncertainties, which may include statements about our:
. business strategy;
. estimates for the growth of the disk drive market;
. plans for entering the desktop segment of the disk drive market;
. plans for the introduction of new products;
. anticipated sources of funds, including the net proceeds from this
offering, to fund our operations for the 12 months following the date of
this prospectus; and
. plans, objectives, expectations and intentions contained in this
prospectus that are not historical facts.
When used in this prospectus, the words "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions are generally
intended to identify forward-looking statements. Because these forward-looking
statements involve risks and uncertainties, actual results could differ
materially from those expressed or implied by these forward-looking statements
for a number of reasons, including those discussed under "Risk Factors" and
elsewhere in this prospectus.
18
<PAGE>
HOW WE INTEND TO USE THE PROCEEDS FROM THIS OFFERING
We estimate that we will receive net proceeds of $22,602,000 from the sale of
4,200,000 shares of common stock in this offering. This estimate of net
proceeds assumes an initial public offering price of $ per share, after
deducting the estimated underwriting discounts and commissions and offering
expenses.
While we cannot predict with certainty how the proceeds of this offering will
be used, we currently intend to use a portion of the net proceeds to repay the
following notes payable:
. $7.4 million note payable to Western Digital due June 30, 2000 which
bears interest at 8.50%;
. $3.6 million note payable to Maxtor due June 30, 2000 which bears
interest at 7.50%; and
. $1.4 million note payable to Komag due February 15, 2001 which bears
interest at 7.00%.
Except as set forth above, as of the date of this prospectus, we have not
allocated any remaining proceeds from the offering. We currently anticipate
that we will spend between $10 million to $15 million on infrastructure and
capacity expansion during the remainder of fiscal year 1999. We currently
expect that expenditures for infrastructure and capacity expansion will be
funded through a combination of debt financings and cash proceeds from the
offering. Any remaining proceeds from this offering will be used for general
corporate purposes, including working capital. Although we are not currently
engaged in any active negotiations and have no commitments or agreements with
respect to any acquisition, we might in the future use a portion of the
remaining proceeds to pay for acquisitions. Prior to using the net proceeds,
we will invest the net proceeds of this offering in short-term, investment
grade, interest-bearing investments or accounts.
The amounts we actually spend for these purposes may vary significantly and
will depend on a number of factors, including our future revenue and cash
generated by operations and the other factors described under "Risk Factors."
Therefore, we will have broad discretion in the way we use the net proceeds.
DIVIDEND POLICY
We have not declared or paid cash dividends on shares of our common stock or
other securities. We intend to retain any future earnings for future growth
and do not anticipate paying any cash dividends in the foreseeable future. Our
debt obligations currently limit the payment of dividends.
19
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of July 3, 1999.
The pro forma information reflects the filing of an amendment to our amended
and restated certificate of incorporation to provide for authorized capital
stock of 75,000,000 shares of common stock and 5,000,000 shares of undesignated
preferred stock, and the conversion of all outstanding shares of preferred
stock into 15,764,535 shares of common stock on the closing of this offering.
The pro forma as adjusted information reflects the sale of the shares of
common stock offered hereby and application of the net proceeds, including the
repayment of $12.4 million of notes payable, at an assumed initial public
offering price of $6.00 per share and after deducting estimated underwriting
discounts and commissions and our estimated offering expenses.
The outstanding share information excludes:
. 5,304,953 shares of common stock issuable upon the exercise of
outstanding options as of July 3, 1999 at an average exercise price of
$1.15 per share;
. 56,161 shares of common stock issuable, net of cancellations, upon the
exercise of options granted between July 3, 1999 and August 19, 1999 at
an average exercise price of $4.50 per share; and
. 1,029,946 shares of common stock issuable upon the exercise of options
granted on August 19, 1999 at an exercise price of $5 per share.
We reserved 3,456,903 shares of common stock for future issuance under our
stock option plan, director option plan and employee stock purchase plan as of
August 19, 1999.
The information below is qualified by, and should be read in conjunction
with, our consolidated financial statements and the notes to those consolidated
financial statements appearing at the end of this prospectus.
<TABLE>
<CAPTION>
As of July 3, 1999
--------------------------------
Pro forma
Actual Pro forma as adjusted
-------- --------- -----------
(in thousands, except share
data)
<S> <C> <C> <C>
Current portion of notes payable and capital
leases........................................ $ 24,871 $ 24,871 $ 12,478
======== ======== ========
Notes payable and capital leases, less current
portion....................................... $ 23,529 $ 23,529 $ 23,529
Stockholders' equity:
Series A convertible preferred stock, $.001
par value; 15,764,535 shares authorized,
issued and outstanding, actual; 5,000,000
shares authorized, pro forma and pro forma
as adjusted; no shares issued and
outstanding, pro forma and pro forma as
adjusted.................................... 37,122 -- --
Common Stock, $.001 par value; 75,000,000
authorized; 1,213,144 shares issued and
outstanding, actual; 75,000,000 authorized,
pro forma and pro forma as adjusted;
16,977,679 shares issued and outstanding,
pro forma; 21,177,679 shares issued and
outstanding, pro forma as adjusted.......... 589 37,711 60,313
Deferred compensation........................ (197) (197) (197)
Accumulated deficit.......................... (11,524) (11,524) (11,524)
-------- -------- --------
Total stockholders' equity................. 25,990 25,990 48,592
-------- -------- --------
Total capitalization..................... $ 49,519 $ 49,519 $ 72,121
======== ======== ========
</TABLE>
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<PAGE>
DILUTION
As of July 3, 1999, our pro forma net tangible book value, after giving
effect to the conversion of all shares of preferred stock outstanding as of
July 3, 1999 into common stock on the closing of this offering, was
$15,821,000, or approximately $0.93 per share. Pro forma net tangible book
value per share represents the amount of total actual tangible assets less
total actual liabilities, divided by the 16,977,679 shares of common stock
outstanding after giving effect to the conversion of the preferred stock
outstanding as of July 3, 1999 into common stock. After giving effect to the
sale of the 4,200,000 shares of common stock we are offering and deducting the
underwriting discount and commissions and estimated offering expenses, our
adjusted pro forma net tangible book value as of July 3, 1999 would have been
$38,423,000 , or $1.81 per share. This represents an immediate increase in pro
forma net tangible book value of $ per share to existing stockholders and
an immediate dilution of $4.19 per share to new investors. The following table
illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed public offering price per share........................ $ 6
Pro forma net tangible book value per share as of July 3,
1999........................................................ $0.93
Increase per share attributable to new investors............. 0.88
-----
As adjusted pro forma net tangible book value per share after
this offering................................................. 1.81
-----
Dilution per share to new investors............................ $4.19
=====
</TABLE>
The following table sets forth on a pro forma basis, as of July 3, 1999, the
difference between the number of shares of common stock purchased, the total
consideration paid and the average price per share paid by the existing
stockholders and the new investors purchasing shares of common stock in this
offering:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders.. 16,977,679 80.2% $37,998,000 60.1% $2.24
New investors ......... 4,200,000 19.8 25,200,000 39.9% $6.00
---------- ----- ----------- -----
Total................ 21,177,679 100.0% $63,198,000 100.0%
========== ===== =========== =====
</TABLE>
The number of outstanding shares in the foregoing discussion and table
excludes:
. 5,304,953 shares of common stock issuable upon the exercise of
outstanding options as of July 3, 1999 at an average exercise price of
$1.15 per share;
. 56,161 shares of common stock issuable, net of cancellations, upon the
exercise of options granted between July 3, 1999 and August 19, 1999 at
an average exercise price of $4.50 per share; and
. 1,029,946 shares of common stock issuable upon the exercise of options
granted on August 19, 1999 at an exercise price of $5 per share.
We reserved 3,456,903 shares of common stock for future issuance under our
stock option plan, director option plan and employee stock purchase plan as of
August 19, 1999.
21
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and their related notes
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in this prospectus. We have prepared this information
using our consolidated financial statements for the period from April 4, 1994
(inception) to January 1, 1995, the years ended December 31, 1995, December 29,
1996, December 28, 1997 and January 2, 1999 and the six-month periods ended
June 27, 1998 and July 3, 1999. Our consolidated financial statements for the
three years in the period ended January 2, 1999 have been audited by Ernst &
Young LLP, independent auditors, and are included elsewhere in this
prospectus. Our consolidated financial statements for the period from April 4,
1994 (inception) to January 1, 1995 and the year ended December 31, 1995 have
been audited by Ernst & Young LLP, independent auditors, and are not included
in this prospectus. Our consolidated financial statements for the six-month
periods ended June 27, 1998 and July 3, 1999 have not been audited and are
included elsewhere in this prospectus. For a discussion of the computation of
pro forma net income per common share, you should review Note 1 to our
consolidated financial statements. Our unaudited consolidated financial
statements include all adjustments, consisting of normal recurring accruals,
which we consider necessary for a fair presentation of the financial position
and the results of operations for these periods. Operating results for the six
months ended July 3, 1999 are not necessarily indicative of the results that
may be expected for the entire year ending January 1, 2000.
<TABLE>
<CAPTION>
Period from
April 4, 1994 Years Ended Six Months Ended
(inception) ---------------------------------------------- -----------------
to Jan. 1, Dec. 28, Jan. 2, June 27, July 3,
1995 Dec. 31, 1995 Dec. 29, 1996 1997 1999 1998 1999
------------- ------------- ------------- -------- -------- -------- -------
(predecessor) (predecessor) (predecessor) (unaudited)
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Revenue:
Product sales, net..... $ 556 $ 99 $ 4,421 $ 52,369 $177,669 $91,850 $70,693
Product sales to
related parties, net.. -- 15,702 20,871 -- -- -- --
Technology transfers
and royalties......... -- 4,000 1,500 2,000 1,750 750 2,093
------- ------- ------- -------- -------- ------- -------
Total revenue......... 556 19,801 26,792 54,369 179,419 92,600 72,786
Cost of sales.......... 1,164 17,844 22,616 41,222 137,001 69,057 50,928
------- ------- ------- -------- -------- ------- -------
Gross (loss) profit... (608) 1,957 4,176 13,147 42,418 23,543 21,858
Operating expenses:
Research and
development........... 4,627 6,269 5,066 20,287 25,458 11,611 16,780
Selling, general and
administrative........ 641 2,806 3,418 5,198 6,618 3,503 2,680
Acquired in-process
technology............ -- -- -- 6,000 -- -- --
------- ------- ------- -------- -------- ------- -------
Total operating
expenses............. 5,268 9,075 8,484 31,485 32,076 15,114 19,460
------- ------- ------- -------- -------- ------- -------
Operating (loss)
income................ (5,876) (7,118) (4,308) (18,338) 10,342 8,429 2,398
Interest income
(expense), net........ 38 100 (659) (1,066) (2,438) (904) (1,572)
------- ------- ------- -------- -------- ------- -------
(Loss) income before
income taxes and
extraordinary item.... (5,838) (7,018) (4,967) (19,404) 7,904 7,525 826
Provision for income
taxes................. -- -- -- -- 1,475 1,402 206
------- ------- ------- -------- -------- ------- -------
(Loss) income before
extraordinary item.... (5,838) (7,018) (4,967) (19,404) 6,429 6,123 620
Extraordinary item, net
of income taxes....... -- -- -- -- 306 -- --
------- ------- ------- -------- -------- ------- -------
Net (loss) income...... $(5,838) $(7,018) $(4,967) $(19,404) $ 6,735 $ 6,123 $ 620
======= ======= ======= ======== ======== ======= =======
Historical basic net
income (loss) per
share................. $ (4.50) $ (1.92) $ (1.38) $ 441.00 $ 12.36 $ 14.31 $ 0.68
======= ======= ======= ======== ======== ======= =======
Historical diluted net
income (loss) per
share................. $ (4.50) $ (1.92) $ (1.38) $ 441.00 $ 0.33 $ 0.30 $ 0.03
======= ======= ======= ======== ======== ======= =======
Shares used in
computing historical
basic
net income (loss) per
share................. 1,297 3,664 3,593 44 545 428 913
======= ======= ======= ======== ======== ======= =======
Shares used in
computing historical
diluted net income
(loss) per share...... 1,297 3,664 3,593 44 20,573 20,726 20,717
======= ======= ======= ======== ======== ======= =======
Pro forma basic net
income per share...... $ 0.42 $ 0.39 $ 0.04
======== ======= =======
Pro forma diluted net
income per share...... $ 0.33 $ 0.30 $ 0.03
======== ======= =======
Shares used in
computing pro forma
basic
net income per share.. 16,093 15,754 16,677
======== ======= =======
Shares used in
computing pro forma
diluted net income per
share................. 20,573 20,276 20,717
======== ======= =======
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
Dec. 28, Jan. 2, July 3,
Jan. 1, 1995 Dec. 31, 1995 Dec. 29, 1996 1997 1999 1999
------------- ------------- ------------- -------- ------- -----------
(predecessor) (predecessor) (predecessor) (unaudited)
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Consolidated Balance
Sheet Data:
Cash and cash
equivalents........... $12,113 $ 7,264 $ 6,770 $22,574 $24,350 $22,083
Working capital
(deficit)............. 11,083 8,253 3,636 10,114 (1,721) (4,697)
Total assets........... 19,644 33,763 32,615 65,973 89,766 90,328
Current portion of
notes payable and
capital leases........ -- 1,767 3,056 14,545 16,678 24,871
Notes payable and
capital leases, less
current portion....... -- 7,858 10,483 22,344 22,879 23,529
Stockholders' equity... 17,950 20,936 15,974 15,534 25,214 25,990
</TABLE>
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following "Management's Discussion and Analysis of Financial Condition
and Results of Operations" should be read in conjunction with our consolidated
financial statements and the related notes appearing at the end of this
prospectus.
Overview
We supply recording head products to the computer hard disk drive industry.
We were founded in 1994 and initially focused exclusively on high performance
recording head technologies for hard disk drives in the server market. We
expanded our focus to develop recording head products for the mobile market and
subsequently the desktop market. Our products have been successfully
integrated into Seagate's industry leading 10,000 revolutions per minute, or
rpm, Cheetah server disk drives, Toshiba's high-performance mobile disk drives
and Maxtor's desktop disk drives.
Our first customer and largest initial investor was HP who accounted for
substantially all of our product sales through 1996. In July 1996, HP
announced it was exiting the disk drive industry and would be selling its
equity interest in us. As a result, we recapitalized in January 1997. In
connection with the recapitalization, the original investor group, including
HP, sold their interest in us to a new investor group. The recapitalization
was accounted for under the purchase method of accounting, with the $23.2
million purchase price, including $1.2 million of transaction related fees,
exceeding our net book value by $7.7 million. This excess was allocated, based
on fair value, $6.0 million to in-process technology, $700,000 to developed
technology, $910,000 to assembled workforce and $100,000 to goodwill. We
expensed the $6.0 million assigned to in-process technology during the three
months ended March 30, 1997. We are amortizing the developed technology,
assembled workforce and goodwill over periods ranging from one to three years.
Amortization of assembled workforce and goodwill is included in research and
development expense and amortization of developed technology is included in
cost of sales.
We sell wafers, sliders and head gimbal assemblies to our customers. Each
wafer contains up to 22,000 potential recording heads and these are sold to
customers who have the capacity to convert our wafers into completed recording
heads. We provide sliders and head gimbal assemblies for customers who do not
have access to an established back-end production operation and thus do not
have the capacity to convert our wafers into completed recording heads.
Multiple head gimbal assemblies are typically assembled into a head stack
assembly before integration into a hard disk drive. We currently do not sell
head stack assemblies. The majority of our sales to date have been based on
our DSMR technology. During 1998 and for the first six months of 1999, sales of
products based on DSMR technology represented 94.3% and 94.6% of total
revenues, respectively. We expect products based on DSMR technology to decline
as a percentage of our revenue over the next year. We do not expect any
material sales from products based on DSMR technology after the first half of
2000. We have historically had a limited number of customers and expect this
to continue to be the case. Our sales are generally made pursuant to
individual purchase orders with revenue from product sales recognized upon
shipment. These purchase orders are subject to cancellation, modification,
quantity reduction or rescheduling without significant penalties.
We have licensed our DSMR technology to Seagate in exchange for technology
transfer fees, royalty payments and minimum purchase commitments. Through July
3, 1999, we received $9.3 million from technology transfer fees and $2.1
million in royalties. We have recognized the technology transfer fees as
revenue upon the achievement of stipulated milestones and recognized royalties
based on Seagate sales as reported by Seagate to us. We will not receive any
additional technology transfer fees in the future under these agreements. We
expect Seagate to decrease production of DSMR recording head products over the
next 12 months. Therefore, we do not expect the royalty payments or purchase
obligations to continue to be significant after the first half of fiscal year
2000. We cannot assure you that we will enter into any similar type of
agreements with Seagate or any other party in the future.
24
<PAGE>
Cost of sales consists primarily of wafer fabrication expenses,
subcontracting expenses and licensee fees. Wafer fabrication expenses include
employee related expenses for direct labor as well as manufacturing indirect
labor, quality assurance, equipment and facility maintenance and manufacturing
engineering support. Wafer fabrication expenses also include the cost of parts
and services required for the maintenance of the equipment, equipment rental,
equipment depreciation, material costs, both direct and indirect, and a
significant portion of our facility expenses. Subcontracting expense is
typically based on the number of sliders or head gimbal assemblies shipped by
the subcontractor and includes the cost of any material purchased from third
parties such as suspensions on which recording heads are attached.
Subcontracting prices are determined in part by subcontracting yields, with
lower yields resulting in higher subcontracting prices. Licensee fees include
the amortization of licenses we have previously purchased from third parties.
We produce our wafers in our own fabrication facility located in Milpitas.
The operation of a wafer fabrication facility is highly capital intensive and
involves numerous costs which cannot be reduced or eliminated quickly in
responses to changing conditions. For the purpose of providing prototype
products for internal use and early product samples to our customers, we have
limited slider and head gimbal assembly operations in our Milpitas facility.
The majority of the costs associated with these operations are classified as
research and development expenses. Currently, we subcontract almost all of our
slider and head gimbal assembly production to third parties. Slider and head
gimbal assembly fabrication are similarly capital intensive but also require
substantially more labor during the manufacturing and test processes. We have
primarily used SAE, a Hong Kong based subsidiary of TDK, for our slider and
head gimbal assembly subcontracting requirements.
We hold a 49.5% interest in MRST, a Hong Kong joint venture with SFI
Investment Limited. SFI also has ownership interests in other subcontracting
operations. MRST was formed to provide subcontracting services to us. MRST
currently is providing us subcontracting services by further subcontracting
work to other third parties. MRST intends to develop internal slider assembly
capacity to meet a portion of our slider requirements and to continue to
subcontract the balance of our slider requirements. We will record our
allocable share of MRST's financial results under the equity method of
accounting.
Gross profit on wafer sales is primarily determined by the level of wafer
output in relation to the large and relatively fixed costs associated with
operating a wafer fabrication facility. Wafers typically are priced and sold
based on the number of potential recording heads, or candidates, contained in
them. Sliders and head gimbal assembly gross profits reflect the cost of the
candidate as well as the subcontracting costs and, in the case of head gimbal
assemblies, the costs of the suspensions used. Candidate selling prices are
substantially lower than slider and head gimbal assembly selling prices but
generate a larger gross margin. Recently, the hard disk drive industry has
been under severe price pressure and has responded in part by placing similar
pressure on component suppliers such as ourselves. In addition, our
competitors may be willing to sell products at low or negative gross margins to
partially offset the fixed costs associated with their operations. Our
quarterly revenues and gross profits may change due to many factors, including:
. average unit selling prices;
. product mix;
. the level of unit sales in relation to fixed costs and capacity;
. manufacturing yields; and
. material costs.
Research and development expense includes salaries and related costs of
employees engaged in research, design and development activities and fees paid
to consultants and outside service providers. Other important elements are the
cost of prototype wafers, sliders and head gimbal assemblies produced for
research and development purposes and a portion of our facility expenses. We
believe that continued investment in research and development is critical to
our strategic objectives. As a result, we expect these expenses to increase in
absolute dollars in the future.
25
<PAGE>
Selling, general and administrative expense consists primarily of employee
related expenses for executive, finance, information systems and human resource
personnel, professional fees, other corporate expenses and a portion of our
facility expenses. We expect selling, general and administrative expenses to
increase in absolute dollars as we increase personnel and incur additional
costs related to our operation as a public company.
In connection with the grant of certain stock options to employees during
1997 and the first three months of 1998, we recorded deferred compensation of
$331,000, representing the difference between the deemed fair value of the
common stock underlying the options and the exercise price of certain options
at the date of grant. This amount is presented as a reduction of stockholders'
equity and amortized ratably over the vesting period of the applicable
options. Amortization of deferred compensation recorded in 1998 and in the
first six months of 1999 was $81,461 and $41,482, respectively. We currently
expect to record amortization of deferred compensation related to these option
grants of approximately $21,000 per quarter through the last quarter of 2001.
We operate on a 52 or 53 week fiscal year with quarterly results based on
fiscal quarters of thirteen or fourteen weeks in duration ending on the last
Saturday of each quarter. The fiscal years ended December 29, 1996 and
December 28, 1997 each contained 52 weeks consisting of four thirteen week
quarters. The fiscal year ended January 2, 1999 contained 53 weeks consisting
of three thirteen week quarters and one fourteen week quarter which was the
quarter ended October 3, 1998.
Results of Operations
The following table sets forth the results of our operations as a percentage
of total revenue for the periods indicated. Our historical operating results
are not necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
Years Ended Six Months Ended
------------------------------- ----------------
Dec. 28, Jan. 2, June 27, July 3,
Dec. 29, 1996 1997 1999 1998 1999
------------- -------- ------- -------- -------
(predecessor)
<S> <C> <C> <C> <C> <C>
Revenue:
Product sales, net.......... 16.5 % 96.3 % 99.0% 99.2% 97.1%
Product sales to related
parties, net............... 77.9 -- -- -- --
Technology transfers and
royalties.................. 5.6 3.7 1.0 0.8 2.9
----- ----- ----- ----- -----
Total revenue.............. 100.0 100.0 100.0 100.0 100.0
Cost of sales................ 84.4 75.8 76.3 74.6 70.0
Gross margin................. 15.6 24.2 23.7 25.4 30.0
Operating expenses:
Research and development.... 18.9 37.3 14.2 12.5 23.0
Selling, general and
administrative............. 12.7 9.6 3.7 3.8 3.7
Acquired in-process
technology................. -- 11.0 -- -- --
----- ----- ----- ----- -----
Total operating expenses... 31.6 57.9 17.9 16.3 26.7
Operating (loss) income...... (16.0) (33.7) 5.8 9.1 3.3
Interest income (expense),
net......................... (2.5) (2.0) (1.4) (1.0) (2.2)
----- ----- ----- ----- -----
Loss (income) before income
taxes and extraordinary
item........................ (18.5) (35.7) 4.4 8.1 1.1
Provision for income taxes... -- -- 0.8 1.5 0.3
----- ----- ----- ----- -----
(Loss) income before
extraordinary item.......... (18.5) (35.7) 3.6 6.6 0.8
Extraordinary item, net of
income taxes................ -- -- 0.2 -- --
----- ----- ----- ----- -----
Net (loss) income............ (18.5)% (35.7)% 3.8% 6.6% 0.8%
===== ===== ===== ===== =====
</TABLE>
26
<PAGE>
Comparison of Six Months Ended July 3, 1999 and June 27, 1998
Total Revenue. Total revenue decreased 21.4% to $72.8 million for the first
six months of 1999, from $92.6 million for the same period in 1998. During the
first six months of 1999, Seagate and Toshiba each represented more than
ten percent of our total revenue and combined represented 94.4% of our total
revenue as compared to 90.6% during the first six months of 1998.
Approximately $29.0 million of the decrease in total revenue related to lower
head gimbal assembly unit sales to Toshiba. During the first six months of
1999, head gimbal assembly and slider sales represented 53.0% of product sales
as compared to 72.5% during the first six months of 1998. HGAs and sliders
have higher average selling prices, reflecting the additional processing and
materials required. The decrease in total revenue was partially offset by an
increase in wafer sales of $7.9 million and an increase in technology transfers
and royalty revenue of $1.3 million.
Cost of Sales; Gross Profit. Gross profit decreased to $21.9 million in the
first six months of 1999 from $23.5 million in the comparable period of 1998.
Gross margin increased to 30.0% during the first six months of 1999 from 25.4%
during the first six months of 1998. Gross margin improved because of a shift
in product mix. Specifically, during the first six months of 1999, wafers,
which typically have a higher gross margin, represented a larger portion of
total revenue. In addition, an increase in revenue from technology transfer
fees and royalties of $1.3 million during the first six months of 1999 helped
increase gross margin.
Research and Development Expense. Research and development expense increased
44.8% to $16.8 million in the first six months of 1999, representing 23.0% of
total revenue, from $11.6 million and 12.5% of total revenue for the same
period in 1998. This increase resulted primarily from an increase in research
and development head count of $2.2 million and the increased volume of
prototype activities of $2.3 million, especially related to the development of
our giant magneto-resistive products.
Selling, General and Administrative Expense. Selling, general and
administrative expense decreased 22.9% to $2.7 million in the first six months
of 1999, representing 3.7% of total revenue, from $3.5 million and 3.8% of
total revenue for the same period in 1998. This decrease reflects $0.4 million
of professional fees incurred during the first six months of 1998 for an
uncompleted financing. In addition, selling, general and administrative
expense was reduced during the first six months of 1999 to reflect the receipt
of $497,691 in payments on debt which had previously been expensed as
unrecoverable.
Interest Income (Expense), net. Interest expense net of interest income
increased 77.8% to $1.6 million in the first six months of 1999, representing
2.2% of total revenue, from $0.9 million and 1.0% of total revenue for the same
period in 1998. Interest expense increased significantly as we incurred debt
to finance our capacity expansion.
Provision for Income Taxes. We recorded a $0.2 million provision for income
taxes for the first six months of 1999 compared to a $1.4 million provision for
the same period in 1998. The provision for income taxes for the first six
months of 1999 was based on a projected annual effective tax rate of 25.0%.
The projected 1999 annual effective tax rate is less than the federal statutory
rate primarily due to the anticipated realization of tax net operating loss and
tax credit carryforwards. A portion of our loss carryforwards may be subject
to annual utilization limitations imposed by the "change in ownership"
provisions of the Internal Revenue Code of 1986, as amended, and similar state
provisions. See Note 9 to our consolidated financial statements.
Comparison of Years Ended January 2, 1999 and December 28, 1997
Total Revenue. Total revenue increased 229.8% to $179.4 million in 1998 from
$54.4 million in 1997 as the result of successful qualifications into customer
programs, increased production capacity and increased volume sales of head
gimbal assemblies and sliders. During 1998, Seagate and Toshiba each
represented more than ten percent of our total revenue and combined represented
94.1% of our total revenue as
27
<PAGE>
compared to 85.5% during 1997. During 1998, our three largest customers were
purchasing production volume units for the entire year whereas during 1997,
customers and programs were being added during the year.
Cost of Sales; Gross Profit. Gross profit increased to $42.4 million in 1998
from $13.1 million in 1997, while gross margins remained relatively constant.
Gross profit increased primarily as a result of increased product sales.
Research and Development Expense. Research and development expense increased
25.6% to $25.5 million in 1998, representing 14.2% of total revenue, from $20.3
million and 37.3% of total revenue in 1997. The increase in research and
development expense was primarily the result of increased activities related to
new product qualifications.
Selling, General and Administrative Expense. Selling, general and
administrative expense increased 26.9% to $6.6 million in 1998, representing
3.7% of total revenue, from $5.2 million and 9.6% of total revenue in 1997.
This increase was primarily a result of professional fees incurred during the
first six months of 1998 for an uncompleted financing.
Acquired In-process Technology. We accounted for our January 1997
recapitalization under the purchase method of accounting, as all of the
stockholders after the recapitalization were new stockholders. Of the total
purchase price of approximately $23.2 million, including transaction costs, we
allocated approximately $6.0 million to the purchase of in-process technology.
We determined the values assigned to the in-process and developed
technologies through established valuation techniques in the information
storage industry using the income approach. To determine the value of in-
process and developed technologies, we considered, among other factors: the
nature of each project; the classification into developed or in-process
technology; the state of development of each project; the relative importance
of each project to our success; the time and cost needed to complete each
project; expected income; and associated risks which included the inherent
difficulties and uncertainties in completing the projects. We also considered
the inherent risks related to the viability of, and potential changes to,
future target markets.
The income approach required the estimation of revenues, cost of revenues and
operating expenses. These estimates were substantially consistent with
subsequent actual operating results. We used these estimates in the valuation
of these technologies and discounted the expected future cash flows from the
acquired technologies to their present values. The rates used to discount the
future cash flows to their present value were based on our weighted average
cost of capital and considered risks related to the characteristics and
applications of each technology acquired, existing and future markets and
assessments of the life cycle of the technology. Discount rates of 27.5% and
30.0% were used for valuing the developed and in-process technologies,
respectively, and are intended to be commensurate with our maturity and the
uncertainties in the estimates described above. The present values determined
are considered to be the fair values of the technologies acquired.
The estimates we used in valuing in-process technology were based on
assumptions we believe to be reasonable, but which are inherently uncertain and
unpredictable. Our assumptions may be incomplete or inaccurate, and we cannot
assure you that unanticipated events and circumstances will not occur.
Accordingly, actual results may vary from projected results.
Prior to HP's departure from the disk drive business in July 1996, we
developed proprietary DSMR products for HP's use in server disk drives with
speeds up to 7,200 revolutions per minute, or rpm. After HP's exit and prior to
the recapitalization, we spent considerable resources developing new DSMR
products for Seagate's use in server disk drives with speeds up to 10,000 rpm
and new DSMR products for Toshiba's
28
<PAGE>
use in mobile disk drives. We also commenced the development of soft adjacent
layer magneto resistive products for use by Maxtor in their desktop disk drives
during this period. At the time of the recapitalization, none of these products
had reached technological feasibility. Additionally, the technologies being
developed were unique to each prospective customer's specifications.
Furthermore, each of these technologies were still subject to significant
technological risks and complexities. As of the recapitalization date, none of
these projects had received customer acceptance, all were in the pre-production
stage, and none of the technologies had alternative future uses.
At the recapitalization date, we estimated that we were approximately three-
fourths complete with our development efforts. This estimate was based on the
development effort that had occurred as of the recapitalization date relative
to the total effort to complete the technology acquired. A significant portion
of the development efforts for the projects in development was focused on the
compatibility of the manufacturing process technologies and the engineering
designs for the anticipated products. A substantial amount of design and
prototyping is required to ensure the products being developed will be
commercially viable both in terms of function and cost. This challenge is
further complicated by a manufacturing process which typically involves in
excess of 300 separately defined steps, each with its own level of complexity.
As a result, the complexity of the development efforts is weighted towards the
beginning of the development cycle when the design changes and prototyping
occurs. Over time the volume of the design changes and prototyping diminish and
the development efforts shift toward customer qualifications which are less
extensive in terms of time, cost and complexity.
Subsequent to the recapitalization, we anticipated spending approximately
$4.6 million to bring the in-process technologies to technological feasibility.
This additional spending was required for engineering development, prototyping,
testing and customer qualification.
The development projects were completed, and these products commenced
shipping over the six months subsequent to the recapitalization. The actual
costs and time to complete these projects were within the expectations utilized
in the determination of the value assigned to the in-process technologies.
Interest Income (Expense), net. Interest expense net of interest income
increased 118.2% to $2.4 million in 1998, representing 1.4% of total revenue,
from $1.1 million and 2.0% of total revenue in 1997. Interest expense
increased significantly as we incurred debt to finance our capacity expansion.
Provision for Income Taxes. We recorded a $1.5 million provision for income
taxes in 1998 at an effective rate of 18.7%. No federal income tax expense was
recorded in 1997 due to an operating loss. The 18.7% effective tax rate used
to record the 1998 provision for income taxes was less than the statutory rate
primarily due to the realization of tax net operating loss carryforwards. At
January 2, 1999, we had net deferred tax assets of $11.8 million relating
principally to tax net operating loss carryforwards, research credit
carryforwards and temporary differences between the carrying amount of assets
and liabilities for financial reporting purposes and the amounts used for
income tax purposes. Realization of deferred tax assets is dependent on future
earnings, if any, the timing and amount of which are uncertain. Accordingly, a
valuation allowance, in an amount equal to the net deferred tax assets as of
January 2, 1999 and December 28, 1997, has been established to reflect these
uncertainties. See Note 9 of our consolidated financial statements.
Comparison of Years Ended December 28, 1997 and December 29, 1996
Total Revenue. Total revenue increased 103.0% to $54.4 million in 1997 from
$26.8 million in 1996 due to successful qualifications into customer programs,
increased production capacity and commencement of volume sales of head gimbal
assemblies and sliders. During 1997, revenues from Seagate and Toshiba each
represented more than ten percent of our total revenue and combined represented
85.5% of our total revenue as compared to 21.7% during 1996. During 1996,
product sales to HP represented 77.9% of total revenue, the majority of which
occurred during the first half of the year prior to HP's exit from the disk
drive industry.
29
<PAGE>
During 1997, we commenced volume sales of head gimbal assemblies and
sliders. Sales of head gimbal assemblies and sliders accounted for 32.7% of
product sales in 1997 compared to 1.0% of product sales in 1996. Product sales
of sliders and HGAs prior to 1997 primarily consisted of sales of sample units
to potential customers. Substantially all HGA sales in 1997 were to Toshiba
for use in their mobile disk drive products.
Cost of Sales; Gross Profit. Gross profit increased to $13.1 million in 1997,
from $4.2 million in 1996. Gross margin increased to 24.2% in 1997, from 15.6%
in 1996. This increase resulted primarily from a higher utilization of plant
capacity. Also during 1997, we amortized $642,000 of intangible assets
relating to the recapitalization.
Research and Development Expense. Research and development expense increased
298.0% to $20.3 million in 1997, representing 37.3% of total revenue, from $5.1
million and 18.9% of total revenue in 1996. Subsequent to our
recapitalization, we expanded our research and development activities including
the hiring of additional personnel and increasing wafer, slider and head gimbal
assembly prototyping activities. This increase in research and development
expense also reflects a $1.3 million charge in 1997 relating to the write-off
of certain leasehold improvements resulting from our decision to consolidate
our research and development facilities. Also during 1997, we amortized
$448,000 of intangible assets relating to the recapitalization. During the
second half of 1996, we significantly reduced research and development expense
in response to the decision of HP, our primary customer, to exit the disk drive
market.
Selling, General and Administrative Expense. Selling, general and
administrative expense increased 52.9% to $5.2 million in 1997, representing
9.6% of total revenue, from $3.4 million and 12.7% of total revenue in 1996.
This increase reflects significant infrastructure growth in 1997 following our
cost reduction program implemented in the second half of 1996.
Interest Income (Expense), net. Interest expense net of interest income
increased 57.1% to $1.1 million in 1997, representing 2.0% of total revenue,
from $0.7 million and 2.5% of total revenue in 1996. Interest expense increased
significantly as our average debt balance increased to finance our capacity
expansion.
Provision for Income Taxes. Due to operating losses incurred since inception,
we did not record a provision for income taxes in 1996 or 1997. At December
28, 1997, we had net deferred tax assets of $13.5 million relating principally
to tax net operating loss carryforwards, research credit carryforwards and
temporary differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
Realization of deferred tax assets is dependent on future earnings, if any, the
timing and amount of which are uncertain. Accordingly, a valuation allowance,
in an amount equal to the net deferred tax assets as of December 28, 1997 and
December 29, 1996, has been established to reflect these uncertainties. See
Note 9 of our consolidated financial statements.
30
<PAGE>
Quarterly Results of Operations
The following tables set forth our operating results for each of the six most
recent quarters expressed in dollars and as a percentage of total revenue. The
information for each of these quarters is unaudited and, in our opinion, this
information has been prepared on the same basis as our audited consolidated
financial statements included in this prospectus and includes all necessary
accruals, consisting only of normal recurring adjustments, we consider
necessary for fair presentation in accordance with generally accepted
accounting principles. This information should be read in conjunction with our
consolidated financial statements and their related notes included in this
prospectus. Our operating results for any three-month period are not
necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------
Mar. 28, Jun. 27, Oct. 3, Jan. 2, Apr. 3, Jul. 3,
1998 1998 1998 1999 1999 1999
-------- -------- ------- ------- ------- -------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Product sales, net..... $37,954 $53,895 $45,714 $40,106 $36,205 $34,488
Technology transfers
and royalties......... -- 750 -- 1,000 -- 2,093
------- ------- ------- ------- ------- -------
Total revenue......... 37,954 54,645 45,714 41,106 36,205 36,581
Cost of sales........... 27,345 41,712 36,360 31,584 26,063 24,865
------- ------- ------- ------- ------- -------
Gross profit........... 10,609 12,933 9,354 9,522 10,142 11,716
Operating expenses:
Research and
development........... 4,952 6,659 6,944 6,903 7,591 9,189
Selling, general and
administrative........ 1,570 1,932 1,822 1,294 1,312 1,368
------- ------- ------- ------- ------- -------
Total operating
expenses............. 6,522 8,591 8,766 8,197 8,903 10,557
Operating income........ 4,087 4,342 588 1,325 1,239 1,159
Interest expense, net... (408) (495) (648) (887) (845) (727)
------- ------- ------- ------- ------- -------
Income (loss) before
income taxes and
extraordinary item..... 3,679 3,847 (60) 438 394 432
Provision (benefit) for
income taxes........... 685 717 (9) 82 98 108
------- ------- ------- ------- ------- -------
Income (loss) before
extraordinary item..... 2,994 3,130 (51) 356 296 324
Extraordinary item, net
of income taxes ....... -- -- 306 -- -- --
------- ------- ------- ------- ------- -------
Net income.............. $ 2,994 $ 3,130 $ 255 $ 356 $ 296 $ 324
======= ======= ======= ======= ======= =======
<CAPTION>
Three Months Ended
------------------------------------------------------
Mar. 28, Jun. 27, Oct. 3, Jan. 2, Apr. 3, Jul. 3,
1998 1998 1998 1999 1999 1999
-------- -------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Product sales, net..... 100.0% 98.6% 100.0% 97.6% 100.0% 94.3%
Technology transfers
and royalties......... -- 1.4 -- 2.4 -- 5.7
------- ------- ------- ------- ------- -------
Total revenue......... 100.0 100.0 100.0 100.0 100.0 100.0
Cost of sales........... 72.0 76.3 79.5 76.8 72.0 68.0
------- ------- ------- ------- ------- -------
Gross margin........... 28.0 23.7 20.5 23.2 28.0 32.0
Operating expenses:
Research and
development........... 13.1 12.3 15.2 16.8 21.0 25.1
Selling, general and
administrative........ 4.1 3.5 4.0 3.1 3.6 3.7
------- ------- ------- ------- ------- -------
Total operating
expenses............. 17.2 15.8 19.2 19.9 24.6 28.8
Operating income........ 10.8 7.9 1.3 3.3 3.4 3.2
Interest expense, net... (1.1) (0.9) (1.4) (2.2) (2.3) (2.0)
------- ------- ------- ------- ------- -------
Income (loss) before
income taxes and
extraordinary item..... 9.7 7.0 (0.1) 1.1 1.1 1.2
Provision (benefit) for
income taxes........... 1.8 1.3 0.0 0.2 0.3 0.3
------- ------- ------- ------- ------- -------
Income (loss) before
extraordinary item..... 7.9 5.7 (0.1) 0.9 0.8 0.9
Extraordinary item, net
of income taxes........ -- -- 0.7 -- -- --
------- ------- ------- ------- ------- -------
Net income.............. 7.9% 5.7% 0.6% 0.9% 0.8% 0.9%
======= ======= ======= ======= ======= =======
</TABLE>
31
<PAGE>
Total Revenue. Following our recapitalization in January 1997 and through the
quarter ended June 27, 1998, total revenue increased in each quarter as we
successfully qualified into new customer programs and increased production
capacity to supply these new programs. Initial revenue growth occurred as a
result of an increase in wafer sales followed by the commencement of volume
head gimbal assembly sales during the quarter ended September 28, 1997.
Starting in the quarter ended October 3, 1998 and continuing through the
quarter ended April 3, 1999, total revenue declined as a result of a reduction
in head gimbal assembly sales. Head gimbal assembly sales fell during this
period as our primary head gimbal assembly customer, Toshiba, began to
transition away from our DSMR recording head products to giant magneto-
resistive recording heads on an improved suspension. The reduction of head
gimbal assembly sales was partially offset during this period by an increase in
wafer sales. During the quarter ended July 3, 1999, product sales continued to
decline, but total revenue increased due to the commencement of royalties from
Seagate of $2.1 million.
Cost of Sales; Gross Profit. Gross profit fluctuated from quarter to quarter
as a result of factors such as fluctuations in revenue levels, product mix,
expenses associated with the increase of plant capacity and timing of
technology transfer fees and royalty revenue. During the three quarters ended
October 3, 1998, gross margin declined in part due to the higher concentration
of head gimbal assembly sales and the lower gross margin associated with these
sales. During the quarter ended January 2, 1999, gross margin rose slightly in
spite of a decline in total revenue as we took steps to reduce costs, including
a reduction in head count. We also received a technology transfer fee which
contributed to the increase in gross margin. During the quarters ended
April 3, 1999 and July 3, 1999, engineering activities consumed a larger
portion of total wafer production costs. This reduced cost of sales and
improved gross profit. During the quarter ended July 3, 1999, gross margin
increased in part due to the commencement of royalty payments from Seagate.
Research and Development Expense. Research and development expense has
trended upwards in support of additional customer programs and the development
of new technologies since our recapitalization. We currently operate a
prototype slider and head gimbal assembly operation, primarily for the purpose
of providing rapid feedback for technology development in addition to the
production of wafers for the purpose of research and development. During the
quarters ended June 27, 1998 and October 3, 1998, we substantially increased
our research and development head count as well as increasing our prototype
activities. During the quarter ended January 2, 1999, our research and
development expense decreased slightly due to a reduction in head count, which
was substantially offset by an increase in prototype activities. During the
quarters ended April 3, 1999 and July 3, 1999, research and development expense
increased as a result of an increase in head count as well as increased
prototype activities related to the introduction of our giant magneto-resistive
products.
Selling, General and Administrative Expense. During the quarters ended June
27, 1998 and October 3, 1998, selling, general and administrative expense
increased as a result of increased professional fees incurred during the first
six months of 1998 for an uncompleted financing. During the quarter ended
January 2, 1999, selling, general and administrative expense declined as a
result of a reduction in head count. During the quarter ended April 3, 1999,
selling, general and administrative expense increased slightly in part as a
result of severance expense for one of our former officers, which was partially
offset by receipt of $400,000 in partial payment of a debt previously expensed
as unrecoverable. During the quarter ended July 3, 1999, selling, general and
administrative expense increased as a result of increased head count that was
partially offset by receipt of an additional $97,691 as payment of the balance
of a debt previously expensed as unrecoverable.
Liquidity and Capital Resources
We have historically financed operations through a combination of private
equity, private debt and equipment financings. As part of our
recapitalization, we received net proceeds of $34.4 million from the issuance
of our Series A preferred stock and received aggregate loan commitments from
certain industry lenders, including Western Digital and Maxtor, of up to $18.0
million of which $11.0 million was funded at,
32
<PAGE>
or shortly following, the closing of the recapitalization and $7.0 million was
subsequently funded. We used $23.2 million of these amounts to purchase all
outstanding equity of the predecessor company. During 1998, we renegotiated
the terms of two of the three promissory notes that were then outstanding.
Under the renegotiated terms, these two notes are scheduled to be fully repaid
by June 30, 2000. Both of these notes can be made payable, by the lender, upon
the closing of this offering. As of July 3, 1999, the outstanding balances
under these two notes were in aggregate $11.0 million, which we expect to repay
with a portion of the net proceeds of this offering. In connection with the
recapitalization, HP and Asahi Komag agreed to leave in place guarantees of
equipment notes payable with terms of up to five years in exchange for our
agreement to reimburse them for any payments made under the guarantees. The
reimbursement obligation to HP and Asahi Komag is secured by equipment owned by
us. During 1997, we purchased capital equipment from Komag related to a
facility being subleased from them. The equipment was purchased with a note
which becomes immediately payable upon the closing of this offering. As of
July 3, 1999, the outstanding balance under this note was $1.4 million, which
we expect to repay with a portion of the net proceeds of this offering.
Our operating activities provided net cash of $23.5 million in 1998 and $9.6
million during the first six months of 1999. Cash generated during both
periods reflects net income plus depreciation and amortization. Cash provided
by operations during 1998 also reflects a relative increase in accounts payable
primarily relating to increased volume with subcontractors.
Cash used in investing activities during 1998 and the six months ended July
3, 1999 was $41.4 million and $2.5 million, respectively. Investing activities
consist primarily of the purchase of capital equipment and leasehold
improvements. During 1998, we made substantial investments in capital
equipment in order to increase production capacity. We expect to continue to
make investments in capital equipment to increase capacity and to provide the
capability for new technologies. We currently plan to spend between
approximately $20.0 million and $25.0 million during 1999 on capital
expenditures. As of July 3, 1999, we had outstanding noncancellable
commitments for the purchase of property, plant and equipment of
$10.2 million. In addition, during 1998 and the first six months of 1999, we
entered into operating leases for equipment in the amounts of $35.0 million and
$2.3 million, respectively, for terms of up to five years. Amounts payable
during the next year under our equipment operating leases approximates $12.0
million.
Our financing activities provided net cash of $19.7 million in 1998 and used
net cash of $9.4 million in the six months ended July 3, 1999. During 1998, we
utilized our credit line to provide $7.5 million of cash. We also issued 1.1
million shares of our Series A preferred stock in exchange for $2.7 million of
cash. During 1998, we received $19.9 million of net cash from the financing of
equipment purchases through the issuance of notes payable and leasing
arrangements, less $10.6 million of repayment on outstanding notes payable and
capital leases. During the six months ended July 3, 1999, we used cash to
reduce our credit line by $4.5 million and we used $5.0 million for the
repayment of outstanding notes payable and capital leases.
Our principal source of liquidity at July 3, 1999 was cash and cash
equivalents of $22.1 million and balances available under a $15.0 million
credit facility with Silicon Valley Bank under which $3.0 million was
outstanding as of July 3, 1999. The availability of borrowings under the
credit facility is determined from time to time by our cash and accounts
receivable balances, with borrowings also subject to quarterly profitability
and satisfaction of certain non-financial covenants. The credit facility is
secured by substantially all of our assets, excluding intellectual property and
equipment financed through notes and capital leases. The borrowings on the
credit facility bear interest at a rate equal to the bank's prime lending rate
plus one quarter, which was 8.25% as of July 3, 1999. The credit facility
expires in August 2000.
As of July 3, 1999, we had a working capital deficit of $4.7 million. Upon
the completion of this offering we expect working capital to be positive.
We believe the proceeds from this offering, cash balances, funds available
under our credit facility, expected equipment financings and any cash generated
from operations will provide adequate cash to fund
33
<PAGE>
our operations for at least the next 12 months. Our future capital
requirements, however, will depend on many factors. To meet anticipated future
capital requirements, we may need sources of capital in addition to the
proceeds from this offering. There is no assurance that additional funds will
be available to us or that, if available, these additional funds will be
obtained upon terms and conditions acceptable to us. If we are unable to
obtain sufficient capital, we will need to curtail our operating and capital
expenditures, which could materially harm our business.
Year 2000 Readiness
Many currently installed computer systems and software products are coded to
accept a two digit value as representing the year. Starting on January 1,
2000, it will be necessary to use a four digit value to distinguish dates from
the twentieth and twenty-first centuries. As a result, many companies'
computer systems and software will need to be upgraded in order to be "Year
2000" compliant. We could be impacted by the "Year 2000" issue through our
internal systems, including our information technology infrastructure as well
as our manufacturing equipment. We could also be impacted due to the effect
upon our suppliers and customers. We believe our products are not affected by
"Year 2000" issues because they do not include embedded logic nor do they store
data internally.
Our information technology systems include computers, network infrastructure,
telecommunications equipment, manufacturing software, accounting software,
payroll service software and internally developed application specific
software. In early 1999, we hired an external consultant to provide a high
level review of the compliance of these systems. We are in the process of
upgrading our software to address the "Year 2000" issue and repair or replace
any computers which are not compliant. We believe our network infrastructure
and telecommunications equipment is "Year 2000" compliant, although final
testing and verification still needs to occur. Because a large portion of our
software is obtained from our vendors on a non-custom basis, we believe that
upgrades for our commercial programs will be available. We currently estimate
the costs associated with making our internal systems "Year 2000" compliant,
and the consequences of incomplete or untimely resolution of making our systems
and operations compliant, will not materially harm our business.
A significant portion of our manufacturing and test equipment either include
embedded logic or store data internally, or both. A large number of these
systems are directly connected to our network to provide data used in the
determination of whether products meet manufacturing specifications. The
majority of these systems use software proprietary to the equipment. We have
begun contacting the equipment manufacturers to assess each systems'
compliance. Based on the responses we receive, we will either repair, replace
or remove non-compliant equipment from our operations if the failure to do so
would materially harm our business.
We also rely, directly and indirectly, on the external systems of our
customers, suppliers, subcontractors, creditors, financial organizations and
governmental entities, both domestic and international, for accurate exchange
of data. Even if our internal systems are not materially affected by the "Year
2000" issue, we could be affected through disruptions in the operation of the
enterprises with which we interact.
The costs associated with assessment and remediation have not been material
to date. We do not expect the cost of future assessment, remediation and
testing to exceed $1.0 million. We expect to complete our review, testing and
verification of "Year 2000" readiness by early in the fourth quarter of 1999.
We are in the process of developing contingency plans for continuing operations
in the event problems, both identified and unidentified, should occur.
34
<PAGE>
BUSINESS
Overview
We provide recording head products to the computer hard disk drive industry.
We sell our recording head products to the server, desktop and mobile segments
of the disk drive industry. Our volume sales have included sales to Seagate
for use in its industry leading 10,000 rpm Cheetah server disk drives, to SAE
for incorporation into Maxtor's desktop disk drives and to Toshiba for use in
its mobile disk drives. For the six months ended July 3, 1999, Seagate and
Toshiba accounted for 48.8% and 45.6% of our total revenue. By outsourcing the
lower margin aspects of our manufacturing processes, we significantly reduce
our fixed costs and are able to focus on wafer design for innovative recording
head products.
Industry Background
Growth of Digital Information
The last decade has seen an explosion in the volume of business critical
digital data being captured and stored in business environments. This is a
result of the tremendous growth in strategic software applications, such as
enterprise resource planning, decision support, data mining and sales force
automation systems. At the same time, the growth of the Internet has
significantly expanded the opportunity for online transaction processing,
including automated reservation systems, inventory tracking systems, electronic
trading and electronic commerce. All of these business applications involve
significant amounts of digital data that is stored on servers and desktops.
Digital information is also becoming a larger part of individuals' lives away
from the office. Due to the use of complex multimedia data types, such as 3-D
images, audio and full motion video content, and the widespread availability of
these data types over the Internet, the data accessed and used daily by
individuals has greatly increased storage requirements. For example, a three
minute digital audio file requires approximately 500 times the hard drive
storage space required for one page of text. Moreover, the ongoing transition
from analog appliances to digital devices, such as digital video recorders, is
expected to further increase data storage needs in the home.
As businesses and individuals increasingly depend on digital information, the
need to store and retrieve data both efficiently and reliably dramatically
increases. According to International Data Corporation, or IDC, an independent
industry research company, from 1994 to 2002, shipments of direct access
storage capacity, which excludes tape and optical storage, are expected to
increase more than a hundredfold.
Disk Drive Market
Hard disk drives are the primary means for direct access storage of digital
information. The hard disk drive industry is commonly divided into three
distinct market segments: server, desktop and mobile.
Server. Server disk drives typically function as an inter-connected group of
disk drives which collectively contain a repository of information to be
accessed by multiple parties. The disk drives for servers are designed to
handle large amounts of information quickly and reliably. Factors driving
growth in the demand for servers and server storage capacity include:
. adoption by businesses of enterprise-wide, operational applications;
. implementation of corporate e-mail and scheduling software;
. introduction and adoption by businesses of decision support and other
applications that enable the use of operational data as a strategic tool;
. the expansion of the Internet and intranets; and
. increasingly complex operating systems.
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<PAGE>
According to IDC, the server disk drive market is expected to grow from $6.8
billion in 1998 to $19.9 billion in 2003, reflecting projected unit growth from
14.1 million units in 1998 to 28.9 million units in 2003. On average, a server
disk drive contains approximately ten recording heads.
Desktop. The desktop disk drive market includes disk drives sold to
manufacturers of personal computers, or PCs, and computer workstations. Disk
drives designed into desktop computers must comply with industry standards and
be delivered in high volumes at low prices per unit. While PCs are used in
both business and home environments, workstations are almost exclusively used
in the business, scientific and educational environments. Desktop hard disk
drives typically store data and programs for:
. personal productivity applications such as word-processing and
spreadsheets;
. interfaces to corporate applications;
. digitized photographs, videos and music;
. entertainment and educational applications;
. data retrieved from servers, including the Internet; and
. increasingly complex operating systems.
These applications require increasingly greater storage capacity and have
sharply increased the demand for high capacity disk drives. Growth in the
desktop disk drive market closely mirrors the growth in the demand for PCs and
computer workstations. According to IDC, the desktop disk drive market is
expected to grow from $15.2 billion in 1998 to $18.6 billion in 2003,
reflecting projected unit growth from 111.7 million units in 1998 to 205.9
million units in 2003. On average, a desktop disk drive contains approximately
three recording heads.
Mobile. The mobile disk drive market includes disk drives sold to
manufacturers for use in notebook and sub-notebook computers as well as in
specialty applications. Mobile disk drives must be physically small and light
weight, consume limited amounts of power and be capable of performing in
demanding environments. Similar to desktop disk drives, these drives store
much of the same information relating to corporate applications, personal
productivity, digitized information, entertainment and educational
applications, but require more technologically advanced disk drive components.
According to IDC, the mobile disk drive market is expected to grow from $3.4
billion in 1998 to $4.2 billion in 2003, reflecting projected unit growth from
17.9 million units in 1998 to 33.4 million units in 2003. On average, a mobile
disk drive contains approximately four recording heads.
Disk Drive Technology
The basic elements of the disk drive have remained essentially the same since
hard disk drives were introduced in 1956. The principal components of a hard
disk drive are disks, or "media," recording heads, a spindle/motor assembly, an
actuator and electronics. Each disk drive typically contains from one to ten
disks that are attached to a spindle/motor assembly. As the disks rotate, the
actuator positions the recording heads over the disks to read and write data.
The process of writing data involves magnetically orienting microscopically
small sections of the disk surface in alternating directions. Data is arranged
into concentric circles, or "tracks," on the surface of the media. During the
data read-back process, the recording head precisely senses the location of
transitions between these areas of differing magnetic orientation.
Sophisticated codes embedded in the disk drive electronics are used to
translate the relative location of these transitions into digital data
recognizable by the computer's operating system.
A hard disk drive can contain multiple recording heads and disks, with disk
sizes often varying between disk drives. A common unit of measure used to
describe storage capacity of disk drives, known as "areal density," represents
the amount of information in one square inch of disk space.
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<PAGE>
Recording Head Technology
In the quest for higher areal densities, substantial advances have been made
in recording head technology. Early recording heads consisted of a simple
ferrite core onto which a copper wire coil was wrapped. The physical
limitations of the initial wrapped wire designs were overcome through the use
of photolithography processes, similar to those used in semiconductor
manufacturing, to pattern the coil onto a ceramic substrate. This concept
produced recording heads known as "thin film" inductive recording heads which
were commercially introduced in the late 1980s. The improvements of the
semiconductor-like processes enabled these types of heads to achieve areal
densities beyond 1.0 billion bits per square inch. Thin film inductive
recording heads, however, are limited by their sensitivity to disk speed and
signal frequency limitations. Because of these limitations, thin film
inductive recording heads gave way to magneto-resistive recording heads.
Magneto-resistive recording heads were commercially introduced in the mid-
1990s and represented a fundamental shift in technology. According to Trend
Focus, the market for recording heads is expected to grow from $6.5 billion in
1998 to $8.5 billion in 2002. In 1998, magneto-resistive heads, including
giant magneto-resistive heads, represented over 90% of the revenues for all
recording heads consumed by the hard disk drive industry.
A magneto-resistive recording head utilizes a separate read and write element
in contrast to previous recording heads which used a single element for both
functions. By separating the functionality of the two elements, each can be
optimized for its task. The write element of a magneto-resistive recording
head is based on the same inductive principles as a thin film inductive
recording head. The read element, however, is fundamentally different from the
inductive write technology. The read element of an magneto-resistive recording
head is based on a physical phenomenon known as the "magneto-resistive effect,"
which describes how certain metals' electrical resistance change when exposed
to a magnetic field. To accomplish the reading of data, an electrical current
is passed through the magneto-resistive read element of the head by the
electronics. As the head flies over the disk, the magnetic field emanating
from the recorded bits changes the resistance of the read element. This change
in resistance is monitored precisely by the disk drive electronics and is used
to decode the information stored on the disk. The increased signal sensitivity
of magneto-resistive technology allows greater areal density or, in other
words, greater storage capacity.
The design and fabrication of magneto-resistive recording heads is complex
and requires detailed knowledge of materials, manufacturing processes and
device technology. The current generation of recording heads, giant magneto-
resistive, is beginning to exploit the fundamental physics of materials in
order to increase their areal density capabilities. Giant magneto-resistive's
complex structure of multiple layers of ultra-thin films provides significantly
higher signal sensitivity than conventional magneto-resistive heads. The
ability to continue to provide recording heads capable of advancing areal
densities will increasingly depend on the recording head manufacturer's ability
to understand the fundamental physics and magnetic properties of materials and
the ability to develop manufacturing processes capable of producing them.
Challenges Faced by the Disk Drive Industry
Disk drive manufacturers face significant competition and a demanding
marketplace characterized by a constant requirement for next generation
products with increased capacity at a lower cost. To remain competitive, drive
manufacturers must rapidly introduce products with increasingly complex
component technology. We estimate that between 1993 and 1998 the average
storage capacity per drive increased from 343 megabytes to 5,170 megabytes (5.2
gigabytes), while at the same time, the average cost per megabyte of storage
fell from $0.80 to $0.04. Disk drive manufacturers that fail to remain on the
computer industry's storage capacity/cost curve experience significantly
reduced margins and market share.
The ability to source components that will enable industry-leading areal
densities in large part defines a disk drive manufacturer's competitive
ability. With each technology transition, opportunities are created for
37
<PAGE>
disk drive manufacturers and their suppliers to capture or lose market share.
Disk drive design time can be substantial, ranging from three to 18 months.
When the manufacturer selects suppliers for new designs, it is taking a
substantial risk the chosen suppliers will be able to provide leading-edge
technologies in volume and on time. Consequently, suppliers with a proven
ability to provide leading-edge components in a predictable manner are valuable
to disk drive manufacturers.
Our Approach and Strategy
We use our broad and fundamental understanding of recording head technology
to develop products that we believe provide our customers with significant
performance advantages and faster time to volume production. This in turn
allows our customers to market their products more quickly to capture the
higher margins attendant with being an early supplier of advanced disk drives.
Since inception, we have been dedicated exclusively to the development of
magneto-resistive recording heads. Our research and development organization
includes a number of industry pioneers who have significant expertise in the
underlying sciences, technologies and manufacturing processes required for the
design and production of increasingly advanced recording heads. The depth and
expertise of our research and development organization recently enabled us to
transition to giant magneto-resistive head technology in approximately nine
months. By outsourcing back-end manufacturing processes, we significantly
reduce our capital expenditures and are able to focus our resources on wafer
design for innovative recording head products. The key elements of our strategy
include the following:
Introduce Innovative Recording Head Products. We intend to gain market share
with leading disk drive manufacturers by offering them value-added products
designed to meet their technological, volume production and timing
requirements. Our broad and fundamental understanding of recording head
technology allows us to deliver a range of solutions to disk drive
manufacturers in each of the industry's market segments. We have developed,
and are continuing to develop, a range of recording head products designed to
enable our customers to deliver leading-edge products. As areal densities
continue to grow, we believe only recording head component suppliers with an
excellent knowledge of recording head fundamentals will be able to provide
leading-edge products on a predictable and timely basis. We intend to continue
to focus on the fundamentals of recording head technology and to develop our
expertise in magnetic modeling, device development, device application and
integration, as well as process development.
Outsource Back-End Manufacturing. We intend to continue to outsource our
lower margin, labor intensive back-end manufacturing processes, such as slider
processing and head gimbal assembly and testing. We believe our business
model, which couples our recording head wafers with the existing high-quality,
high-capacity back-end production capabilities of customers and subcontract
manufacturers, represents the most efficient use of our capital and engineering
resources. This business model enables us to focus our research and
development efforts on the higher value-added wafer design and production
processes while significantly reducing our fixed costs. We believe this model
also makes it easier for us to increase or decrease our output in response to
changes in customer demand and enabled us to remain profitable even while
increasing capacity during the recent volatility in the disk drive market.
Provide Targeted Solutions to Market Segments. We are targeting our recording
head products to the server, desktop and mobile segments of the disk drive
market. Our range of magneto-resistive products can be utilized in each disk
drive market segment and can be optimized for specific applications.
Specifically, we believe that our experience in the performance-oriented high
data rate server and high areal density mobile market segments, coupled with
our recent expansion in wafer manufacturing capacity, has positioned us to
address the largest market segment--desktop disk drives. This segment
represented less than ten percent of our sales in 1998. In addition, given the
different growth rates and cycles of the three market segments, participation
in all segments of the disk drive market may minimize our exposure to adverse
developments in any single market segment.
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<PAGE>
Focus on Collaborative Relationships with Industry Participants. We work
closely with Seagate, SAE and other disk drive component manufacturers to
develop compatible products which can be effectively incorporated into leading-
edge disk drives. We believe that close technical collaboration with our
customers and their other suppliers during the design phase enables us to
participate in establishing technological and design requirements for new
products, facilitates integration of our products, improves our ability to
reach cost effective high volume manufacturing rapidly and enhances the
likelihood that we will become a primary supplier.
Products
We sell our products in the form of wafers, sliders and head gimbal
assemblies. We are currently shipping production volumes of these products
with areal densities up to 6.0 billion bits per square inch and are in the
early stages of volume production of products with areal densities up to 10.0
billion bits per square inch. In addition, we are providing samples and
technology demonstration units with areal densities up to 14.0 billion bits per
square inch.
Giant Magneto-Resistive. Giant magneto-resistive is our newest product line.
Our giant magneto- resistive recording heads employ a complex multi-layer read
element resulting in significantly greater signal sensitivity than provided by
conventional magneto-resistive heads. The increased sensitivity makes it
possible to detect smaller recorded bits and to read these bits at a higher
data rate. We believe our understanding and experience in the manufacturing of
the ultra-thin films used in our earlier recording heads has provided us with a
significant advantage in our continued development of giant magneto-resistive
recording heads. We are currently shipping early production volume of our
giant magneto-resistive products to the desktop and mobile market. We are also
providing samples of giant magneto-resistive products with areal densities in
excess of 14.0 billion bits per square inch.
DSMR. The majority of our sales to date have come from our DSMR products.
DSMR heads utilize two magneto-resistive read elements resulting in an
amplified signal more impervious to sources of signal noise in the storage
system. Because of the significant performance advantages DSMR heads have over
standard magneto-resistive products, they have successfully penetrated the high
performance, high data rate server and high areal density mobile disk drive
markets, both of which emphasize performance over compliance with industry
standards. DSMR heads, however, are not well suited for the desktop market
because they are incompatible with the industry standard magneto-resistive
products.
In early 1999, the disk drive industry began its transition to giant magneto-
resistive technology. We expect that most of our future revenue will come from
the sale of giant magneto-resistive products.
Technology
The data storage industry depends primarily upon the principles embodied in
the field of magnetics to store and subsequently retrieve the vast amount of
information used by the computing industry. Magnetic recording employs the use
of "hard" magnetic materials to store information. Hard magnetic materials are
materials that require strong magnetic fields to orient the direction of
magnetization within the materials. These materials, once oriented,
permanently retain this magnetic orientation until they are reoriented by
another strong magnetic field.
Early magnetic recording heads employed the principle of induction to read
and write data on magnetic disks. The principle of induction defines a
relationship between magnetism and electricity. When a magnetic material is
wrapped with a coil of an electric conductor, such as copper, magnetic fields
are produced when an electric current is passed through the copper conductor.
Conversely, when the magnetic material passes by a magnetic field, an electric
current is induced in the copper conductor. This inductive process is used to
create the strong magnetic fields that orient the hard magnetic materials on
the surface of the recording disk. The reverse of this inductive process was
also used for many years to read back the
39
<PAGE>
information stored on the surface of the disk. As areal densities approached
1.0 billion bits per square inch, the inherent conflict of designing an element
for both reading and writing increased.
Magneto-resistive technology derives its name from a class of materials which
change resistance in the presence of a magnetic field. Magneto-resistive
recording heads utilize an inductive write head based on the same inductive
principles of earlier technologies combined with a magneto-resistive element to
provide the read function. These magneto-resistive elements are designed and
fabricated to provide many times the signal sensitivity or reading efficiency
of the inductive read head technology. The inherent conflict of designing an
element for both reading and writing is eliminated by enabling each element to
be optimized for its unique purpose.
Giant magneto-resistive is an advanced application of magneto-resistive
technology. By employing multiple layers of ultra thin films, giant magneto-
resistive heads are able to provide significantly higher signal sensitivity
than conventional recording heads. The most common type of giant magneto-
resistive is a spin valve sensor. In its simplest form, the spin valve
consists of four film layers, a magnetic sensing layer, a non-magnetic metal
spacer layer, a magnetic pinned layer and an exchange layer. The magnetic
orientation of the pinned layer is fixed and held in place by the adjacent
exchange layer, while the magnetic orientation of the sensing layer changes in
response to the magnetic field from the disk. The level of electrical
resistance of this multi-layer thin film sensor depends on the relative
magnetic orientation of the sensor and pinned layer, yielding low resistance
when they are in parallel state and high resistance at anti-parallel state.
Giant magneto-resistive recording heads provide significantly stronger signals
than conventional magneto-resistive recording heads, enabling higher areal
densities.
Customers
We sell our products to leading manufacturers in each of the server, mobile
and desktop segments of the disk drive market. During 1998 and the first six
months of 1999, 26.9% and 48.8%, respectively, of our total revenues were from
Seagate for the server market and 67.2% and 45.6%, respectively, of our total
revenues were from Toshiba for the mobile market. During 1998 and the first six
months of 1999, 5.7% and 5.4% of our total revenues, respectively, were from
sales of recording head wafers to SAE for resale to Maxtor for the desktop
market. We have also had volume sales of wafers to SAE for resale to Maxtor.
During 1998 and the first six months of 1999, we generated revenues from 12 and
4 customers, respectively. The following are examples of customer programs by
market segment.
Server Market: Seagate Cheetah Programs. We worked with Seagate to produce a
recording head capable of being integrated into a server disk drive with a
rotational speed of 10,000 revolutions per minute, or rpm. Previously, no disk
drive manufacturer had commercially produced a 10,000 rpm drive, in part, due
to the unavailability of a commercial recording head suitable for such a
product. We supplied Seagate with a wafer level slider to produce a DSMR head
capable of handling the data transmission rate necessary for a 10,000 rpm
drive. This DSMR head was then incorporated into Seagate's industry leading
Cheetah family of disk drive products. We are currently supplying product for
the third generation disk drive in the Cheetah family.
Mobile Market: Toshiba Programs. Toshiba was seeking a supplier capable of
developing a low mass, high areal density recording head mounted to an advanced
wireless suspension less sensitive to signal noise common in the mobile
environment. Our DSMR products were selected, in part, due to the combination
of their high areal density performance and the improved immunity to noise.
The performance of our DSMR recording heads allowed us to become a leading
supplier to Toshiba.
Desktop Market: Maxtor. With our recently expanded manufacturing capacity, we
are actively targeting the desktop disk drive market. We are currently
providing volume shipments of our giant magneto-resistive products for use in
Maxtor's desktop disk drives and are providing early stage samples of our giant
magneto-resistive products to Seagate and Western Digital for use in desktop
disk drives.
40
<PAGE>
Our Manufacturing Processes
The production of recording heads involves the design and manufacture of
wafers, the processing of wafers into individual sliders, the assembly of
sliders into head gimbal assemblies, the testing of head gimbal assemblies and
the assembly of multiple head gimbal assemblies into head stack assemblies.
Our customers purchase wafers, sliders and head gimbal assemblies incorporating
our recording heads. We do not currently assemble or sell head stack
assemblies.
Wafer Fabrication
We design and manufacture recording head wafers using highly-complex,
advanced fabrication processes similar to the semiconductor wafer fabrication
process, but we use a ceramic wafer instead of a silicon wafer. Each 4.5 inch
square wafer contains up to 22,000 potential recording heads.
Since our incorporation, we have periodically expanded our wafer fabrication
facility. In 1998, we completed a significant plant expansion increasing our
manufacturing facility from approximately 30,000 square feet to approximately
100,000 square feet and more than doubling our wafer manufacturing capacity.
Our facilities are capable of further expansion. We continuously strive to
develop new manufacturing processes, improve manufacturing yields and achieve
timely delivery of new prototype products for customer qualification.
Slider Fabrication
In the slider fabrication processes, completed wafers are sliced into rows
containing up to 45 candidates per row. The slider fabrication processes
involve high precision shaping technologies utilized to define the slider's or
the head's aerodynamic properties. Precise aerodynamic properties allow the
recording head to "fly" at approximately one to two micro-inches above the disk
surface. The slider rows are subsequently cut into individual sliders and
tested for defects. Our slider capacity is limited and only supports our
technology development and production of limited prototype volumes. We
subcontract volume production of sliders to third parties.
Head Gimbal Assembly and Testing
In the conversion of a slider to a head gimbal assembly, the slider is
attached to a stainless steel suspension. During this process, the electrical
connections are made to electrical contacts on the recording head. The
recording head is then put through tests simulating the environment of a disk
drive so that the performance of the recording head can be measured. The
attributes measured include signal strength, stability and error rate. These
measurements are compared to the specifications of the customer before
shipment. We subcontract volume assembly and testing of head gimbal assemblies
to third parties.
We have limited head gimbal assembly and testing capacity sufficient to
support technology development and limited prototype volumes. Our internal
slider and head gimbal assembly prototype activities facilitate information
feedback to the wafer design and fabrication operations as well as supplying
customers with low volume prototype sample units. These activities serve to
enhance quality, improve wafer yields and reduce development cycle times.
Subcontract Manufacturers
SAE. We utilize subcontract manufacturers for volume production of sliders
and head gimbal assemblies. Currently, our primary subcontract manufacturer is
SAE. In May 1999, we entered into an agreement with SAE and its parent TDK
under which:
. SAE committed to allocate slider and head gimbal assembly capacity to us
or our designee sufficient to manufacture five million head gimbal
assemblies per month;
41
<PAGE>
. we agreed to consign wafers to SAE sufficient to manufacture up to five
million head gimbal assemblies per month, with SAE having the right to
purchase the resulting head gimbal assemblies; and
. SAE agreed to assist MRST in establishing its own slider manufacturing
capacity.
The initial term of this agreement is three years with an automatic one year
renewal on its anniversary date. Either party, however, may terminate the
agreement if it notifies the other party prior to the end of the initial period
or on the anniversary date thereof that it does not wish to extend the
agreement on the next anniversary of the agreement.
MRST. We have invested in MRST, a Hong Kong based joint venture with SFI.
SFI is a Hong Kong based holding company with holdings in the recording head
business among other investments. MRST was created to build and operate on a
limited basis a subcontract manufacturing operation in China. In our agreement
with SAE, SAE has agreed to provide MRST assistance in establishing its
manufacturing capabilities to achieve the output of one million sliders per
month. SAE has the exclusive right to utilize MRST's manufacturing capacity
for three years.
To date, the work we have subcontracted to MRST has been further
subcontracted to SAE. Our investment in MRST has been minimal and MRST has not
established its own slider manufacturing capacity. We currently own 49.5% of
MRST and have an option to acquire another ten percent of MRST from SFI at fair
market value on the purchase date. This option expires on January 1, 2008.
Marketing and Sales
We rely on our application engineers, in conjunction with our materials team,
as our primary sales and marketing force. As of July 3, 1999, there were ten
people in applications engineering and nine people in our materials group. We
have structured our sales approach to treat the different business units of
disk drive companies as separate customers. Disk drive manufacturers typically
have separate teams focused on the server, desktop and mobile segments of the
disk drive market. Each of these teams may have its own management and
engineering personnel, design facilities, manufacturing locations and
technological requirements. By focusing on the individual groups, we hope to
better evaluate, coordinate and respond with value-added products to meet the
unique technological requirements and other needs of each business segment.
This approach is intended to deepen customer relationships and to increase the
likelihood of our products being designed into a particular group's disk drive
products.
Research and Development
Our business is centered around a core team of experienced engineers and
technologists, many of whom are leaders in their particular field or
discipline. As of July 3, 1999, 53 of our research and development engineers
held Doctorate degrees. These engineers are involved in advancing our core
recording head technologies. Research and development expense for the first
six months of 1999 was approximately $16.8 million, and for the fiscal years of
1998, 1997 and 1996 was approximately $25.5 million, $20.3 million and $5.1
million, respectively.
Our research and development efforts are targeted at the enhancement of our
existing recording head products, development of new recording head products
and the evolution and improvement of the processes used to manufacture our
recording head products.
Competition
We compete with other independent recording head suppliers such as ALPS,
Applied Magnetics, Read-Rite, TDK, and its wholly-owned subsidiary SAE, and
Yamaha. In addition, we compete with the captive recording head manufacturing
operations of disk drive companies. Captive producers who produce some or all
of their recording heads for internal use include Fujitsu, Hitachi, IBM and
Seagate.
42
<PAGE>
Some of our competitors have become particularly aggressive in the
development and marketing of recording heads. For example, IBM, a recognized
leader in magneto-resistive technology, has captured significant market share
in the non-captive recording head market. IBM did so by broadly advancing, and
making available to competing disk drive manufacturers, its recording head
products, in direct competition with us. As disclosed below, we have licensed
to IBM our existing patents and future patents that are filed by us prior to
January 1, 2003. This licensing arrangement may allow IBM to compete more
effectively against us in the future.
The market for our products is highly competitive and we expect increased
competition in the future. We have experienced pricing pressures in the past
and will likely experience increased price competition in the future. In
addition to price, we believe that the most important competitive factors in
our industry are timely delivery of high-quality new technologies, customer
support and the ability to reach volume production rapidly. We believe that we
are generally competitive as to these factors.
Intellectual Property and Proprietary Rights
As of September 30, 1999, we had 12 patents issued in the United States.
These patents generally have terms of 20 years from their filing. We also have
31 patent applications pending. Our issued and pending patent applications
relate primarily to recording head designs and related manufacturing processes.
We also have a variety of licenses and cross-licenses with third parties such
as Seagate and Julich for the use of their respective patents and technologies.
As disclosed below, we have licensed to IBM our existing patents and future
patents that are filed by us prior to January 1, 2003. Due to the rapid
technological change that characterizes the recording head industry, we believe
that improvement of existing products, reliance upon trade secrets and
unpatented know-how and development of new products are more important than
patent protection in establishing and maintaining a competitive advantage.
Nevertheless, we believe that patents are of value to our business and we
intend to continue to obtain patents, when available, and to license patents of
other parties in connection with our research and development activities.
However, these owned and licensed patents may not provide us the desired
protection or may be designed around or challenged by our competitors.
In April 1998, we entered into a technology license and purchase agreement
with Seagate. Under this agreement:
. we licensed our DSMR technology to Seagate;
. we received technology transfer fees upon the achievement of milestones;
. Seagate agreed to purchase minimum volumes based on their requirements;
and
. Seagate agreed to pay us a royalty based on head gimbal assemblies
shipped from wafers produced by Seagate utilizing our DSMR technology.
Through July 3, 1999, we have recognized approximately $2.1 million of
royalty revenue, $1.0 million of technology transfer revenues and $61.2 million
of product revenue under minimum purchase obligations from Seagate in
connection with this agreement.
Seagate has used, and we expect Seagate will continue to use through the
first half of fiscal year 2000, the licensed DSMR technology to manufacture a
significant portion of its DSMR wafer demand. However, we do not expect
related royalty payments or purchase obligations to continue to be significant
after the first half of fiscal year 2000.
In July 1999, we entered into a patent license agreement and a technology
transfer agreement with IBM. Under these agreements, among other things:
. we licensed to IBM, for the life of the patents, all of our existing and
future patents that are filed by us prior to January 1, 2003;
43
<PAGE>
. IBM has agreed to license to us, for the life of the patents, 11 IBM
patents issued prior to January 1, 2003;
. we agreed to transfer to IBM know-how related to two write-head related
manufacturing processes;
. we have not recognized and do not expect to recognize any revenues; and
. we agreed to pay IBM a license fee.
Backlog
Our sales are made pursuant to short-term purchase orders. These orders may
be subject to change, cancellation or rescheduling by the customer without
significant penalties. We also believe it is common industry practice for disk
drive manufacturers to place orders in excess of their requirements and to
change or cancel outstanding purchase orders in response to shifting business
conditions. In light of these factors, backlog as of any particular date may
not be indicative of our actual revenue or operating results for a subsequent
period.
Employees
As of July 3, 1999, we had 628 employees including 425 in operations, 174 in
research and development and 29 in general and administrative, all of whom are
located in California. Our employees are not represented by any collective
bargaining agreement, and we have never experienced a work stoppage. We
believe our employee relations are good.
Facilities
We lease premises in three locations in Milpitas, California under three
leases which expire in 2000, 2004 and 2007 covering approximately 165,000 total
square feet. One of the leased facilities is subleased to SAE. We believe our
existing facilities are adequate to meet our needs for the immediate future and
that future growth can be accomplished by leasing additional or alternative
space on commercially reasonable terms.
Legal Proceedings
As of the date of this prospectus, we are not a party to any material legal
proceeding.
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<PAGE>
MANAGEMENT
Executive Officers and Directors
The following table sets forth certain information regarding our executive
officers and directors as of July 3, 1999:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<C> <C> <S>
President, Chief Executive Officer and
Mike Chang, Ph.D. ............. 55 Director
Kochan Ju, Ph.D. .............. 51 Vice President of Technology and Director
Vice President of Operations and
David Begin.................... 52 Marketing
William Bennett................ 53 Vice President of Human Resources
Mao-Min Chen, Ph.D. ........... 49 Vice President of Wafer Process
Thomas Surran.................. 36 Chief Financial Officer
Po-Kang Wang, Ph.D. ........... 45 Vice President of Engineering
Ta-Lin Hsu, Ph.D.(1)........... 56 Chairman of the Board
Tu Chen, Ph.D. (1)............. 64 Vice Chairman of the Board
Irwin Federman(2).............. 64 Director
Heinrich Sussner, Ph.D.(2)..... 50 Director
David Tsang.................... 57 Director
</TABLE>
- -------------------------
(1) Member of the Compensation Committee
(2) Member of the Audit Committee
Mike Chang has served as our President and Chief Executive Officer and as a
member of the board of directors since July 1997. Prior to joining us, from
December 1994 to June 1997, Dr. Chang served as Senior Vice President of
Engineering at SAE Magnetics, Ltd. and served on its board of directors from
April 1996 to June 1997. From August 1989 to November 1994, Dr. Chang served
as Vice President of Disk Drive Research and Development at Conner Peripherals,
Inc., a disk drive company. Dr. Chang holds a B.S. in Electrical Engineering
from National Taiwan University and a Ph.D. in Electrical Engineering from the
University of Notre Dame.
Kochan Ju has served as our Vice President of Technology and as a member of
the board of directors since 1994. Prior to joining us, from September 1992 to
July 1994, Dr. Ju served as Vice President, Technology at Dastek, Inc., a thin
film head manufacturer. Dr. Ju has a number of issued and pending patents in
the area of recording heads. Dr. Ju holds a B.S. in Engineering Science from
Cheng Kung University, an M.S. in Physics from National Taiwan University, an
M.S. in Applied Mathematics from SUNY at Stony Brook and a Ph.D. in Electrical
Engineering from the California Institute of Technology.
David Begin has served as our Vice President of Operations since December
1997. Additionally, Mr. Begin began serving as our Vice President of Marketing
in May 1999. Prior to joining us, from January 1994 to November 1994, Mr.
Begin served as President and Chief Executive Officer at Cambrian Instruments,
a test equipment manufacturer. From January 1992 to December 1993, Mr. Begin
was Chief Operating Officer at Akashic Memories, a thin film media
manufacturer. Mr. Begin also held various management positions at IBM,
including management of recording head manufacturing and thin film media
operations. Mr. Begin received his B.S. in Chemical Engineering from
Northeastern University.
William Bennett has served as our Vice President of Human Resources since
August 1997. From July 1996 to July 1997, Mr. Bennett worked as a private
consultant for other technology companies. Mr. Bennett served as Vice
President of Human Resources at Cirrus Logic, Inc., a semiconductor company,
from June 1989 to July 1996. Previously, Mr. Bennett was Vice President of
Human Resources at System Industries, Inc. and Monolithic Memories, Inc. Mr.
Bennett received his A.A.S. in Industrial Relations from Brooklyn College.
45
<PAGE>
Mao-Min Chen has served as our Vice President of Wafer Process since our
inception in July 1994. Prior to joining us, Dr. Chen was Director of Process
Technologies at Dastek, Inc., a thin film head manufacturer, from July 1993 to
July 1994. Dr. Chen has a number of issued and pending patents in recording
head technology. Dr. Chen holds a B.S. in Nuclear Engineering from National
Tsing-Hua University and a Ph.D. in Materials Science from the University of
Minnesota.
Thomas Surran joined us in July 1994 as our Director of Finance and became
our Chief Financial Officer in September 1994. From June 1991 to June 1994,
Mr. Surran served in various financial management positions including Director
of Finance and Controller with Everex Systems, Inc., a personal computer
manufacturer. Prior to joining Everex Systems, Inc., Mr. Surran held various
positions at Sorrento Associates, Inc., a venture capital firm, and Heller
Financial, Inc. Mr. Surran received his B.S. from Xavier University and his
M.B.A. from the University of Chicago.
Po-Kang Wang has served as our Vice President of Engineering since October
1997. From April 1995 to October 1997, Dr. Wang served as Vice President,
Advanced Head Design at SAE Magnetics, Ltd. From March 1993 to April 1995, Dr.
Wang served as the Executive Director of Channel Integration at Conner
Peripherals, Inc., a disk drive company. Dr. Wang has a number of issued and
pending patents in the area of recording head technology. Dr. Wang holds a
B.S. in Physics from National Taiwan University, an M.S. in Physics from Tsing-
Hua University and a Ph.D. in Physics from the University of Illinois.
Ta-Lin Hsu has served as our Chairman of the board of directors since
February 1997. Dr. Hsu joined Hambrecht & Quist in 1985 as a General Partner
and became the Managing Director of H&Q Asia Pacific in July 1987. Dr. Hsu
became President of H&Q Asia Pacific in 1990 and its Chairman in 1993. Dr. Hsu
holds a B.S. in Physics from National Taiwan University, an M.S. in
Electrophysics from Polytechnic Institute of Brooklyn and a Ph.D. in Electrical
Engineering from the University of California, Berkeley.
Tu Chen currently serves as our Vice Chairman of the board and served as
Chairman of the board from 1994 to 1996. Dr. Chen is a co-founder of Komag, a
thin film media manufacturer, and served as the Chairman of its board of
directors from its inception in 1983 until August 1999. Previously, Dr. Chen
was a research scientist at Xerox Corporation's Palo Alto Research Center and
Northrop Corp. Dr. Chen also serves as a director of several private
companies. Dr. Chen received his B.S. from Cheng-Kung University and his M.S.
and Ph.D. from the University of Minnesota.
Irwin Federman has been a member of our board of directors since February
1997. Since April 1990, Mr. Federman has been a general partner of U.S.
Venture Partners, a venture capital investment firm. Mr. Federman also serves
on the board of directors of Checkpoint Software Technologies, Ltd., Komag,
Incorporated, SanDisk Corporation, MMC Networks, Inc., Netro Corporation and
Western Digital Corporation. Mr. Federman holds a B.S. in Economics from
Brooklyn College and an honorary Doctorate of Engineering Science from Santa
Clara University.
Heinrich Sussner has been a member of our board of directors since February
1997. Dr. Sussner has served as Senior Managing Director with H&Q Asia Pacific
since July 1998. From October 1996 to June 1998, Dr. Sussner served as Chief
Technical Officer at Phase Metrics, Inc. From 1980 to 1996, Dr. Sussner held
several technical and management positions with IBM, including serving as
Director of IBM's Almaden Research Facility for data storage technology and as
Executive Consultant for technology investments in Europe.
David Tsang has been a member of our board of directors since April 1998.
Mr. Tsang is the founder of Oak Technology, Inc., a semiconductor company, and
has served as its President from inception in July 1987 until January 1998, as
a director of Oak Technology since October 1987 and as Chairman of its board
since January 1991. Mr. Tsang is also a director of ASE Test, Ltd. Mr. Tsang
holds a B.S. in Electrical Engineering from Brigham Young University and an
M.S. in Electrical Engineering from Santa Clara University.
46
<PAGE>
In September 1999, Mr. Tsang, without admitting or denying guilt, consented
to the entry of a civil judgement relating to alleged violations of the
antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934
and Rule 10b-5 under this act. The SEC had alleged that, prior to a favorable
earnings announcement by Oak Technology for the quarter ended December 31,
1995, Mr. Tsang, then Oak Technology's chairman and president, conveyed this
information to his brother. Mr. Tsang's brother and sister-in-law then
allegedly traded profitably in Oak Technology securities based on this
information.
Our directors have been divided into three classes: Class I, Class II and
Class III. Members of each class hold office for staggered three-year terms.
Messrs. Chang and Sussner are our Class I directors, Messrs. Federman and Ju
are our Class II directors; and Messrs. Chen, Hsu and Tsang are our Class III
directors. The terms of our Class I, Class II and Class III directors will
expire at the annual meeting of our stockholders in 2000, 2001 and 2002,
respectively. At each annual stockholder meeting, stockholders will elect a
successor for each director whose term expires at the meeting. Newly elected
directors will then hold office until the third annual meeting of stockholders
following their election and until their respective successors have been duly
elected and qualified or until their earlier resignation or removal. Officers
serve at the discretion of the board of directors and are appointed annually.
There are no family relationships between any of our directors or executive
officers.
Board Committees
Audit Committee. The audit committee of the board of directors consists of
Mr. Irwin Federman and Dr. Heinrich Sussner. The audit committee aids
management in the establishment and supervision of our financial controls,
evaluates the scope of the annual audit, reviews audit results, consults with
management and our independent auditors prior to the presentation of financial
statements to stockholders and, as appropriate, initiates inquiries into
aspects of our financial affairs.
Compensation Committee. The compensation committee of the board of directors
consists of Dr. Tu Chen and Dr. Ta-Lin Hsu. The compensation committee is
responsible for determining salaries, incentives and other forms of
compensation for directors, officers and other employees and administers
various incentive compensation and benefit plans.
Director Compensation and Other Arrangements
Directors do not currently receive cash compensation for their service as
directors. Non-employee directors are eligible to participate in our Director
Option Plan and 1997 Stock Option Plan. Effective upon completion of this
offering, non-employee directors will receive, in addition to actual expenses
incurred, an annual retainer of $12,000, $1,000 for each board of directors
meeting attended, and $750 for attending committee meetings if no board of
directors meeting is held on that date. Effective upon consummation of this
offering, each non-employee director will receive the first annual grant of
12,500 options under our Director Option Plan.
Compensation Committee Interlocks and Insider Participation
None of our executive officers serve as a member of the compensation
committee of the board of directors or on the compensation committee of any
entity that has one or more executive officers serving as a member of our board
of directors or compensation committee.
Employment Contracts and Change of Control Arrangements
We do not currently have any employment contract in effect with our executive
officers. Accordingly, the employment of any of our executive officers may be
terminated at any time at the discretion of the board of directors.
47
<PAGE>
Executive Compensation
The following table contains information in summary form concerning the
compensation paid to our chief executive officer and each of our most highly
compensated executive officers whose total salary, bonus and other compensation
exceeded $100,000 during the fiscal year ended January 2, 1999. In accordance
with the rules of the SEC, the compensation described in this table does not
include perquisites and other personal benefits received by the executive
officers named in the table below which do not exceed the lesser of $50,000 or
ten percent of the total salary and bonus reported for these officers.
Officer Promissory Note. In December 1997, we loaned $400,000 to David Begin,
Vice President of Operations and Marketing, as a hiring incentive. In
connection with the loan, Mr. Begin executed a promissory note that bears
interest at 5.93% per annum, compounded semiannually, and is due and payable on
the earlier of (a) January 1, 2001, (b) ten days following his voluntary
termination of employment with us, or (c) ten days following his termination of
employment by us for cause. We also entered into a debt forgiveness agreement
which forgives Mr. Begin's obligation to pay principal and accrued interest to
us pursuant to the note, in $100,000 increments plus accrued interest per year
if he is employed by us on January 1, 1998, January 1, 1999, January 1, 2000
and January 1, 2001. Mr. Begin's obligation will also be forgiven upon a sale
or transfer by merger, sale of stock or otherwise of a majority of our
outstanding voting securities, provided that Mr. Begin is employed by us at the
time of the event.
Summary Compensation Table
<TABLE>
<CAPTION>
1998 Annual
Compensation(1)
--------------- All Other 1998
Name and Principal Positions Salary Bonus Compensation
- ---------------------------- -------- ------ --------------
<S> <C> <C> <C>
Mike Chang....................................... $264,472 -- --
President and Chief Executive Officer
David Begin(2)................................... 172,817 -- 100,000
Vice President of Operations and Marketing
Kochan Ju........................................ 214,277 50,657 --
Vice President of Technology
Mao-Min Chen..................................... 200,221 41,457 --
Vice President of Wafer Process
Po-Kang Wang..................................... 200,215 5,757 --
Vice President of Engineering
</TABLE>
- --------
(1) Includes salary or bonus earned in the fiscal year of 1997 but paid in the
fiscal year of 1998.
(2) Other 1998 compensation includes partial forgiveness of debt.
48
<PAGE>
Option Grants in Last Fiscal Year
The following table contains information in summary form concerning stock
options awarded to the executive officers named in the summary compensation
table during the year ended January 2, 1999. All such options were awarded
under our 1997 Stock Option Plan.
<TABLE>
<CAPTION>
Individual Grants(1)
---------------------------------------------
Potential
Realized Value
at Assumed
Annual Rates of
Number of % of Stock Price
Securities Total Options Appreciation for
Underlying Granted to Exercise Option Term(3)
Options Employees in Price Per Expiration ----------------
Name Granted 1998(2) Share Date 5% 10%
- ---- ---------- ------------- --------- ---------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Mike Chang...... 0 -- -- -- -- --
David Begin..... 40,000 1.57% $2.25 12/01/08 $56,600 $143,435
Kochan Ju....... 0 -- -- -- -- --
Mao-Min Chen.... 0 -- -- -- -- --
Po-Kang Wang.... 0 -- -- -- -- --
</TABLE>
- --------
(1) All options granted during the fiscal year were granted under our 1997
Stock Option Plan. Each option becomes exercisable upon grant and vests
according to a vesting schedule, subject to the employee's continued
employment with us.
(2) In fiscal 1998, we granted employees and consultants options to purchase an
aggregate of 2,548,905 shares of our common stock.
(3) We are including the gains or "option spreads" that would exist for the
options we granted to our named executive officer. We calculate these
gains by assuming an annual compounded stock price appreciation of five
percent and ten percent, respectively, from the date of the option grant
until the termination date of the option. These option spreads are not
estimates or projections of our future common stock price.
Aggregated Options Exercised in Last
Fiscal Year and Fiscal Year-End Option Values
The following table contains information in summary form concerning the
exercise of stock options by the executive officers named in the summary
compensation table during the fiscal year ended January 2, 1999 and stock
options held as of January 2, 1999 by these executive officers.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options at
Shares Options at Fiscal Year End Fiscal Year End(1)
Acquired Value ----------------------------- -------------------------
Name on Exercise Realized Exercisable (2) Unexercisable Exercisable Unexercisable
- ---- ----------- -------- --------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Mike Chang.............. -- -- 489,141 -- 2,367,442 --
David Begin............. -- -- 200,000 -- 790,000 --
Kochan Ju............... 10,000 $ 59,000 481,064 -- 2,748,757 --
Mao-Min Chen............ 91,842 207,237 389,222 -- 2,206,889 --
Po-Kang Wang............ -- -- 300,000 -- 1,452,000 --
</TABLE>
- --------
(1) Represents the difference between the the assumed initial offering price of
$6.00 and the exercise of such options.
(2) All options described herein are subject to early exercise provisions as
set forth in each optionee's respective stock option agreement. Certain
exercisable options may be partially or completely unvested according to
the vesting schedules contained in each such stock option agreement.
49
<PAGE>
Employee Benefit Plans
1997 Stock Option Plan
Our stock option plan became effective in February 1997. In August 1999, our
board of directors amended and restated the option plan reserving a total of
10,159,107 shares of common stock for issuance under the option plan, plus an
annual increase to be added each year on the date of the annual stockholders
meeting equal to the lesser of
. four percent of the outstanding shares on such date;
. 1,500,000 shares; or
. an amount determined by our board of directors.
In August 1999, our stockholders approved this amendment. As of July 3,
1999, 1,211,144 shares of common stock had been issued upon the exercise of
options granted under the option plan. The number of options outstanding under
the option plan includes:
. 5,304,953 shares of common stock issuable upon the exercise of
outstanding options as of July 3, 1999 at an average exercise price of
$1.15 per share;
. 56,161 shares of common stock issuable, net of cancellations, upon the
exercise of options granted between July 3, 1999 and August 19, 1999 at
an average exercise price of $4.50 per share; and
. 1,029,946 shares of common stock issuable upon the exercise of options
granted on August 19, 1999 at an exercise price of $5 per share.
Our stock option plan provides for grants of incentive stock options within
the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, to
employees (including officers and employee directors) and nonstatutory stock
options to employees (including officers and employee directors), non-employee
directors and consultants. The purpose of the option plan is to attract and
retain the best available personnel for positions of substantial responsibility
and to provide additional incentive to employees and consultants to promote the
success of our business. The option plan may be administered by the board of
directors or a committee of the board of directors. The board of directors or
the committee determines the optionees and the terms of options granted,
including the exercise price, number of shares subject to the option and the
exercisability thereof. Options granted under the option plan are generally
not transferable by the optionee. Options granted under the option plan must
generally be exercised within three months of the end of optionee's status as
an employee or consultant, within six months after such optionee's termination
by disability or within 12 months after such optionee's termination by death or
permanent disability, but in no event later than the expiration of the option's
term. The exercise price of an option is determined by the board or committee
administering the plan. However, the exercise price of incentive stock options
cannot be less than 100% of the fair market value of common stock on the date
of grant. With respect to any participant who owns stock possessing more than
ten percent of the voting power of all classes of our stock, the exercise price
of any incentive stock option granted must equal at least 110% of the fair
market value on the grant date and the maximum term of the incentive stock
option must not exceed five years. The term of all other options granted under
the option plan may not exceed ten years.
The standard forms of our incentive stock option agreement and nonstatutory
stock option agreement contain provisions for the early exercise of unvested
stock options. Such option agreements contain provisions for the repurchase of
unvested shares by us with 60 days written notice to an optionee under certain
circumstances described in these agreements.
In the event of a change in control, including a merger into another
corporation, a sale of substantially all of our assets or our liquidation or
dissolution, the option plan allows each outstanding option to be assumed or an
equivalent option substituted by the successor corporation. In the event the
successor corporation refuses to assume or substitute for the outstanding
options, each outstanding option will be fully vested and exercisable for a
period of ten days prior to the date of the change of control, including shares
as to which it
50
<PAGE>
would not otherwise be vested. If the option is not assumed or substituted or
exercised prior to the date of the change of control, such outstanding option
shall terminate and cease to be outstanding as of the effective date of the
change of control. Unless terminated sooner, the option plan will terminate
ten years from its effective date. The board of directors has authority to
amend or terminate the option plan, provided that no such action may impair the
rights of the holder of any outstanding options without the written consent of
such holder.
1999 Employee Stock Purchase Plan
Our 1999 employee stock purchase plan was adopted by the board of directors
in August 1999 and approved by the stockholders in August 1999 and will be
effective upon consummation of the initial public offering. A total of
750,000 shares of common stock has been authorized for issuance under the
purchase plan, plus an annual increase to be added on January 1 of each year
equal to the number of shares needed to restore the maximum number of shares of
common stock that may be available for grant under the purchase plan to 750,000
shares.
The purchase plan, which is intended to qualify under Section 423 of the
Internal Revenue Code of 1986, as amended, contains consecutive, overlapping 24
month offering periods. Each offering period consists of four purchase
periods, each approximately six months in length. The offering periods
generally start on the first trading day on or after February 1 and August 1 of
each year, except for the first such offering period which commences on the
first trading day on or after the effective date of this offering and ends on
the last trading day on or before January 31, 2002.
Employees are eligible to participate in the purchase plan if they are
customarily employed by us or any participating subsidiary for at least 20
hours per week and more than five months in any calendar year. However, any
employee who (a) immediately after grant owns stock possessing five percent or
more of the total combined voting power or value of all classes of our capital
stock or (b) whose rights to purchase stock under all of our employee stock
purchase plans accrues at a rate that exceeds $25,000 worth of stock for each
calendar year may not be granted an option to purchase stock under the purchase
plan.
The purchase plan permits eligible employees to purchase common stock through
payroll deductions, which may not exceed ten percent of an employee's
compensation. Compensation is defined to include the participant's gross
earnings, commissions, overtime and shift premiums, but excludes bonuses. The
price of stock purchased under the purchase plan is equal to 85% of the fair
market value of the common stock at the beginning of each offering period or
the last day of the purchase period, whichever is lower. The maximum number of
shares a participant may purchase during a single purchase period is 5,000
shares.
Rights granted under the purchase plan are not transferable by a participant
other than by will, the laws of descent and distribution or as otherwise
provided under the purchase plan. The purchase plan provides that, in the
event of our merger with or into another corporation or a sale of substantially
all of our assets, each outstanding option shall be assumed or substituted for
by the successor corporation. If the successor corporation refuses to assume
or substitute for the outstanding options, the offering period then in progress
will be shortened and a new exercise date will be set with the new exercise
date occurring before the proposed sale or merger. The purchase plan will
terminate ten years from its effective date. The board of directors has the
authority to amend or terminate the purchase plan, except that generally no
such action may adversely affect any outstanding rights to purchase stock under
the purchase plan. The board of directors has discretion to amend the purchase
plan in the event that the operation of the purchase plan would result in
unfavorable financial accounting consequences.
Director Option Plan
Our 1999 director option plan was adopted by the board of directors in August
1999 and approved by the stockholders in August 1999. A total of 150,000
shares of common stock has been reserved for issuance under the director plan,
plus an annual increase to be added each year on the day after the date of the
51
<PAGE>
annual stockholder meeting equal to the lesser of (a) the number of shares
needed to restore the maximum number of shares available for grant to 150,000
shares or (b) an amount determined by the board of directors. The outside
directors are eligible to participate in the director plan, which provides for
the grant of nonstatutory stock options pursuant to an automatic,
nondiscretionary grant mechanism. The director plan provides that each outside
director, except for employee directors who become outside directors, shall be
granted a nonstatutory stock option to purchase 50,000 shares of common stock
on the date that the person first becomes an outside director. Thereafter,
each outside director shall be automatically granted an option to purchase
12,500 shares of common stock each year on the date of the annual stockholders
meeting provided that the director has served on the board for at least the
preceding six months. The director plan provides that the initial option shall
become vested as to 25% of the shares subject to the option on the first
anniversary of its date of grant, with monthly vesting thereafter. Each
subsequent option shall become vested in equal monthly installments over a one
year period beginning after all previously granted options have fully vested.
The exercise price per share of all options granted under the director plan
shall be equal to the fair market value of a share of our common stock on the
date of grant. Options granted to outside directors under the director plan
have a ten year term. These options, however, will expire unless exercised
within three months following the termination of an outside director's status
as a director for any reason other than death or disability or within 12 months
following the termination of an outside director's status as a director due to
death or disability. In the event of a merger or sale of substantially all of
our assets, all outstanding options may be assumed or substituted by the
successor corporation. They are not assumed or substituted, they shall become
fully vested and exercisable for a period of 30 days from the date the board
notifies the optionee of the option's full vesting, after which period the
option shall terminate. Assumed options become fully vested and exercisable if
the director ceases his or her status with us or any successor company other
than, by a voluntary resignation. Generally, no option granted under the
director plan is transferable by the optionee other than by will or the laws of
descent and distribution. If not terminated earlier, the director plan will
have a term of ten years.
Limitation of Liability and Indemnification Matters
Our Amended and Restated Certificate of Incorporation limits the liability of
directors to the fullest extent permitted by the Delaware General Corporation
Law. Under Delaware law, a director's liability to a company or its
stockholders may not be limited with respect to
. any breach of his duty of loyalty to the company or its stockholders;
. acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
. unlawful payments or dividends or unlawful stock repurchases or
redemptions; or
. transactions from which the director derived an improper personal
benefit.
Our bylaws provide that we shall indemnify our officers and directors and may
indemnify our employees and agents in certain circumstances. We have also
entered into agreements to indemnify our directors and executive officers, in
addition to the indemnification provided for in our bylaws. We believe that
these provisions and agreements are necessary to attract and retain qualified
directors and executive officers. Our bylaws also permit us to secure
insurance on behalf of any officer, director, employee or other agent for any
liability arising out of his or her actions, regardless of whether Delaware law
would permit indemnification. In addition, we maintain directors' and
officers' liability insurance.
There is no pending litigation or proceeding involving any of our directors,
officers, employees or agents where indemnification will be required or
permitted. We are not aware of any pending or threatened litigation or
proceeding that might result in a claim for such indemnification.
52
<PAGE>
RELATED PARTY TRANSACTIONS
The Recapitalization. In January 1997, Headway Technologies, Inc.
(California), a wholly-owned subsidiary of Headway Technologies, Inc., was
acquired in a recapitalization by an investor group led by H&Q Asia Pacific.
In addition to the related transactions described below, the recapitalization
was effected through the following series of transactions:
. the investor group formed and capitalized a new Delaware corporation,
Headway Technologies, Inc. (which at that time was called Headway
Holdings, Inc.);
. we formed a wholly-owned subsidiary which was merged with and into
Headway California, with Headway California becoming our wholly-owned
subsidiary; and
. all outstanding shares of capital stock of Headway California were
converted into the right to receive cash in an aggregate amount of $22.0
million. Of the $22.0 million in aggregate proceeds distributed to former
Headway California shareholders, the four largest shareholders HP, Komag,
Inc., Asahi Komag Co., Ltd., and Asahi Glass America, Inc. collectively
received $21.9 million, representing approximately 73.0% of their total
$30.0 million cash investment.
The recapitalization was funded by:
. the purchase by the investor group of approximately $35.0 million of
Series A preferred stock at a per share price of $2.39; and
. aggregate loan commitments by industry lenders, including Western Digital
and Maxtor of approximately $18.0 million of which $11.0 million was
funded at or shortly following closing. As of July 3, 1999, $13.4
million was owed to the industry lenders. All of the loan commitments by
the industry lenders are unsecured and bear interest at annual rates
ranging from 5.0% to 8.5%, compounded monthly. Amounts repaid to the
industry lenders under these commitments are in part determined by
product purchases. For the $11.0 million of notes payable to customers at
July 3, 1999, in addition to scheduled loan repayments at the time of
these scheduled payments we are required to repay additional principal in
an amount equal to 10% of product purchases during the relevant period.
All loan repayments, including any increase related to product purchases,
are paid in cash.
53
<PAGE>
[RECAPITALIZATION CHART APPEARS HERE]
In connection with the recapitalization, HP and Asahi Komag guaranteed to
third-party creditors our performance under existing equipment leasing
obligations of Headway California, which equals an aggregate amount of $13.5
million. In consideration of each guarantor's agreement to permit the guaranty
to remain in effect, we entered into an agreement with the guarantors in which
we agreed to reimburse the guarantors for any payments made by them pursuant to
the guaranties and to secure a portion of such reimbursement obligation with
certain equipment owned by us.
We entered into an agreement amending the Master Technology License Agreement
between HP, Komag, Asahi Komag and Headway California. Under the amended
license agreement, HP, Komag and Asahi Komag granted exclusive licenses to us
with respect to recording head technologies for disk drives. In turn, we
granted the licensees a nonexclusive license to manufacture, using our
technology, products outside the scope of our core business including
technology previously licensed to us by the licensees on an exclusive basis,
that was in the licensees' possession prior to the recapitalization or for
which we had obtained or applied for a patent prior to the recapitalization.
Under this license, (a) HP was granted the right to manufacture heads for tape
drives and floppy disk drives that are manufactured by or for HP, provided that
HP shall have first offered us the opportunity to manufacture such heads for
HP, and (b) Komag and Asahi Komag were granted the right to use our technology
to manufacture certain media products such as storage disks.
Series A Preferred Stock and Warrants. In connection with the
recapitalization, we issued to Hambrecht & Quist LLC a warrant to purchase
389,918 shares of our common stock at a purchase price of
54
<PAGE>
$0.10 per share. The purchasers of Series A preferred stock in the
recapitalization included, among others, the following officers, directors and
holders of more than five percent of our voting securities:
<TABLE>
<CAPTION>
Shares of
Preferred Stock(1)
------------------
<S> <C>
Ta-Lin Hsu(2)................................................ 9,607,428
Irwin Federman(3)............................................ 1,670,857
Western Digital (Tuas-Singapore) pte Ltd. ................... 2,924,000
Maxtor Corporation........................................... 417,715
</TABLE>
- --------
(1) The purchasers of these securities are entitled to registration rights.
See "Description of Capital Stock--Registration Rights."
(2) Represents 6,683,429 shares held by Asia Pacific Growth Fund II, L.P. of
which H&Q Asia Pacific II, L.L.C. is its General Partner, 1,670,857 shares
held by China Dynamic Growth Fund, L.P. of which H&Q Asia Pacific, Ltd. is
its General Partner, 626,571 shares held by H&Q Philippines Ventures II,
Inc. of which Hambrecht & Quist LLC owns a minority equity interest and H&Q
Asia Pacific, Ltd. owns shares and participates in management and 626,571
shares held by HanTech Venture Capital Corporation of which Hambrecht &
Quist LLC owns a minority equity interest and H&Q Asia Pacific, Ltd. owns
shares and participates in management. Dr. Hsu is Chairman, President and
Managing Director of H&Q Asia Pacific.
(3) Represents collectively 1,503,771 shares held by U.S. Venture Partners V,
L.P. of which Presidio Management Group V, L.L.C. is its General Partner,
83,543 shares held by USVP V International, L.P. of which Presidio
Management Group V, L.L.C. is its General Partner, 46,784 held by 2180
Associates Fund V of which Presidio Management Group V, L.L.C. is its
General Partner and 36,759 shares held by U.S. Venture Partners V Ent.,
L.P. Mr. Federman is a Managing Member of Presidio Management Group, V,
L.L.C., and is the general partner of each of U.S. Venture Partners V,
L.P., USVP V International, L.P., 2180 Associates Fund V, L.P. and USVP V
Entrepreneurs Partners, L.P.
On March 11, 1998, we sold 1,144,535 shares of our Series A preferred stock
at a price of $2.39 per share in a private placement transaction, including
sales to certain members of the investor group who participated in the January
1997 recapitalization. The purchasers of the preferred stock included, among
others, the following officers, directors and holders of more than five percent
of our voting securities:
<TABLE>
<CAPTION>
Shares of
Preferred Stock(1)
------------------
<S> <C>
Heinrich Sussner............................................. 62,657
Tu Chen...................................................... 62,657
Irwin Federman(2)............................................ 208,857
Western Digital (Tuas-Singapore) pte Ltd..................... 281,956
</TABLE>
- --------
(1) The purchasers of these securities are entitled to registration rights.
(2) Represents collectively 187,971 shares held by U.S. Venture Partners V,
L.P. of which Presidio Management Group V, L.L.C. is its General Partner,
10,443 shares held by USVP V International, L.P. of which Presidio
Management Group V, L.L.C. is its General Partner, 4,595 shares held by
USVP V Entrepreneur International, L.P. of which Presidio Management Group
V, L.L.C. is its General Partner and 5,848 held by 2180 Associates Fund V
of which Presidio Management Group V, L.L.C. is its General Partner. Mr.
Federman is a Managing Member of Presidio Management Group, V, L.L.C., and
is the general partner of each of U.S. Venture Partners V, L.P., USVP V
International, L.P., 2180 Associates Fund V, L.P. and USVP V Entrepreneurs
Partners, L.P.
Other Transactions. In connection with the commencement of employment of our
Vice President of Operations, we entered into a loan agreement of $400,000. See
" Management--Employment Contracts and Change of Control Arrangements."
55
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth the beneficial ownership of our common stock
as of July 3, 1999, and as adjusted to reflect the sale of the shares of common
stock in this offering, by:
. each person or entity known by us to own beneficially more than five
percent of our common stock;
. our chief executive officer and each of the executive officers named in
the summary compensation table and each of our directors; and
. all of our executive officers and directors as a group.
The address of all the beneficial owners, unless otherwise noted, is 678 South
Hillview Drive, Milpitas, California 95035.
The beneficial ownership is calculated based on 16,977,679 shares of our
common stock outstanding as of July 3, 1999 and 21,177,679 shares outstanding
immediately following the completion of this offering. Beneficial ownership is
determined in accordance with the rules of the SEC and generally includes
voting and investment power with respect to securities. Unless otherwise
indicated, each person or entity named in the table has sole voting and
investment power with respect to all shares of capital stock listed as owned by
such person. Shares issuable upon the exercise of options that are currently
exercisable or become exercisable within 60 days of July 3, 1999 are considered
outstanding for the purpose of calculating the percentage ownership of the
person holding the options but are not deemed outstanding for computing the
percentage ownership of any other person. All of the options and warrants held
by the beneficial owners in the table below will be immediately exercisable and
vested upon consummation of this offering.
The number of shares includes 15,764,535 shares of common stock issuable upon
conversion of our Series A convertible preferred stock upon consummation of
this offering.
<TABLE>
<CAPTION>
Percentage of
Shares Outstanding
----------------------
Number of Shares Before this After this
Name and Address Beneficially Owned Offering Offering
- ---------------- ------------------ ----------- ----------
<S> <C> <C> <C>
Ta-Lin Hsu(1)..................... 9,634,428 56.7% 45.5
H&Q Asia Pacific, Ltd.
One Bush Street
San Francisco, CA 94104
Western Digital (Tuas Singapore)
pte Ltd.......................... 3,205,956 18.9 15.1
8105 Irvine Center Drive
Irvine, CA 92718
Irwin Federman(2)................. 1,904,714 11.2 9.0
US Venture Partners
2180 Sand Hill Road, Suite 300
Menlo Park, CA 94025
Mao-Min Chen(3)................... 491,064 2.9 2.3
Kochan Ju(4)...................... 491,064 2.9 2.3
Mike Chang(5)..................... 489,141 2.9 2.3
Po-Kang Wang...................... 300,000 1.8 1.4
David Begin....................... 200,000 1.2 *
Heinrich Sussner(6)............... 112,657 * *
Tu Chen(7)........................ 112,657 * *
David Tsang....................... 50,000 * *
Executive officers and directors
as a group (12 persons)(8)....... 14,121,173 83.2 66.7
</TABLE>
- ---------------------
*Represents less than 1% of our outstanding common stock.
56
<PAGE>
(1) Includes 25,000 shares subject to options exercisable within 60 days of
July 3, 1999. Represents 6,685,429 shares held by Asia Pacific Growth Fund
II, L.P. of which H&Q Asia Pacific II, L.L.C. is its General Partner;
1,670,857 shares held by China Dynamic Growth Fund, L.P. of which H&Q Asia
Pacific, Ltd. is the general partner of China Dynamic's general partner;
626,571 shares held by H&Q Philippines Ventures II, Inc. of which
Hambrecht & Quest LLC owns a minority equity interest and H&Q Asia
Pacific, Ltd. owns shares and participates in management; and 626,571
shares held by HanTech International Venture Capital Corporation of which
Hambrecht & Quist LLC owns a minority equity interest and H&Q Asia
Pacific, Ltd. owns shares and participates in management. Dr. Hsu is
Chairman, President and Managing Director of H&Q Asia Pacific, Ltd.
(2) Includes 25,000 shares subject to options exercisable within 60 days of
July 3, 1999. Represents ownership by the following entities of which
Presidio Management Group V, L.L.C. is the General Partner: 46,784 shares
held by 2180 Associates Fund V; 1,503,771 shares held by U.S. Venture
Partners, L.P.; 36,759 shares held by U.S. Venture Partners V Enterprises,
L.P.; and 83,543 shares held by USVP V International, L.P. Mr. Federman
is a Director of the Company and a Managing Member of Presidio Management
Group, V, L.L.C., and is the General Partner of each of U.S. Venture
Partners V, L.P., USVP V International, L.P., 2180 Associates Fund V, L.P.
and USVP V Entrepreneurs Partners, L.P.
(3) Includes 389,222 shares subject to options exercisable within 60 days of
July 3, 1999. Dr. Chen is Vice President of Wafer Process.
(4) Includes 481,064 shares subject to options exercisable within 60 days of
July 3, 1999. Dr. Ju is a Director and Vice President of Technology.
(5) Includes 489,141 shares subject to options exercisable within 60 days of
July 3, 1999. Dr. Chang is a Director, President and Chief Executive
Officer.
(6) Includes 50,000 shares subject to options exercisable within 60 days of
July 3, 1999. Dr. Sussner is a Director.
(7) Includes 50,000 shares subject to options exercisable within 60 days of
July 3, 1999. Dr. Chen is a Director.
(8) Includes 2,059,427 shares subject to options exercisable within 60 days of
July 3, 1999 held by our executive officers and directors.
57
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering, we will be authorized to issue 75,000,000
shares of common stock, $.001 par value, and 5,000,000 shares of undesignated
preferred stock, $0.001 par value.
The following summary of certain provisions of our capital stock describes
all material provisions of, but is not complete and is subject to, our Amended
and Restated Certificate of Incorporation and our bylaws that are included as
exhibits to the registration statement of which this prospectus forms a part
and by the provisions of applicable law. Our Amended and Restated Certificate
of Incorporation and bylaws contain certain provisions that are intended to
enhance the likelihood of continuity and stability in the composition of our
board of directors and that may have the effect of delaying, deferring or
preventing a future takeover or change in control unless such takeover or
change in control is approved by our board of directors.
Common Stock
As of July 3, 1999, there were 16,977,679 shares of common stock outstanding
held of record by approximately 148 stockholders.
The issued and outstanding shares of common stock are, and the shares of
common stock being offered by us will be, upon payment therefor, validly
issued, fully paid and nonassessable. Subject to the prior rights of the
holders of any preferred stock, the holders of outstanding shares of common
stock are entitled to receive dividends out of assets legally available
therefor at such times and in such amounts as the board of directors may from
time to time determine. The shares of common stock are neither redeemable nor
convertible and the holders thereof have no preemptive or subscription rights
to purchase any of our securities. Upon our liquidation, dissolution or
winding up, the holders of our common stock are entitled to share ratably in
all of our assets that are legally available for distribution, after payment of
all debts and other liabilities and subject to the prior rights of any holders
of any preferred stock then outstanding. Each outstanding share of our common
stock is entitled to one vote on all matters submitted to a vote of
stockholders and has cumulative voting rights with respect to the election of
directors.
Warrants
As of July 3, 1999, there were outstanding warrants to purchase (a) an
aggregate of 389,918 shares of our common stock at an exercise price of $0.10
per share, which expires on February 4, 2002, and (b) an aggregate of 179,816
shares of common stock at an exercise price of $2.39 per share, which expires
on March 31, 2003. The first warrant will be automatically deemed exercised in
full immediately prior to (a) the time the warrant would otherwise expire or
(b) a sale of the company.
Preferred Stock
Effective upon the closing of this offering, we will be authorized to issue
5,000,000 shares of undesignated preferred stock. The board of directors has
the authority to issue preferred stock in one or more series and to fix the
price, rights, preferences, privileges and restrictions thereof, including
dividend rights, dividend rates, conversion rights, voting rights, terms of
redemption, redemption prices, liquidation preferences and the number of shares
constituting a series or the designation of such series, without any further
vote or action by our stockholders. The issuance of preferred stock, while
providing desirable flexibility in connection with possible recapitalizations
and other corporate purposes, could have the effect of delaying, deferring or
preventing our change in control without further action by the stockholders and
may adversely affect the market price of our common stock and the voting and
other rights of the holders of common stock. We have no current plans to issue
any shares of preferred stock.
Certain Provisions of Delaware Law
We are subject to Section 203 of the Delaware General Corporation Law.
Section 203 prohibits a publicly held Delaware corporation from engaging in a
business combination with an interested stockholder
58
<PAGE>
for a period of three years after the date of the transaction in which the
person became an interested stockholder, unless: (a) prior to such date, the
board of directors of the corporation approves either the business combination
or the transaction that resulted in the stockholder becoming an interested
stockholder; (b) upon consummation of the transaction that resulted in the
stockholder becoming an interested stockholder, the interested stockholder owns
at least 85% of the outstanding voting stock, excluding certain shares held by
employee directors and employee stock plans; or (c) on or after the
consummation date the business combination is approved by the board of
directors and by the affirmative vote of at least 66 2/3% of the outstanding
voting stock that is not owned by the interested stockholder.
Section 203 defines a business combination to include: (a) any merger or
consolidation involving the corporation and the interested stockholder; (b) any
sale, transfer, pledge or other disposition of ten percent or more of the
assets of the corporation involving the interested stockholder; (c) subject to
certain exceptions, any transaction that results in the issuance or transfer by
the corporation of any stock of the corporation to the interested stockholder;
(d) any transaction involving the corporation that has the effect of increasing
the proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (e) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation. In
general, Section 203 defines an interested stockholder as any entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.
Registration Rights
As of July 3, 1999, holders of 15,764,535 shares of our common stock, and
their permitted transferees are entitled to certain rights with respect to the
registration of such shares under the Securities Act. Under the terms of our
Registration Rights Agreement dated as of February 4, 1997, as amended, the
holders will be entitled to certain rights with respect to the registrable
securities. Under the Registration Rights Agreement, if at any time after this
offering we propose to register any of our common stock under the Securities
Act, the holders of registrable securities are entitled to notice of such
registration and to include their registrable securities therein; provided,
among other conditions, that the underwriters have the right to limit the
number of shares included in any such registration. Beginning six months after
the closing of the offering, the holders of at least 30.0% of the registrable
securities have the right to require us, on not more than two occasions, to
file a registration statement under the Securities Act in order to register all
or any part of their registrable securities, provided that the aggregate
offering price exceeds $10.0 million. We may, in certain circumstances, defer
such registration and the underwriters have the right, subject to certain
limitations, to limit the number of shares included in such registrations.
Further, the holders of at least 20.0% of the registrable securities may
require us to register all or any portion of their registrable securities on
Form S-3, when that form becomes available to us, subject to certain conditions
and limitations. Generally, we have agreed to bear all expenses incurred in
connection with these registrations. We have also agreed to indemnify the
holders of registration rights.
The registration rights terminate upon the earlier of the seventh anniversary
date of this offering or the time when the registrable securities may be sold
within two successive quarters under Rule 144.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is American Stock
Transfer & Trust Company and its telephone number is (212) 936-5100.
59
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of our common stock in the public market after
the offering could adversely affect the market price of our common stock and
our ability to raise equity capital in the future on terms favorable to us.
After the offering, shares of our common stock will be outstanding,
assuming that the underwriters do not exercise the over-allotment option. Of
these shares, all of the shares sold in this offering will be freely
tradable without restriction or further registration under the Securities Act,
unless these shares are purchased by "affiliates" as that term is defined in
Rule 144 under the Securities Act. The remaining shares of common stock held
by existing stockholders are "restricted securities" as that term is defined in
Rule 144 under the Securities Act. Restricted securities may be sold in the
public market only if registered or if they qualify for an exemption from
registration under Rule 144 or 701 under the Securities Act, which rules are
summarized below.
The following table shows approximately when the 16,977,679 shares of our
common stock that are not being sold in this offering but which will be
outstanding when this offering is complete will be eligible for sale in the
public market:
<TABLE>
<CAPTION>
Eligibility of
Restricted Shares for
Sale in the Public
Market
---------------------
<S> <C>
At effective date....... 0
180 days after the
effective date.........
After 180 days post
effective date.........
</TABLE>
Resale of most of the restricted shares that will become available for sale
in the public market starting 180 days after the effective date will be limited
by volume and other resale restrictions under Rule 144 because the holders are
our affiliates.
Rule 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned shares of our
common stock for at least one year is entitled to sell, within any three-month
period, a number of shares that is not more than the greater of:
. one percent of the number of shares of common stock then outstanding,
which will equal approximately shares immediately after this
offering; or
. the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks before a notice of the
sale on Form 144 is filed.
Sales under Rule 144 must also comply with the manner of sale provisions and
notice requirements and to the availability of current public information about
us.
Rule 144(k)
Under Rule 144(k), a person who has not been one of our affiliates at any
time during the 90 days before a sale, and who has beneficially owned the
restricted shares for at least two years, is entitled to sell the shares
without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
Rule 701
In general, under Rule 701 of the Securities Act as currently in effect, any
of our employees, consultants or advisors who purchase shares from us under a
stock option plan or other written agreement can resell those shares 90 days
after the effective date of this offering in reliance on Rule 144, but without
60
<PAGE>
complying with some of the restrictions, including the holding period,
contained in Rule 144. All of the options issued under our 1997 Stock Option
Plan will become immediately vested and exercisable upon consummation of this
offering and will be able to be resold after the 90-day period, subject to
lock-up agreements.
Lock-Up Agreements
All officers and directors and some of the holders of common stock and
options to purchase common stock have agreed pursuant to "lock-up" agreements
that they will not offer, sell, contract to sell, pledge, grant any option to
sell, or otherwise dispose of, directly or indirectly, any shares of common
stock or securities convertible or exchangeable for common stock, or warrants
or other rights to purchase common stock for a period of 180 days after the
date of this prospectus without the prior written consent of Hambrecht & Quist
LLC.
Registration Rights
Upon completion of this offering, the holders of 15,764,535 shares of our
common stock will be entitled to rights with respect to the registration of
their shares under the Securities Act. After registration, these shares will
become freely tradable without restriction under the Securities Act. Any sale
of securities by these shareholders could have a material adverse effect on the
trading price of our common stock.
61
<PAGE>
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
underwriters named below, through their representatives, Hambrecht & Quist LLC
and Banc of America Securities LLC, have severally agreed to purchase from us
the following respective numbers of shares of common stock:
<TABLE>
<CAPTION>
Number of
Name Shares
- ---- ---------
<S> <C>
Hambrecht & Quist LLC.................................................
Banc of America Securities LLC........................................
----
</TABLE>
<TABLE>
<S> <C>
Total.....................................................................
===
</TABLE>
The Underwriting Agreement provides that the obligations of the underwriters
are subject to certain conditions precedent, including the absence of any
material adverse change in our business and the receipt of certain
certificates, opinions and letters from us, our counsel and the independent
auditors. The nature of the underwriters' obligation is such that they are
committed to purchase all shares of common stock offered hereby if any shares
are purchased.
The following table shows the per share and total underwriting discounts and
commissions we will pay to the underwriters. These amounts are shown assuming
both no exercise and full exercise of the underwriters' over-allotment option
to purchase additional shares.
Underwriting Discounts and Commissions Payable by Us
<TABLE>
<CAPTION>
With Without
Over-Allotment Over-Allotment
Exercise Exercise
-------------- --------------
<S> <C> <C>
Per Share......................................... $ $
Total............................................. $ $
</TABLE>
We estimate that the total expenses of this offering, excluding underwriting
discounts and commissions, will be approximately $ .
The underwriters propose to offer the shares of common stock directly to the
public at the initial public offering price set forth on the cover page of this
prospectus and to certain dealers at such price less a concession not in excess
of $ per share. The underwriters may allow and the dealers may reallow a
concession not in excess of $ per share to certain other dealers. After
the initial public offering of the shares, the offering price and other selling
terms may be changed by the underwriters. The representatives have informed us
that the underwriters do not intend to confirm discretionary sales of more than
five percent of the shares of common stock offered in this offering.
We have granted to the underwriters an option, exercisable no later than 30
days after the date of this prospectus, to purchase up to additional shares
of common stock at the initial public offering price, less the underwriting
discount set forth on the cover page of this prospectus. To the extent that
the underwriters exercise this option, each of the underwriters will have a
firm commitment to purchase approximately the same percentage thereof which the
number of shares of common stock to be purchased by it shown in the above table
bears to the total number of shares of common stock offered hereby. We will be
obligated, pursuant to the option, to sell shares to the underwriters to the
extent the option is exercised. The underwriters may exercise this option only
to cover over-allotments made in connection with the sale of shares of common
stock offered hereby.
At our request, the underwriters will reserve up to $ of shares of
common stock to be issued by us and offered for sale, at the initial public
offering price, to directors, officers, employees,
62
<PAGE>
business associates and other persons related to us. The number of shares of
common stock available for sale to the general public will be reduced to the
extent that such individuals purchase all or a portion of these reserved
shares. Any reserved shares which are not purchased will be offered by the
underwriters to the general public.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
The offering of the shares is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the
right to reject an order for the purchase of shares in whole or in part.
We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act, and to contribute to payments
the underwriters may be required to make in respect thereof.
Our shareholders, including executive officers and directors, and optionees
who will own in the aggregate 16,977,679 shares of common stock after the
offering, have agreed not to, without the prior written consent of Hambrecht &
Quist LLC, offer, sell or otherwise dispose of any shares of common stock,
options or warrants to acquire shares of common stock or securities
exchangeable for or convertible into shares of common stock owned by them
during the 180-day period following the date of this prospectus. We have
agreed that we will not, without the prior written consent of Hambrecht & Quist
LLC, offer, sell or otherwise dispose of any shares of common stock, options or
warrants to acquire shares of common stock or securities exchangeable for or
convertible into shares of common stock during the 180-day period following the
date of this prospectus, except that we may issue shares upon the exercise of
options granted prior to the date hereof, and may grant additional options
under our stock option plans, provided that, without the prior written consent
of Hambrecht & Quist LLC, the additional options shall not be exercisable
during that period.
Prior to this offering, there has been no public market for our common
stock. The initial public offering price for our common stock will be
determined by negotiation among us and the representatives of the
underwriters. Among the factors to be considered in determining the initial
public offering price are prevailing market and economic conditions, our
revenues and earnings, market valuations of other companies engaged in
activities similar to ours, estimates of our business potential and our
prospects, the present state of our business operations, our management and
other factors deemed relevant.
Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
our common stock at levels above those which might otherwise prevail in the
open market, including by entering stabilizing bids, effecting syndicate
covering transactions or imposing penalty bids. A stabilizing bid means the
placing of any bid or effecting of any purchase for the purpose of pegging,
fixing or maintaining the price of the common stock. A syndicate covering
transaction means the placing of any bid on behalf of the underwriting
syndicate or the effecting of any purchase to reduce a short position created
in connection with this offering. A penalty bid means an arrangement that
permits the underwriters to reclaim a selling concession from a syndicate
member in connection with this offering when shares of common stock sold by the
syndicate member are purchased in syndicate covering transactions. Such
transactions may be effected on the Nasdaq National Market, in the over-the-
counter market or otherwise. This stabilizing, if commenced, may be
discontinued at any time.
A prospectus in electronic format is being made available on a web site
maintained by Hambrecht & Quist LLC. In addition, some broker-dealers may
choose to make the prospectus in electronic format available on web sites
maintained by them.
Ta-Lin Hsu, the chairman of the board of directors, is affiliated with
Hambrecht & Quist LLC, a representative and a principal underwriter of this
offering. In addition, as more fully set forth in "Related Party
Transactions," Hambrecht & Quist LLC holds a warrant to purchase 389,918 shares
of our common stock, and funds affiliated with Hambrecht & Quist LLC hold an
aggregate of 9,607,428 shares of our Series A preferred stock.
63
<PAGE>
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for us by
Wilson Sonsini Goodrich & Rosati, P.C., Palo Alto, California. Certain legal
matters in connection with this offering will be passed upon for the
underwriters by Morrison & Foerster LLP, San Francisco, California. As of the
date of this prospectus, members and trusts of Wilson Sonsini Goodrich &
Rosati, P.C. beneficially own an aggregate of 31,327 shares of our Series A
preferred stock.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our consolidated
financial statements at December 28, 1997 and January 2, 1999, and for each of
the three years in the period ended January 2, 1999 (which, for the year ended
December 29, 1996 relates to the financial statements of the predecessor
Company), as set forth in their report. We've included our consolidated
financial statements in the prospectus and elsewhere in the registration
statement in reliance on Ernst & Young LLP's report, given their authority as
experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with Securities and Exchange Commission in Washington, D.C. a
Registration Statement on Form S-1 under the Securities Act with respect to the
common stock offered in this prospectus. This prospectus, filed as part of the
registration statement, does not contain all of the information set forth in
the registration statement and its exhibits and schedules, portions of which
have been omitted as permitted by the rules and regulations of the SEC. For
further information about us and the common stock, we refer you to the
registration statement and to its exhibits and schedules. Statements in this
prospectus about the contents of any contract, agreement or other document are
not necessarily complete and, in each instance, we refer you to the copy of
such contract, agreement or document filed as an exhibit to the registration
statement, and each such statement being qualified in all respects by reference
to the document to which it refers. Anyone may inspect the registration
statement and its exhibits and schedules without charge at the public reference
facilities the SEC maintains at 450 Fifth Street, N.W., Washington, D.C. 20549
and at the regional offices of the SEC located at 7 World Trade Center, Suite
1300, New York, New York 10048 and 500 West Madison Street, Suite 1400,
Chicago, Illinois, 60661. You may obtain information on the public reference
facilities by calling the SEC at 1-800-SEC-0330. You may also inspect these
reports and other information without charge at a Web site maintained by the
SEC. The address of this site is http://www.sec.gov.
Upon completion of this offering, we will become subject to the informational
requirements of the Exchange Act and, in accordance therewith, file reports,
proxy statements and other information with the SEC. You will be able to
inspect and copy these reports, proxy statements and other information at the
public reference facilities maintained by the SEC and at the SEC's regional
offices at the addresses noted above. You also will be able to obtain copies
of this material from the Public Reference Section of the SEC as described
above, or inspect them without charge at the SEC's Web site. We have applied
for quotation of our common stock on the Nasdaq National Market. If we receive
approval for quotation on the Nasdaq National Market, then you will be able to
inspect reports, proxy and information statements and other information
concerning us at the National Association of Securities Dealers, Inc. at 1735 K
Street, N.W., Washington, D.C. 20006.
64
<PAGE>
HEADWAY TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
CONTENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets................................................. F-3
Consolidated Statements of Operations....................................... F-4
Consolidated Statements of Stockholders' Equity............................. F-5
Consolidated Statements of Cash Flows....................................... F-6
Notes to Consolidated Financial Statements.................................. F-8
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Headway Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Headway
Technologies, Inc. as of December 28, 1997 and January 2, 1999 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended January 2, 1999 (which, for the
year ended December 29, 1996, relates to the financial statements of the
predecessor Company). These consolidated 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. 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 our audits provide a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Headway Technologies, Inc. at December 28, 1997 and January 2, 1999, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended January 2, 1999, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
San Jose, California
February 26, 1999,
except for paragraph 1 of Note 11, as to which the date is
April 26, 1999
F-2
<PAGE>
HEADWAY TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
Pro Forma
Stockholders'
December 28, January 2, July 3, Equity at
1997 1999 1999 July 3, 1999
------------ ---------- -------- -------------
(unaudited)
ASSETS
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents..... $ 22,574 $ 24,350 $ 22,083
Accounts receivable, net of
allowances of $530, $530 and
$130 at December 28, 1997,
January 2 and July 3, 1999... 10,225 8,498 8,250
Inventories................... 5,082 4,627 5,100
Prepaid expenses.............. 275 2,280 509
Other current assets.......... 53 197 170
-------- -------- --------
Total current assets........ 38,209 39,952 36,112
Property and equipment:
Machinery and equipment....... 35,831 55,766 58,051
Leasehold improvements........ 7,328 21,610 21,703
-------- -------- --------
43,159 77,376 79,754
Less accumulated depreciation
and amortization............. (16,521) (28,209) (36,237)
-------- -------- --------
Net property and equipment.... 26,638 49,167 43,517
Intangible assets, net of
accumulated amortization of
$1,284, $1,891, and $1,976 at
December 28, 1997, January 2,
1999, and July 3, 1999....... 726 119 10,169
Other assets.................. 400 528 530
-------- -------- --------
Total assets................ $ 65,973 $ 89,766 $ 90,328
======== ======== ========
<CAPTION>
LIABILITIES AND STOCKHOLDERS'
EQUITY
<S> <C> <C> <C> <C>
Current liabilities:
Borrowings under line of
credit....................... $ -- $ 7,500 $ 3,000
Accounts payable.............. 6,203 11,852 7,422
Accrued compensation and
related expenses............. 2,140 2,118 2,386
Other accrued liabilities..... 2,207 3,525 3,130
Advance from customer......... 3,000 -- --
Current portion of capital
leases....................... 179 1,586 1,678
Current portion of notes
payable...................... 14,366 15,092 23,193
-------- -------- --------
Total current liabilities... 28,095 41,673 40,809
Capital leases, less current
portion...................... 358 5,482 4,619
Notes payable, less current
portion...................... 21,986 17,397 18,910
Commitments and contingencies
Stockholders' equity:
Series A convertible preferred
stock; $0.001 par value;
14,620,000, 15,764,535 and
15,764,535 shares authorized,
issued and outstanding at
December 28, 1997, January 2,
1999, and July 3, 1999,
respectively; 5,000,000
shares authorized, none
issued and outstanding pro
forma at July 3, 1999;
aggregate liquidation
preference of $34,942,
$37,677, and $37,677 at
December 28, 1997, January 2,
1999, and July 3, 1999,
respectively................. 34,382 37,122 37,122 $ --
Common stock; $0.001 par
value; 25,000,000 shares
authorized; 137,428, 698,096,
and 1,213,144 shares issued
and outstanding at December
28, 1997, January 2, 1999,
and July 3, 1999,
respectively; 75,000,000
authorized, 16,977,679 shares
issued and outstanding pro
forma at July 3, 1999........ 350 474 589 37,711
Deferred compensation......... (319) (238) (197) (197)
Accumulated deficit........... (18,879) (12,144) (11,524) (11,524)
-------- -------- -------- --------
Total stockholders' equity.. 15,534 25,214 25,990 $ 25,990
-------- -------- -------- ========
Total liabilities and
stockholders' equity....... $ 65,973 $ 89,766 $ 90,328
======== ======== ========
</TABLE>
See Accompanying Notes
F-3
<PAGE>
HEADWAY TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended Six Months Ended
------------------------------------- -----------------
December 29, December 28, January 2, June 27, July 3,
1996 1997 1999 1998 1999
------------- ------------ ---------- -------- -------
(predecessor) (unaudited)
<S> <C> <C> <C> <C> <C>
Revenue:
Product sales, net.... $ 4,421 $ 52,369 $177,669 $91,850 $70,693
Product sales to
related parties,
net.................. 20,871 -- -- -- --
Technology transfers
and royalties........ 1,500 2,000 1,750 750 2,093
------- -------- -------- ------- -------
Total revenue........ 26,792 54,369 179,419 92,600 72,786
Cost of sales........... 22,616 41,222 137,001 69,057 50,928
------- -------- -------- ------- -------
Gross profit............ 4,176 13,147 42,418 23,543 21,858
Operating expenses:
Research and
development.......... 5,066 20,287 25,458 11,611 16,780
Selling, general and
administrative....... 3,418 5,198 6,618 3,503 2,680
Acquired in-process
technology........... -- 6,000 -- -- --
------- -------- -------- ------- -------
Total operating
expenses............ 8,484 31,485 32,076 15,114 19,460
Operating (loss)
income................. (4,308) (18,338) 10,342 8,429 2,398
Other income (expense):
Interest income....... 406 953 875 495 381
Interest expense...... (1,065) (2,019) (3,313) (1,399) (1,953)
------- -------- -------- ------- -------
(659) (1,066) (2,438) (904) (1,572)
(Loss) income before
income taxes and
extraordinary item..... (4,967) (19,404) 7,904 7,525 826
Provision for income
taxes.................. -- -- 1,475 1,402 206
------- -------- -------- ------- -------
(Loss) income before
extraordinary item..... (4,967) (19,404) 6,429 6,123 620
Extraordinary item--gain
related to early
retirement of debt, net
of income taxes of
$67.................... -- -- 306 -- --
------- -------- -------- ------- -------
Net (loss) income....... $(4,967) $(19,404) $ 6,735 $ 6,123 $ 620
======= ======== ======== ======= =======
(Loss) income per share
before extraordinary
item(1):
Basic................. $ (1.38) $(441.00) $ 11.80 $ 14.31 $ 0.68
======= ======== ======== ======= =======
Diluted............... $ (1.38) $(441.00) $ 0.31 $ 0.30 $ 0.03
======= ======== ======== ======= =======
Pro forma--basic...... $ 0.40 $ 0.39 $ 0.04
======== ======= =======
Pro forma--diluted.... $ 0.31 $ 0.30 $ 0.03
======== ======= =======
Net (loss) income(1):
Basic................. $ (1.38) $(441.00) $ 12.36 $ 14.31 $ 0.68
======= ======== ======== ======= =======
Diluted............... $ (1.38) $(441.00) $ 0.33 $ 0.30 $ 0.03
======= ======== ======== ======= =======
Pro forma--basic...... $ 0.42 $ 0.39 $ 0.04
======== ======= =======
Pro forma--diluted.... $ 0.33 $ 0.30 $ 0.03
======== ======= =======
Shares used in computing
per share
information(1):
Basic................. 3,593 44 545 428 913
======= ======== ======== ======= =======
Diluted............... 3,593 44 20,573 20,276 20,717
======= ======== ======== ======= =======
Pro forma--basic...... 16,093 15,754 16,677
======== ======= =======
Pro forma--diluted.... 20,573 20,276 20,717
======== ======= =======
</TABLE>
- --------
(1) Loss per share before extraordinary item and net loss per share for 1996
were calculated assuming common shares issued in connection with the
January 1997 Recapitalization (see Note 1) were outstanding for the entire
year.
See Accompanying Notes
F-4
<PAGE>
HEADWAY TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Series A
Redeemable Class 1 Series A
Convertible Convertible Convertible Notes
Preferred Stock Stock Common Stock Preferred Stock Common Stock Receivable
---------------- --------------- -------------- ---------------- ------------- From Deferred
Shares Amount Shares Amount Shares Amount Shares Amount Shares Amount Officers Compensation
------ -------- ------ ------- ------ ------ ------- -------- ------ ------ ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1995
(predecessor).... 3,000 $ 29,985 1,200 $ 3,498 3,584 $ 359 -- $ -- -- $ -- $ (50) $ --
Issuance of
common stock in
connection with
option plans.... -- -- -- -- 31 3 -- -- -- -- -- --
Repurchase of
common stock and
related payment
on note
receivable...... -- -- -- -- (29) (3) -- -- -- -- 6 --
Net loss and
comprehensive
net loss........ -- -- -- -- -- -- -- -- -- -- -- --
------ -------- ------ ------- ------ ----- ------- -------- ----- ---- ----- ------
Balance at
December 29, 1996
(predecessor).... 3,000 29,985 1,200 3,498 3,586 359 -- -- -- -- (44) --
Liquidation of
predecessor
Series A
redeemable
convertible
preferred,
common and Class
1 convertible
stock........... (3,000) (29,985) (1,200) (3,498) (3,586) (359) -- -- -- -- 44 --
Issuance of
Series A
convertible
preferred stock,
net of issuance
costs of $618... -- -- -- -- -- -- 14,620 34,382 -- -- -- --
Issuance of
common stock in
connection with
recapitalization.. -- -- -- -- -- -- -- -- 2 1 -- --
Issuance of
common stock in
connection with
option plans.... -- -- -- -- -- -- -- -- 135 18 -- --
Deferred
compensation
related to
grants of common
stock options... -- -- -- -- -- -- -- -- -- 331 -- (331)
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- -- -- -- 12
Net loss and
comprehensive
net loss of
predecessor
company for the
period from
December 30,
1996 through
January 23,
1997, the date
of
recapitalization.. -- -- -- -- -- -- -- -- -- -- -- --
Net loss and
comprehensive
net loss for the
period from
January 24, 1997
through December
28, 1997........ -- -- -- -- -- -- -- -- -- -- -- --
------ -------- ------ ------- ------ ----- ------- -------- ----- ---- ----- ------
Balance at
December 28,
1997............. -- -- -- -- -- -- 14,620 34,382 137 350 -- (319)
Issuance of
Series A
convertible
preferred
stock........... -- -- -- -- -- -- 1,145 2,740 -- -- -- --
Issuance of
common stock in
connection with
option plans.... -- -- -- -- -- -- -- -- 561 124 -- --
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- -- -- -- 81
Net income and
comprehensive
net income...... -- -- -- -- -- -- -- -- -- -- -- --
------ -------- ------ ------- ------ ----- ------- -------- ----- ---- ----- ------
Balance at
January 2, 1999.. -- -- -- -- -- -- 15,765 37,122 698 474 -- (238)
Issuance of
common stock in
connection with
option plans
(unaudited)..... -- -- -- -- -- -- -- -- 515 115 -- --
Amortization of
deferred
compensation
(unaudited)..... -- -- -- -- -- -- -- -- -- -- -- 41
Net income and
comprehensive
net income
(unaudited)..... -- -- -- -- -- -- -- -- -- -- -- --
------ -------- ------ ------- ------ ----- ------- -------- ----- ---- ----- ------
Balance at July
3, 1999
(unaudited)...... -- $ -- -- $ -- -- $ -- 15,765 $ 37,122 1,213 $589 $ -- $ (197)
====== ======== ====== ======= ====== ===== ======= ======== ===== ==== ===== ======
<CAPTION>
Total
Accumulated Stockholders'
Deficit Equity
----------- -------------
<S> <C> <C>
Balance at
December 31, 1995
(predecessor).... $(12,856) $ 20,936
Issuance of
common stock in
connection with
option plans.... -- 3
Repurchase of
common stock and
related payment
on note
receivable...... -- 3
Net loss and
comprehensive
net loss........ (4,967) (4,967)
----------- -------------
Balance at
December 29, 1996
(predecessor).... (17,823) 15,975
Liquidation of
predecessor
Series A
redeemable
convertible
preferred,
common and Class
1 convertible
stock........... 18,348 (15,450)
Issuance of
Series A
convertible
preferred stock,
net of issuance
costs of $618... -- 34,382
Issuance of
common stock in
connection with
recapitalization.. -- 1
Issuance of
common stock in
connection with
option plans.... -- 18
Deferred
compensation
related to
grants of common
stock options... -- --
Amortization of
deferred
compensation.... -- 12
Net loss and
comprehensive
net loss of
predecessor
company for the
period from
December 30,
1996 through
January 23,
1997, the date
of
recapitalization.. (525) (525)
Net loss and
comprehensive
net loss for the
period from
January 24, 1997
through December
28, 1997........ (18,879) (18,879)
----------- -------------
Balance at
December 28,
1997............. (18,879) 15,534
Issuance of
Series A
convertible
preferred
stock........... -- 2,740
Issuance of
common stock in
connection with
option plans.... -- 124
Amortization of
deferred
compensation.... -- 81
Net income and
comprehensive
net income...... 6,735 6,735
----------- -------------
Balance at
January 2, 1999.. (12,144) 25,214
Issuance of
common stock in
connection with
option plans
(unaudited)..... -- 115
Amortization of
deferred
compensation
(unaudited)..... -- 41
Net income and
comprehensive
net income
(unaudited)..... 620 620
----------- -------------
Balance at July
3, 1999
(unaudited)...... $(11,524) $ 25,990
=========== =============
</TABLE>
See Accompanying Notes
F-5
<PAGE>
HEADWAY TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended Six Months Ended
------------------------------------- -----------------
December 29, December 28, January 2, June 27, July 3,
1996 1997 1999 1998 1999
------------- ------------ ---------- -------- -------
(predecessor) (unaudited)
<S> <C> <C> <C> <C> <C>
Operating activities
Net loss of predecessor
company for the year
ended December 29,
1996, and for the
period from December
30, 1996 through
January 23, 1997, the
date of
recapitalization,
respectively.......... $(4,967) $ (525) $ -- $ -- $ --
Net (loss) income for
the period from
January 24, 1997
through December 28,
1997, for the year
ended January 2, 1999,
the six months ended
June 27, 1998, and
July 3, 1999,
respectively.......... -- (18,879) 6,735 6,123 620
Adjustments to
reconcile net (loss)
income to net cash
provided by (used in)
operating activities:
Amortization of
deferred
compensation......... -- 12 81 39 41
Depreciation and
amortization......... 6,322 9,088 12,311 5,142 8,286
Loss (gain) on write-
down and disposal of
machinery and
equipment............ 41 1,260 (85) (76) (115)
Accrued interest on
notes payable and
capital leases....... -- 632 913 460 531
Acquired in-process
technology........... -- 6,000 -- -- --
Forgiveness of notes
receivable from
employee............. -- -- 200 150 50
Forfeiture of
equipment deposits... 76 -- -- -- --
Gain on early
retirement of debt... -- -- (373) -- --
Changes in operating
assets and
liabilities:
Accounts receivable... 2,897 (8,725) 1,727 (6,304) 248
Inventories........... 46 (3,847) 455 (1,395) (473)
Prepaid expenses...... (4) (6) (2,005) (720) 1,544
Other current assets.. -- (34) (144) (198) 27
Other long-term
assets............... -- (400) (270) (149) 12
Accounts payable...... (232) 4,266 5,649 8,359 (4,430)
Accrued compensation
and related
expenses............. 104 1,230 (22) 513 268
Other accrued
liabilities.......... 27 1,953 1,318 5,617 3,024
Advance from
customer............. -- 3,000 (3,000) (3,000) --
------- -------- -------- -------- -------
Net cash provided by
(used in) operating
activities............. 4,310 (4,975) 23,490 14,561 9,633
------- -------- -------- -------- -------
Investing activities
Purchases of property
and equipment......... (8,766) (19,508) (41,568) (30,768) (2,762)
Proceeds from sales of
machinery and
equipment............. 42 -- 162 91 326
Investment in joint
venture............... -- -- -- -- (64)
------- -------- -------- -------- -------
Net cash used in
investing activities... (8,724) (19,508) (41,406) (30,677) (2,500)
------- -------- -------- -------- -------
</TABLE>
See Accompanying Notes
F-6
<PAGE>
HEADWAY TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS--Continued
(in thousands)
<TABLE>
<CAPTION>
Years Ended Six Months Ended
------------------------------------- -----------------
December 29, December 28, January 2, June 27, July 3,
1996 1997 1999 1998 1999
------------- ------------ ---------- -------- -------
(predecessor) (unaudited)
<S> <C> <C> <C> <C> <C>
Financing activities
Borrowings under line
of credit............. -- -- 7,500 -- --
Proceeds from capital
leases................ -- 537 1,808 -- --
Proceeds from notes
payable............... 6,406 24,626 5,618 5,292 --
Repayment of borrowings
under line of credit.. -- -- -- -- (4,500)
Repayment of capital
leases................ -- -- (595) (94) (771)
Repayment of notes
payable............... (2,492) (4,362) (10,021) (3,280) (4,244)
Repayments of notes
receivable from
officers.............. 3 44 -- -- --
Proceeds from issuance
of convertible
preferred stock, net
of issuance costs..... -- 34,382 2,740 2,740 --
Proceeds from issuance
of common stock....... 3 19 124 82 115
Proceeds from equipment
lease financings...... -- 8,244 12,518 6,186 --
Payments to retire
shares of predecessor
company............... -- (22,049) -- -- --
Transaction costs of
recapitalization...... -- (1,154) -- -- --
------- -------- -------- ------- -------
Net cash provided by
(used in) financing
activities............. 3,920 40,287 19,692 10,926 (9,400)
------- -------- -------- ------- -------
Net change in cash and
cash equivalents....... (494) 15,804 1,776 (5,190) (2,267)
Cash and cash
equivalents at
beginning of period.... 7,264 6,770 22,574 22,574 24,350
------- -------- -------- ------- -------
Cash and cash
equivalents at end of
period................. $ 6,770 $ 22,574 $ 24,350 $17,384 $22,083
======= ======== ======== ======= =======
Supplemental
disclosures:
Cash paid during the
period for interest.... $ 1,036 $ 1,326 $ 2,379 $ 956 $ 1,445
======= ======== ======== ======= =======
Cash paid during the
period for income
taxes.................. $ -- $ -- $ 1,608 $ 310 $ 464
======= ======== ======== ======= =======
Issuance of notes
payable for equipment.. $ -- $ 1,918 $ 5,318 $ -- $ --
======= ======== ======== ======= =======
Recognition of deferred
compensation........... $ -- $ 331 $ -- $ -- $ --
======= ======== ======== ======= =======
Issuance of notes
payable for
technologies and
licenses (including
issuance of notes
payable in connection
with previously accrued
liabilities)........... $ -- $ -- $ -- $ -- $13,327
======= ======== ======== ======= =======
</TABLE>
See Accompanying Notes
F-7
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of July 3, 1999 and for the six months ended
June 27, 1998 and July 3, 1999 is unaudited)
1. The Company and Summary of Significant Accounting Policies
The Company
The accompanying consolidated financial statements include the accounts of
Headway Technologies, Inc. (a Delaware corporation) and its wholly-owned
subsidiaries (the "Company"). The Company designs, manufactures and sells
recording head products to the computer hard disk drive industry.
On January 23, 1997, the shareholders of Headway Technologies, Inc. (the
"Predecessor Company") approved a recapitalization of the Company (the
"Recapitalization"). None of the shareholders in the Predecessor Company were
stockholders in the Company after the Recapitalization and accordingly, the
Recapitalization has been accounted for under the purchase method of accounting
as of the closing date. Effective with the Recapitalization, the Predecessor
Company became a wholly-owned subsidiary of the Company. There are no other
operating activities of the Company. All of the Predecessor Company's
outstanding and unexercised stock options were canceled at the date of the
Recapitalization.
The 1996 financial statements include the accounts of the Predecessor Company
and the 1997 and 1998 consolidated financial statements include the accounts of
the Company. All intercompany transactions have been eliminated in
consolidation. The results of operations of the Predecessor Company for the
period from December 30, 1996 through the date of the Recapitalization, net
revenues of $855,000 and a net loss of approximately $525,000, are included in
the 1997 consolidated statement of operations of the Company.
The purchase price totaled approximately $23.2 million, including
transaction-related costs amounting to approximately $1.2 million and a cash
payment to the Predecessor Company's shareholders of approximately $22.0
million. The purchase price, including transaction costs, was allocated to the
assets and liabilities of the Predecessor Company based on their relative fair
values.
The Company allocated the purchase price as follows (in thousands):
<TABLE>
<CAPTION>
Allocation of
Description Purchase Price
----------- --------------
<S> <C>
Predecessor Company net tangible assets..................... $15,493
In-process technology....................................... 6,000
Assembled workforce......................................... 910
Developed technology........................................ 700
Goodwill.................................................... 100
-------
$23,203
=======
</TABLE>
Values assigned to in-process and developed technology were generally
determined through established valuation techniques in the information storage
industry using the income approach. To determine the value of in-process and
developed technologies, the Company considered, among other factors, the nature
of each project; the classification into developed or in-process technology;
the state of development of each project; the relative importance of each
project to the Company's success; the time and cost needed to complete each
project; expected income; and associated risks which included the inherent
difficulties and uncertainties in completing the projects. The Company also
considered the inherent risks related to the viability of, and potential
changes to, future target markets.
F-8
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
To determine the value of the in-process and developed technology, the
expected future cash flows of each technology project were discounted to their
present value. The rates utilized to discount the future cash flows to their
present value were based on the Company's weighted-average cost of capital and
considered risks related to the characteristics and applications of each
product/technology, existing and future markets, and assessments of the life
cycle stage of the product/technology. The sum of these present values is
considered to be the fair value of each subject project. Discount rates of
27.5% and 30.0% were used for valuing the developed and in-process
technologies, respectively, and are intended to be commensurate with the
Company's corporate maturity and the uncertainties in the economic estimates
described above. Based on the analysis, the Company capitalized $700,000 of
existing technologies that had reached technological feasibility as developed
technology. The in-process technologies had no alternative future use, and as
such the $6,000,000 value attributed to the in-process technologies was charged
to operations in the year ended December 28, 1997.
Values assigned to assembled work force were generally determined through
established valuation techniques in the information storage industry using the
cost approach with consideration to number of employees, acquisition costs, and
tax consequences. Based on the analysis, the assembled work force was assigned
a value of $910,000 which was capitalized.
The developed technology, assembled workforce and goodwill are being
amortized over periods of one to three years. The amortization of assembled
workforce and goodwill is included in research and development expense. The
amortization of developed technology is included in cost of sales. Accumulated
amortization of assembled workforce, developed technology and goodwill totaled
$872,000, $700,000 and $64,000, respectively, at January 2, 1999 ($910,000,
$700,000, and $81,000 at July 3, 1999, respectively).
The estimates used by the Company in valuing in-process technologies were
based on assumptions the Company believes to be reasonable but which are
inherently uncertain and unpredictable. The Company's assumptions may be
incomplete or inaccurate, and no assurance can be given that unanticipated
events and circumstances will not occur. Accordingly, actual results may vary
from projected results. Any such variance may result in a material adverse
effect on the financial condition and results of operations of the Company.
The Predecessor Company was founded and financed by Hewlett Packard Co.
("HP"), Komag, Inc. ("Komag"), Asahi Glass America, Inc. ("Asahi Glass"), and
Asahi Komag Co., Ltd. ("AKCL"). Prior to 1997, the Company sold wafer products
primarily to HP and transferred technology rights to a third party.
Dependence on Limited Suppliers
Certain components necessary for the manufacture of the Company's products
are obtained from a single supplier or a limited group of preferred suppliers.
The Company does not maintain any long-term agreements with any of its
component suppliers. There can be no assurance these single or limited source
suppliers will be able to meet the Company's requirements on a timely basis or
on acceptable terms. If a component supplier raises its prices, there can be
no assurance the Company will be able to obtain substitute suppliers at
acceptable costs or be able to pass these increased costs along to its
customers. In addition, the Company's component suppliers must be qualified
with the Company's customers and, depending on the supplier, the qualification
process for a replacement supplier may be lengthy.
Fiscal Period
The Company operates on a 52- or 53-week fiscal year. The fiscal years ended
December 29, 1996 and December 28, 1997 each contain 52 weeks. The fiscal year
ended January 2, 1999 contains 53 weeks.
F-9
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates, and such differences
could be material to the financial statements.
Interim Financial Information
The interim financial information as of July 3, 1999 and for the six month
periods ended June 27, 1998 and July 3, 1999 is unaudited but includes all
adjustments, consisting only of normal recurring adjustments, that the Company
considers necessary for a fair presentation of its consolidated financial
position at that date and its consolidated results of operations and cash flows
for those periods. Operating results for the six months ended July 3, 1999 are
not necessarily indicative of results that may be expected for any future
periods.
Cash and Cash Equivalents
Cash equivalents are highly liquid investments with insignificant interest
rate risk and maturities of three months or less at their acquisition date and
are stated at amounts that approximate fair value, based on quoted market
prices. Cash equivalents consist principally of investments in money market
accounts with financial institutions. The fair value of these investments
approximates their cost.
Inventories
Inventories are stated at the lower of cost or market. Cost is computed on a
currently adjusted standard basis (which approximates actual cost on a first-
in, first-out basis).
Property and Equipment
Purchased property and equipment is recorded at cost. Property and equipment
acquired in connection with the Recapitalization was recorded at the net book
value of the Predecessor Company which approximated its fair value. Property
and equipment is being depreciated on the straight-line method over estimated
useful lives ranging from three to five years. Leasehold improvements are
amortized over the shorter of the term of the lease or their estimated useful
lives.
Intangible Assets
Intangible assets consist primarily of patent licenses acquired from third
parties and are being amortized on a straight line basis from the dates of
acquisition, generally over eight years. In addition, intangibles assets,
which resulted from the Recapitalization (see Note 1), include developed
technologies, assembled workforce and goodwill which are being amortized on a
straight line basis over periods of one to three years.
Revenue Recognition
Revenue from product sales is recognized upon shipment. Technology transfer
fees are recognized as revenue upon the achievement of stipulated milestones
and recognized royalties based on Seagate sales as reported by Seagate to us.
F-10
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Concentrations of Credit Risk
The Company sells products primarily to customers located in the United
States and Asia. The Company performs ongoing credit evaluations and generally
does not require collateral. Sales to a foreign corporation in China and its
U.S. subsidiaries represented 0%, 11%, 6%, and 5% of the Company's total
revenue in 1996, 1997, 1998, and six months ended July 3, 1999, respectively.
Sales to a foreign corporation in Japan and its U.S. subsidiaries represented
1%, 28%, 67% and 46% of the Company's total revenue in 1996, 1997, 1998 and the
six months ended July 3, 1999, respectively. As of December 28, 1997, January
2, 1999 and July 3, 1999, accounts receivable from these foreign corporations
represented 71%, 67% and 77% of the total accounts receivable, respectively.
Two customers represented 78% and 21% of the Company's total revenue in 1996,
three customers accounted for 11%, 28% and 57% of the Company's total revenue
in 1997, two customers accounted for 27% and 67% of the Company's total revenue
in 1998 and two customers accounted for 49% and 46% of the Company's total
revenue for the six months ended July 3, 1999. Accounts receivable from three
customers represented 94% of the total accounts receivable at December 28, 1997
and two customers represented 97% and 94% of the total accounts receivable at
January 2, 1999 and July 3, 1999, respectively.
Our long-term success depends on the broad market adoption of the Company's
products, particularly the Company's recently introduced GMR products. To
date, almost all of the Company's revenues have been generated through the sale
of our DSMR products. The Company does not expect sales of our DSMR products
to be significant after the first half of 2000.
Research and Development
Research and development costs are expensed as incurred.
Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of
Financial Accounting Standards Board Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
prescribes the accounting for the impairment of long-lived assets, such as
property, plant and equipment and intangible assets, as well as the accounting
for long-lived assets that are held for disposal.
The Company reviews property, plant and equipment and other long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability is measured
by comparison of its carrying amount to the future net cash flows the assets
are expected to generate. If such assets are considered to be impaired, the
impairment to be recognized is measured as the amount by which the carrying
amount of the asset exceeds the present value of the future net cash flows.
During 1997, the Company recorded a charge of $1,253,000 relating to the
write-off of certain leasehold improvements resulting from the decision to
coordinate research and development facilities into existing space. This
amount was included in research and development expenses in the consolidated
statement of operations for 1997.
Stock-Based Compensation
The Company accounts for stock options in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB
25") and in 1996 adopted the disclosure-only
F-11
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
alternative described in Financial Accounting Standards Board Statement No.
123, Accounting for Stock-Based Compensation ("FAS 123") and provides pro forma
disclosures of net income (loss) per share as if the fair value method
prescribed by FAS 123 had been applied in measuring employee compensation
expense.
Income Taxes
The Company accounts for income taxes in accordance with Financial Accounting
Standards Board Statement No. 109, Accounting for Income Taxes ("FAS 109"),
which requires the use of the liability method in accounting for income taxes.
Under this method, deferred income tax assets and liabilities are determined
based on differences between financial reporting and tax bases of assets and
liabilities and are measured using enacted tax rules and laws that are expected
to be in effect when the differences are expected to reverse.
Net (Loss) Income Per Share
The Company adopted Financial Accounting Standards Board Statement No. 128,
Earnings Per Share ("FAS 128") during the year ended December 27, 1997. FAS 128
replaced the calculation of primary and fully diluted net income (loss) per
share with basic and diluted net income (loss) per share. In accordance with
FAS 128, basic net income (loss) per share excludes dilutive potential common
stock and is calculated as net income (loss) divided by the weighted-average
number of common shares outstanding. Diluted net income (loss) per share is
computed using the weighted-average number of common shares outstanding and
dilutive potential common stock outstanding during the period. Dilutive
potential common stock from stock options and warrants (using the treasury
stock method) and the conversion of preferred shares (using the if-converted
method) are excluded from the calculation of net loss per share in 1996 and
1997 as their effect was antidilutive.
Unaudited pro forma basic net income per share for the year ended January 2,
1999 and for the six months ended June 27, 1998 and July 3, 1999 have been
calculated based on net income applicable to common shares and assuming
conversion of preferred shares upon the completion of the Company's initial
public offering, using the if-converted method. Pro forma income per share
information for the years ended December 29, 1999 and December 28, 1999 has not
been separately presented as the impact of the assumed conversion of the
preferred stock would be antidilutive.
Net loss per share for the year ended December 29, 1996 was calculated using
the Predecessor Company's capital structure for the year ended December 29,
1996. The basic and diluted net loss per share for the one month period from
December 29, 1996 through the date of the Recapitalization, assuming the
Predecessor Company's capital structure, was $(0.15).
F-12
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The calculation of basic, diluted, pro forma basic and pro forma diluted net
income (loss) per share is as follows (in thousands, except per share data):
<TABLE>
<CAPTION>
Years Ended Six Months Ended
------------------------------------ ----------------
December 29, December 28, January 2, June 27, July 3,
1996 1997 1999 1998 1999
------------ ------------ ---------- -------- -------
(unaudited)
<S> <C> <C> <C> <C> <C>
Numerator:
(Loss) income before
extraordinary item.. $(4,967) $(19,404) $ 6,429 $ 6,123 $ 620
Extraordinary item... -- -- 306 -- --
------- -------- ------- ------- -------
Net (loss) income...... $(4,967) $(19,404) $ 6,735 $ 6,123 $ 620
======= ======== ======= ======= =======
Historical:
Denominator:
Denominator for
basic net (loss)
income per share:
Weighted-average
shares
outstanding...... 3,593 44 545 428 913
Effect of dilutive
securities:
Employee stock
options............. -- -- 4,024 4,073 3,615
Warrants............. -- -- 456 449 424
Convertible preferred
stock............... -- -- 15,548 15,326 15,765
------- -------- ------- ------- -------
Dilutive potential
common shares......... -- -- 20,028 19,848 19,804
------- -------- ------- ------- -------
Denominator for diluted
net (loss) income per
share................. 3,593 44 20,573 20,276 20,717
======= ======== ======= ======= =======
Basic net (loss) income
per share before
extraordinary item.... $ (1.38) $(441.00) $ 11.80 $ 14.31 $ 0.68
Extraordinary item per
share, net of income
taxes................. -- -- 0.56 -- --
------- -------- ------- ------- -------
Basic net (loss) income
per share............. $ (1.38) $(441.00) $ 12.36 $ 14.31 $ 0.68
======= ======== ======= ======= =======
Diluted net (loss)
income per share
before extraordinary
item.................. $ (1.38) $(441.00) $ 0.31 $ 0.30 $ 0.03
Extraordinary item per
share, net of income
taxes................. -- -- 0.02 -- --
------- -------- ------- ------- -------
Diluted net (loss)
income per share...... $ (1.38) $(441.00) $ 0.33 $ 0.30 $ 0.03
======= ======== ======= ======= =======
Pro forma:
Denominator:
Shares used in
computing pro forma
basic net income
per share.......... 16,093 15,754 16,677
======= ======= =======
Shares used in
computing pro forma
diluted net income
per share.......... 20,573 20,276 20,717
======= ======= =======
Pro forma basic net
income before
extraordinary item per
share................. $ 0.40 $ 0.39 $ 0.04
Pro forma extraordinary
item per share, net of
income taxes.......... $ 0.02 $ -- $ --
------- ------- -------
Pro forma basic net
income per share...... $ 0.42 $ 0.39 $ 0.04
======= ======= =======
Pro forma diluted net
income before
extraordinary item per
share................. $ 0.31 $ 0.30 $ 0.03
Pro forma extraordinary
item per share, net of
income taxes.......... $ 0.02 $ -- $ --
------- ------- -------
Pro forma diluted net
income per share...... $ 0.33 $ 0.30 $ 0.03
======= ======= =======
</TABLE>
F-13
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Comprehensive Income
Effective December 30, 1997, the Company adopted Financial Accounting
Standards Board Statement No. 130, Reporting of Comprehensive Income ("FAS
130"). FAS 130 requires the reporting of comprehensive income and its
components, and requires foreign currency translation adjustments and
unrealized gains or losses on available-for-sale investments to be included in
other comprehensive income. The Company does not have any material components
of other comprehensive income.
Recent Pronouncements
In June 1997, the Financial Accounting Standards Board Statement No. 131,
Disclosures about Segments of an Enterprise and Related Information ("FAS
131"), was issued. FAS 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements. Under FAS 131, operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. FAS 131 is effective for
financial statements for periods beginning after December 15, 1997, and
restatement of comparative information for earlier years is required. Based
upon the criteria of FAS 131, the Company has a single operating segment, which
provides recording heads to the computer hard disk drive industry. Geographic
information for revenues is provided in Note 1 to the consolidated financial
statements.
In June 1998, the Financial Accounting Standards Board Statement No. 133
("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities, was
issued. FAS 133 establishes a new model for accounting for derivatives and
hedging activities and supersedes and amends a number of existing accounting
standards. FAS 133 requires that all derivatives be recognized in the balance
sheet at their fair market value, and the corresponding derivative gains or
losses be either reported in the statement of operations or as a deferred item
depending on the type of hedge relationship that exists with respect to such
derivative. The Company currently does not hold any derivative instruments
that will be affected by the adoption of FAS 133.
Reclassification
Certain 1998, 1997, and 1996 amounts have been reclassified to conform with
July 3, 1999 unaudited presentation.
2. Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
December 28, January 2, July 3,
1997 1999 1999
------------ ---------- -----------
(unaudited)
<S> <C> <C> <C>
Raw materials............................ $1,771 $1,800 $1,865
Work-in-process.......................... 3,311 2,827 3,235
------ ------ ------
$5,082 $4,627 $5,100
====== ====== ======
</TABLE>
F-14
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Related-Party Transactions
Sales to HP comprised 78% of total revenues for 1996. There were no accounts
receivable from HP at December 31, 1996. The Company made purchases from HP
totaling $131,000 for 1996. HP was not a related party in either 1997 or
1998. The Company made purchases totaling $2.6 million for the six months
ended July 3, 1999 from an entity in which the Company acquired an
approximately 50% interest in January 1999 (see Note 12).
The Company leased one of its facilities from Komag under a noncancelable
operating lease during 1996. The 1996 rent expense under this lease was
$268,000. The lease agreement also required the Company to reimburse Komag for
the cost of utilities and other facility services; such amounts totaled
$708,000 for 1996. Komag was not a related party in either 1997 or 1998.
The Company also reimbursed Komag and AKCL for other expenses that totaled
$105,000 for 1996. Such expenses consisted primarily of payroll costs incurred
by Komag, AKCL and their subsidiaries on behalf of the Company. ACKL was not a
related party in either 1997 or 1998.
The Company paid $66,000 of fees during 1996 to AKCL and HP for guarantees of
notes payable to a financial institution.
The Company issued notes payable to two stockholders during 1997. The
current interest rates on these notes are 7.5% and 8.5%. The balance
outstanding under these notes was $11.2 million, $11.3 million, and $11.0
million at December 28, 1997, January 2, 1999, and July 3, 1999, respectively.
The Company paid $1.4 million for investment banking services to an affiliate
of a stockholder of the Company in connection with the Recapitalization.
4. Technology Transfers and Royalties
The Company transferred technology to a third-party and received
nonrefundable payments totaling $1.5 million, $2.0 million, and $1.75 million
in 1996, 1997, and 1998, respectively. All amounts were recorded as revenue.
During the first six months of 1999, the Company earned royalty revenue of
$2.1 million from this third party from sales of products incorporating the
technology.
5. Revolving Line of Credit
In December 1997, the Company entered into a $10 million revolving line of
credit agreement with a bank which was renewed in August 1998. The amount of
the line of credit was increased to $15 million from $10 million and expires on
August 31, 1999. There were no amounts outstanding under the line of credit at
December 28, 1997. As of January 2, 1999 and July 3, 1999, the outstanding
balance under the line of credit was $7.5 million and $3.0 million,
respectively. Borrowings under the line of credit bear interest at either the
bank's prime rate or the bank's prime rate plus 0.25%, depending on the
borrowing base utilized by the Company. At January 2, 1999, the Company's
borrowing base was $15 million and the interest rate was 8.00% ($15 million and
8.25%, respectively, at July 3, 1999). The line of credit is secured by
substantially all of the Company's assets excluding intellectual property and
contains certain financial and nonfinancial covenants.
F-15
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
6. Notes Payable
Notes payable, which, except for notes payable to customers, are
collateralized by substantially all of the assets of the Company, consist of
the following (in thousands):
<TABLE>
<CAPTION>
December 28, January 2, July 3,
1997 1999 1999
------------ ---------- -----------
(unaudited)
<S> <C> <C> <C>
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $92 through July
2000, interest rate of 7.59%............. $ 2,583 $ 1,643 $ 1,145
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $57 through
October 2000, interest rate of 7.39%..... 1,740 1,167 864
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $53 through
October 2000, interest rate of 7.38%..... 1,631 1,094 810
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $50 through
January 2001, interest rate of 6.92%..... 1,675 1,170 904
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $78 through June
2001, interest rate of 7.91%............. 2,854 2,117 1,727
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $193 through
December 2000 and terminal payment of
$1,074 due on February 2001, interest
rate of 13.62%........................... 6,325 4,805 3,962
Promissory note payable to Komag, due upon
the earlier of completion of a qualified
initial public offering of the Company's
common stock or the earlier of February
2001 or termination of the Company's
sublease agreement, interest rate of
7.00%.................................... 1,380 1,380 1,380
Promissory notes payable to shareholders
and various customers due in quarterly
installments beginning September 1998 or
accelerated based on qualified product
sales by the Company to these customers
through June 2000, interest rate of
5.00%.................................... 18,164 -- --
Promissory note payable to a
shareholder/customer due in quarterly
installments beginning October 1998 or
accelerated based on qualified product
sales by the Company to the customer
through June 2000 due at the option of
the holder upon the completion of a
qualified initial public offering of the
Company's common stock, interest rate of
8.50%.................................... -- 7,445 7,444
Promissory note payable to a shareholder
due in quarterly installments beginning
October 1998 through June 2000 or
accelerated based on qualified product
sales by the Company to the customer
through June 2000 or due at the option of
the holder upon the completion of a
qualified initial public offering of the
Company's common stock, interest rate of
7.50%.................................... -- 3,924 3,569
Promissory note payable to customer due in
quarterly installments beginning October
1998 through June 2000, interest rate of
5.00%.................................... -- 2,635 2,388
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $65 through June
2002 and terminal payment of $255 due in
July 2002, interest rate of 13.425%...... -- 2,311 2,072
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $69 through June
2002 and terminal payment of $274 due in
July 2002, interest rate of 13.312%...... -- 2,489 2,232
Promissory note payable to a financial
institution due in monthly principal and
interest installments of $8 through
September 2002 and terminal payment of
$33 due in October 2002, interest rate of
13.04%................................... -- 309 279
Promissory note payable to third parties
due in annual installments beginning in
July 1999 through December 2002, interest
rate of 7.50%............................ -- -- 13,327
------- ------- -------
36,352 32,489 42,103
Less amounts due within one year.......... 14,366 15,092 23,193
------- ------- -------
$21,986 $17,397 $18,910
======= ======= =======
</TABLE>
F-16
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Payments on notes payable are due as follows (in thousands):
<TABLE>
<CAPTION>
January 2, July 3,
1999 1999
---------- -----------
(unaudited)
<S> <C> <C>
1999 (remaining six months at July 3, 1999)......... $15,092 $13,080
2000................................................ 13,061 15,260
2001................................................ 2,976 6,176
2002................................................ 1,360 10,060
------- -------
Total............................................. $32,489 $44,576
======= =======
</TABLE>
Promissory notes payable to shareholders are subordinate to all other notes
payable, capital leases and the revolving line of credit.
The Company renegotiated the terms of two of the four promissory notes
payable to customers during 1998. The repayment terms of one of the
renegotiated notes is based on quarterly payments as compared to the prior
agreements, which also provided for repayments based upon product sales to the
customer; the other is based only on quarterly payments.
In July 1988, the Company recognized an extraordinary gain of $306,000, net
of income taxes of $67,000, as a result of the early retirement of $3.1 million
of an outstanding promissory note payable to a customer.
The fair value of the Company's fixed-rate notes payable is estimated using a
discounted cash flow analysis based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements. The fair value at
July 3, 1999 was estimated to be $41.1 million using an incremental borrowing
rate of 10.5%.
During 1996, 1997 and 1998, a portion of the promissory notes payable to
financial institutions was guaranteed by AKCL and HP. During 1997, the Company
signed a reimbursement agreement under which, if AKCL or HP incurred any
expenses under the guarantees, the Company would reimburse AKCL and HP. The
proceeds from the promissory notes payable were used to purchase manufacturing
equipment which is pledged as collateral under the agreements.
Certain of the Company's debt obligations limit the payment of dividends.
F-17
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Commitments and Contingencies
Lease Obligations
The Company enters into various noncancelable operating and capital leases
for its facilities and sale and leaseback transactions to finance purchases of
property and equipment. The future minimum lease commitments having terms in
excess of one year as of January 2, 1999 are as follows (in thousands):
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
--------- -------
<S> <C> <C>
1999...................................................... $12,337 $ 2,336
2000...................................................... 12,009 2,320
2001...................................................... 11,991 2,134
2002...................................................... 7,873 2,069
2003...................................................... 3,794 --
------- -------
Total minimum lease payments.............................. $48,004 8,859
=======
Less amounts representing interest........................ (1,791)
-------
Present value of minimum capital lease obligations........ 7,068
Less current portion...................................... (1,586)
-------
Noncurrent portion........................................ $ 5,482
=======
</TABLE>
Periodically, the Company will purchase or make advance deposits toward the
purchase of machinery and equipment; and within one to three months enter into
leasing arrangements to finance these assets. These leasing arrangements result
in the reimbursement of the amounts initially paid by the Company and do not
result in any gains or losses. Such reimbursements have been reflected in the
statement of cash flows as proceeds from equipment lease financings.
Machinery and equipment include amounts from assets acquired under capital
leases of $537,000 at December 28, 1997, $7,664,000 at January 2, 1999, and
July 3, 1999. Accumulated amortization of these assets was $15,000, $654,000,
and $1,179,000 at December 28, 1997, January 2, 1999, and July 3, 1999,
respectively.
Rent expense was $453,000, $1,100,000, $7,788,000, and $6,492,000 in 1996,
1997, 1998, and the six months ended July 3, 1999, respectively.
At July 3, 1999, the Company had outstanding commitments to purchase
machinery and equipment totaling approximately $9.4 million. Subsequent to
July 3, 1999, the Company entered into commitments to purchase additional
machinery and equipment totaling approximately $0.8 million.
Future minimum rentals have not been reduced by minimum sublease rentals of
$401,000 due in the future under noncancellable subleases. The Company
subleases office space to a vendor. Rental income under this sublease was
$128,000 and $192,000 for 1998 and the six months ended 1999, respectively.
8. Stockholders' Equity
Common Stock
Common stock has been issued to current and former employees as a result of
the exercise of option agreements. The common shares are generally subject to
certain restrictions, including the right of first refusal by the Company for
the sale or transfer of these shares to an outside party. As part of the
Recapitalization, the Predecessor Company repurchased all outstanding common
shares.
F-18
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Class 1 Convertible Stock and Series A Redeemable Convertible Preferred Stock
Under terms of the Predecessor Company's Series A Redeemable Convertible
Preferred Stock, HP and AKCL purchased 1,500,000 shares each of Series A
Redeemable Convertible Preferred Stock at $10 per share. The purchase of these
shares was contingent upon achieving certain technical and product performance
milestones. As of December 31, 1995, the Company had achieved the milestones,
and a total of 3,000,000 shares of Series A Redeemable Convertible Preferred
Stock was issued. HP and AKCL also agreed to loan the Company up to a total of
$15 million each to fund the Company's operations. No such loans were made in
1996 or in 1997. However, in lieu of providing loans to the Company, HP and
AKCL agreed to guarantee certain third-party loans made to the Company.
In September 1994, Komag and AKCL were issued 1,200,000 shares of Class 1
Convertible Stock. The holders of Class 1 Convertible Stock had limited voting
rights. The holders of Series A Redeemable Convertible Preferred Stock (on an
as-if-converted basis) had the same voting rights as holders of common stock.
Holders of Class 1 Convertible Stock and Series A Redeemable Convertible
Preferred Stock were entitled to receive annual preferential dividends at the
rate of $1.00 per share, as declared by the Board of Directors, prior to the
payment of dividends to holders of the common stock. Such dividends were
noncumulative. No dividends had been declared as of the date of the
Recapitalization.
Class 1 Convertible Stock was not redeemable. Series A Redeemable
Convertible Preferred Stock was redeemable upon the request of a majority of
stockholders after September 2000. The redemption price for Series A
Redeemable Convertible Preferred Stock was $10.00 per share, plus any declared
but unpaid dividends.
In connection with the Recapitalization, the aforementioned Common Stock,
Class 1 Convertible Stock and Series A Redeemable Convertible Preferred Stock
were canceled. Each holder of Common and Class 1 Convertible Stock of the
Predecessor Company received cash proceeds of $0.10 per share, and each holder
of Series A Redeemable Convertible Preferred Stock received cash proceeds of
$7.19 per share for total proceeds of approximately $22.0 million.
The Company's newly issued Series A Convertible Preferred Stock has certain
rights and privileges. The holders of Series A Convertible Preferred Stock are
entitled to receive noncumulative dividends equal to $0.19 per annum, when and
if declared by the Company's Board of Directors. In the event of liquidation,
dissolution or winding up of the Company, the holders of Series A Convertible
Preferred Stock are entitled to receive a liquidation preference of $2.39 per
share plus declared but unpaid dividends, and share, on an as-if converted
basis with the holders of common stock, until an additional $9.56 per share has
been distributed. In addition, each share of Series A Convertible Preferred
Stock is convertible into one share of common stock, initially at a conversion
price per share of $2.39, at the option of the holder or automatically in the
event of an Initial Public Offering involving an aggregate offering price of
not less than $15 million at a per share offering price of $7.00 per share or
more, subject to anti-dilution adjustments. The newly issued Series A
convertible preferred stock is not redeemable.
In March 1998, the Company completed a financing pursuant to which the
Company received approximately $2,740,000 in gross cash proceeds in exchange
for 1,144,535 shares of its Series A Convertible Preferred Stock.
F-19
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Warrants
In February 1997, in connection with the Recapitalization, the Company
granted a related party a warrant to purchase 389,918 shares of the Company's
common stock at an exercise price of $0.10 per share. The warrant expires on
February 4, 2002. In July 1997, in connection with a financing arrangement,
the Company granted to a financing company a warrant to purchase 179,816 shares
of the Company's common stock at an exercise price equal to $2.39 per share.
The warrant expires on March 31, 2003. The value of these warrants at their
respective grant dates was immaterial.
Stock Options
In October 1994, the Predecessor Company adopted the 1994 Stock Option/Stock
Issuance Plan (the "Predecessor Plan"), which provided for incentive stock
options, as defined by the Internal Revenue Code, to be granted to employees,
at an exercise price not less than 100% of the fair value at the grant date as
determined by the Board of Directors. The Predecessor Plan also provided for
nonqualified stock options to be issued to nonemployee officers, directors and
consultants at an exercise price of not less than 85% of the fair value at the
grant date. All options granted under the Predecessor Plan were canceled in
connection with the Recapitalization.
In conjunction with the Recapitalization in January 1997, the Company adopted
the Headway Technologies, Inc. 1997 Stock Option Plan (the "Plan"), which
provides for incentive stock options, as defined by the Internal Revenue Code,
to be granted to employees, at an exercise price not less than 100% of the fair
value at the grant date as determined by the Board of Directors. The Plan also
provides for nonqualified stock options to be issued to nonemployee officers,
directors and consultants at an exercise price of not less than 85% of the fair
value at the grant date.
The options are exercisable at such time or times, or upon such event or
events, and subject to such terms, conditions, performance criteria, and
restrictions as determined by the Board of Directors, within certain
limitations, including a term of 10 years. Generally, granted options vest
ratably over 48 months; however, the Company has issued fully vested options
and options with 12 and 48 month vesting periods. Common shares purchased
under the Plan are subject to certain restrictions including the right of
refusal by the Company for the sale or transfer of shares to outside parties.
As of January 2, 1999, 9,480,000 shares of common stock were reserved for
issance under the Plan.
Certain options under the Plan are immediately exercisable; however, shares
issued are subject to repurchase rights which lapse in a series of installments
measured from the vesting commencement date of the option. Unvested stock is
subject to repurchase agreements whereby the Company has the option to
repurchase unvested shares upon termination of employment at the original issue
price. As of January 2, 1999, there are no shares of outstanding common stock
which are subject to repurchase.
In December 1998, the Board of Directors approved a stock option repricing
program pursuant to which employees of the Company (excluding certain executive
officers) could elect to exchange or amend their then outstanding employee
stock options for new employee stock options having an exercise price of $2.25
per share (equal to the then fair market value). A total of 1,215,020 options
with exercise prices ranging from $2.40 to $6.50 per share were exchanged or
amended under the program.
F-20
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of option activity under the Predecessor Plan and the Plan is as
follows:
<TABLE>
<CAPTION>
Number of Weighted-Average
Shares Exercise Price
---------- ----------------
<S> <C> <C>
Balance at December 31, 1995.................. 1,048,817 $0.23
Options granted............................. 350,200 0.80
Options canceled............................ (197,566) 0.80
Options exercised........................... (31,151) 0.80
---------- -----
Balance at December 29, 1996.................. 1,170,300 0.29
Options canceled in connection with the
Recapitalization........................... (1,170,300) 0.29
Options granted............................. 6,189,435 0.56
Options canceled............................ (538,559) 0.31
Options exercised........................... (135,428) 0.14
---------- -----
Balance at December 28, 1997.................. 5,515,448 0.60
Options granted............................. 2,548,905 4.15
Options canceled............................ (1,635,166) 4.86
Options exercised........................... (560,668) 0.22
---------- -----
Balance at January 2, 1999.................... 5,868,519 0.99
Options granted (unaudited)................. 159,950 3.54
Options canceled (unaudited)................ (208,468) 0.22
Options exercised (unaudited)............... (515,048) 0.74
---------- -----
Balance at July 3, 1999 (unaudited)........... 5,304,953 $1.15
========== =====
</TABLE>
The following table summarizes information about options outstanding at
January 2, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- ----------------------
Average Weighted- Weighted-
Remaining Average Average
Exercise Contractual Exercise Exercise
Price Shares Life (Years) Price Shares Price
-------- --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
$ 0.10 1,067,008 8.1 $0.10 698,975 $0.10
0.33 1,824,967 8.3 0.33 837,376 0.33
1.16 1,353,381 8.5 1.16 477,502 1.16
1.61 105,823 8.8 1.61 32,179 1.61
2.00 255,570 9.0 2.00 68,088 2.00
2.25 1,241,770 9.8 2.25 17,850 2.25
2.40 20,000 9.1 2.40 -- --
------------ --------- --- ----- --------- -----
$ 0.10-$2.40 5,868,519 8.6 $0.99 2,131,970 $0.53
============ ========= === ===== ========= =====
</TABLE>
As of December 29, 1996, December 28, 1996, and July 3, 1999, options
exercisable totaled 246,552, 1,152,729, and 2,373,463, respectively, and the
weighted-average exercise price was $0.21, $0.46, and $0.81, respectively.
F-21
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
At January 2, 1999 and July 3, 1999, the Company has reserved shares of
capital stock for future issuances as follows:
<TABLE>
<CAPTION>
Common Shares
---------------------------
July 3,
January 2, 1999 1999
--------------- -----------
(unaudited)
<S> <C> <C>
Convertible preferred shares..................... 15,764,535 15,764,535
Stock options outstanding........................ 5,868,519 5,304,953
Stock options available for grant................ 2,915,390 2,963,903
Warrants......................................... 569,734 569,734
---------- ----------
25,118,178 24,603,125
========== ==========
</TABLE>
For purposes of pro forma disclosures required by FAS 123, the estimated fair
value of the options is amortized to expense over the options' vesting period.
Pro forma net (loss) income has been determined using the minimum value
method. The minimum value method calculates the fair value of options as the
excess of the estimated fair value of the underlying stock at the date of grant
over the present value of both the exercise price and the expected dividend
payments, each discounted at the risk-free rate, over the expected life of the
option. In determining the estimated fair value of granted stock options under
the minimum value method, the risk-free interest rate was assumed to be 6%, the
dividend yield was estimated to be 0% and the expected life was assumed to be
between 3 and 5 years. Because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the minimum
value method and other methods prescribed by FAS 123 do not necessarily provide
a single measure of the fair value of its stock options. The Company's
information follows (in thousands):
<TABLE>
<CAPTION>
Six Months
Years Ended Ended
------------------------------------ -----------
December 29, December 28, January 2, July 3,
1996 1997 1999 1999
------------ ------------ ---------- -----------
(unaudited)
<S> <C> <C> <C> <C>
Net (loss) income--as
reported................ $(4,967) $(19,404) $6,735 $911
Net (loss) income--as
adjusted................ $(4,998) $(19,534) $5,985 $803
</TABLE>
The weighted-average fair value of options granted during 1996, 1997, 1998,
and the six months ended 1999 was $0.21, $0.13, $0.48, and $0.92, respectively.
Deferred Compensation
The Company recorded deferred compensation expense of $331,000 during 1997
for the difference between the exercise or purchase price and the deemed fair
value of certain of the Company's stock options granted and stock issued under
stock purchase agreements. These amounts are being amortized by charges to
operations over the vesting periods of the individual stock options and stock
purchase agreements, which are generally four years.
Notes Receivable from Officers
Notes receivable from officers outstanding at December 29, 1996, resulting
from the purchase of common stock, were paid in connection with the
Recapitalization. During 1996, the notes earned interest at 6%, payable
annually, and were secured by the shares issued.
In December 1997, the Company loaned an officer $400,000. The note is being
forgiven in equal installments on January 1 of each of the subsequent four
years for as long as the officer continues employment with the Company.
F-22
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Income Taxes
The provision for income taxes for the year ended January 2, 1999 consists of
the following (in thousands):
<TABLE>
<S> <C>
Current provision for income taxes:
Federal............................................................ $1,195
State.............................................................. 280
------
Provision for income taxes........................................... $1,475
======
</TABLE>
An additional income tax expense of approximately $67,000 was allocated to
the extraordinary gain related to early retirement of debt during the year
ended January 2, 1999.
The Company did not incur any federal or state income tax expenses for the
years ended December 29, 1996 or December 28, 1997 due to net operating losses.
The differences between the income tax expense and the amount computed by
applying the federal statutory rate to income (loss) before taxes for the years
ended December 29, 1996, December 28, 1997 and January 2, 1999 are summarized
as follows (in thousands):
<TABLE>
<CAPTION>
December 29, December 28, January 2,
1996 1997 1999
------------ ------------ ----------
<S> <C> <C> <C>
Income tax (benefit) at federal
statutory rate...................... $(1,689) $(6,597) $2,814
Change in valuation allowance........ 1,689 4,557 (2,787)
Write-off of acquired technology..... -- 2,040 --
State taxes, net of federal benefit.. -- -- 178
Amortization of acquired intangible
assets.............................. -- -- 214
Federal alternative minimum tax...... -- -- 944
Other--net........................... -- -- 112
------- ------- ------
Provision for income taxes........... $ -- $ -- $1,475
======= ======= ======
</TABLE>
Deferred income taxes reflect the tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes are as follows (in thousands):
<TABLE>
<CAPTION>
December 28, January 2,
1997 1999
------------ ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................... $ 9,229 $ 6,396
Tax credit carryforwards........................... 2,329 3,415
Reserves and accruals.............................. 2,445 4,071
Other, net......................................... 2 2
-------- --------
Total deferred tax assets.......................... 14,005 13,884
Valuation allowance................................ (13,450) (11,774)
-------- --------
Deferred tax asset................................. 555 2,110
Deferred tax liabilities:
Depreciation and amortization...................... (555) (2,110)
-------- --------
Total deferred tax liabilities....................... (555) (2,110)
-------- --------
Net deferred tax assets.............................. $ -- $ --
======== ========
</TABLE>
F-23
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Realization of deferred tax assets is dependent upon future earnings, the
timing and amount of which are uncertain. Accordingly, a valuation allowance,
in the amount equal to the net deferred tax assets, has been established to
reflect these uncertainties. The valuation allowance for deferred tax assets
increased by approximately $2,148,000 and $5,819,000 during the years ended
December 29, 1996 and December 28, 1997, respectively, and decreased by
approximately $1,676,000 during the year ended January 2, 1999.
As of January 2, 1999, the Company had federal and state net operating loss
carryforwards of approximately $16,325,000 and $14,495,000, respectively. The
Company also had federal and state tax credit carryforwards of approximately
$2,320,000 and $1,658,000, respectively. If not utilized, these carryforwards
will expire beginning in 2009 and 2002 for federal and state income tax
purposes, respectively.
Utilization of the domestic net operating loss carryforwards and tax credit
carryforwards may be subject to a substantial annual limitation due to the
ownership change limitations provided by the Internal Revenue Code of 1986, as
amended, and similar state provisions. The annual limitation may result in the
expiration of net operating loss and tax credit carryforwards before
utilization.
10. Retirement Plan
The Company has a retirement plan under Section 401(k) of the Internal
Revenue Code. Under the retirement plan, participating employees may defer a
portion of their pretax earnings up to the Internal Revenue Service annual
contribution limit. The Plan allows for discretionary employer contributions.
To date, no employer contributions have been made.
11. Contingencies
During 1998, the Company evaluated potential patent infringements of IBM's
technology. Based on discussions held in April 1999 between the Company and
IBM, the Company provided $2,000,000 in cost of sales and other accrued
liabilities as of January 2, 1999 an amount which represents the Company's
estimate of the potential liabilities to IBM for sales of the Company's
potentially infringing products during 1997 and 1998.
In July 1999, the Company finalized the terms of a patent license agreement
and a technology transfer agreement, collectively "the Agreement," with IBM.
In connection with the finalization of the Agreement, the Company accrued
additional amounts for patent infringement for the six months ended July 3,
1999, resulting in a total accrued balance of approximately $3.2 million.
Under the Agreement, eleven patents were licensed to the Company for the life
of those patents. The Company reflected the acquisition of these patents,
among other patents acquired from third parties during the second quarter of
1999, by recording intangible assets and related notes payable as of July 3,
1999. The Agreement also licensed to IBM all of the Company's existing and
future patents filed by the Company through December 31, 2002 for the life of
the patents and transferred to the third party know-how related to two
manufacturing processes. The patents acquired from IBM and other third parties
are being amortized over their remaining estimated useful lives of
approximately eight years.
The Company may become a party to legal disputes and proceedings arising in
the ordinary course of its business activities. In the opinion of management,
resolution of these matters is not expected to have a material adverse effect
on the financial position of the Company. However, depending on the amount and
timing, an unfavorable resolution of some or all of these matters could
materially affect the Company's future financial position, results of
operations or liquidity in a particular period.
F-24
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Joint Venture
In January 1999, the Company entered into a joint venture with a company
located in Hong Kong to provide subcontracting consulting and services for
recording head products. The Company contributed approximately $64,000 and
holds a non-controlling interest in the voting stock of the entity. In
addition, the Company has the right to purchase, at fair value at the
respective date, an additional 10% of the joint venture for approximately 9
years beginning January 13, 1999. The Company is accounting for the joint
venture using the equity method.
13. Subsequent Events (unaudited)
Proposed Public Offering of Common Stock
In August 1999, the Board of Directors authorized the Company to proceed with
an initial public offering of its common stock. If the offering is consummated
as presently anticipated, all of the outstanding preferred stock will
automatically convert to common stock. The unaudited pro forma stockholders'
equity at July 3, 1999 gives effect to the conversion of all outstanding shares
of convertible preferred stock at that date into 15,764,535 shares of common
stock upon the completion of the offering.
1999 Employee Stock Purchase Plan
The Company's 1999 Employee Stock Purchase Plan (the "Purchase Plan") was
adopted by the Board of Directors in August 1999 and approved by the
stockholders in August 1999 and will be effective upon consummation of the
initial public offering. A total of 750,000 shares of common stock has been
authorized for issuance under the Purchase Plan, plus an annual increase to be
added on January 1 of each year equal to the number of shares needed to restore
the maximum number of shares of common stock that may be available for grant
under the purchase plan to 750,000 shares.
The Purchase Plan contains consecutive, overlapping twenty-four-month
offering periods. Each offering period consists of four purchase periods, each
approximately six months in length. The offering periods generally start on
the first trading day on or after February 1 and August 1 of each year, except
for the first such offering period which commences on the first trading day on
or after the effective date of this offering and ends on the last trading day
on or before January 31, 2002.
The Purchase Plan permits eligible employees to purchase common stock through
payroll deductions, which may not exceed ten percent of an employee's
compensation. The price of stock purchased under the Purchase Plan is equal to
85% of the fair market value of the common stock at the beginning of each
offering period or the last day of the purchase period, whichever is lower.
The maximum number of shares a participant may purchase during a single
purchase period is 5,000 shares.
Director Option Plan
The Company's 1999 Director Option Plan (the "Director Plan") was adopted by
the Board of Directors in August 1999 and approved by the stockholders in
August 1999. A total of 150,000 shares of common stock has been reserved for
issuance under the Director Plan, plus an annual increase to be added each year
on the day after the date of the annual stockholder meeting equal to the lesser
of (a) the number of shares needed to restore the maximum number of shares
available for grant to 150,000 shares or (b) an amount determined by the Board
of Directors. The outside directors are eligible to participate in the
Director Plan, which provides for the grant of nonstatutory stock options
pursuant to an automatic,
F-25
<PAGE>
HEADWAY TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
nondiscretionary grant mechanism. The Director Plan provides that each outside
director, except for employee directors who become outside directors, shall be
granted a nonstatutory stock option to purchase 50,000 shares of common stock
on the date that the person first becomes an outside director. Thereafter,
each outside director shall be automatically granted an option to purchase
12,500 shares of common stock each year on the date of the annual stockholder
meeting provided that the director has served on the Board for at least the
preceding six months. The Director Plan provides that the initial option shall
become vested as to 25% of the shares subject to the option on the first
anniversary of its date of grant, with monthly vesting thereafter. Each
subsequent option shall become vested in equal monthly installments over a one
year period beginning after all previously granted options have fully vested.
The exercise price per share of all options granted under the Director Plan
shall be equal to the fair market value of a share of our common stock on the
date of grant. Options granted to outside directors under the Director Plan
have a ten year term.
F-26
<PAGE>
[Upper left corner] [Upper right corner]
Picture of Head Gimbal Assembly Picture of wafer
[Background]
Picture of Periodic Table
[Swirl logo] Headway Technologies
We use our broad and
fundamental understanding
of recording head
technology to develop
products that we believe
provide our customers with
significant performance
advantages and faster time
to volume production.
[Lower left corner] [Lower right corner]
Picture of man inspecting wafer Picture of the inside of a disk drive
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Shares
Headway Technologies, Inc.
Common Stock
------------
PROSPECTUS
------------
Hambrecht & Quist
Banc of America Securities LLC
------------
, 1999
------------
You should rely only on information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.
No action is being taken in any jurisdiction outside the United States to
permit a public offering of the common stock or possession or distribution of
this prospectus in any such jurisdiction. Persons who come into possession of
this prospectus in jurisdictions outside the United States are required to
inform themselves about and to observe any restrictions as to this offering and
the distribution of this prospectus applicable to that jurisdiction.
Until , 1999 (25 days after the date of this prospectus), all dealers
that buy, sell or trade in the securities in this offering, whether or not
participating in this offering, may be required to deliver a prospectus. This
is in addition to the dealers' obligation to deliver a prospectus when acting
as underwriters and with respect to their unsold allotments or subscriptions.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth all expenses, other than the underwriting
discounts and commissions, payable by the Registrant in connection with the
sale of the securities being registered. All amounts shown are estimates
except for the SEC registration fee and the NASD filing fee.
<TABLE>
<S> <C>
SEC registration fee.............................................. $ 9,591
NASD filing fee................................................... 3,950
NASDAQ National Market Fees....................................... 95,000
Blue Sky qualification fees and expenses.......................... 10,000
Printing and engraving expenses................................... 85,000
Accountant's fees and expenses.................................... 400,000
Legal fees and expenses........................................... 130,000
Miscellaneous..................................................... 100,000
---------
Total............................................................. $ 833,541
=========
</TABLE>
Item 14. Indemnification of Directors and Officers.
Section 145 of the Delaware General Corporation Law permits a corporation to
include in its charter documents, and in agreements between the corporation and
its directors and officers, provisions expanding the scope of indemnification
beyond that specifically provided by the current law.
The Registrant's Amended and Restated Certificate of Incorporation provides
for the indemnification of directors to the fullest extent permissible under
Delaware law.
The Registrant's Bylaws provide for the indemnification of officers,
directors and third parties acting on behalf of the Registrant if such person
acted in good faith and in a manner reasonably believed to be in and not
opposed to the best interest of the Registrant, and, with respect to any
criminal action or proceeding, the indemnified party had no reason to believe
his conduct was unlawful.
The Registrant has entered into indemnification agreements with its directors
and executive officers, in addition to indemnification provided for in the
Registrant's Bylaws, and intends to enter into indemnification agreements with
any new directors and executive officers in the future.
The form of Underwriting Agreement filed as Exhibit 1.1 hereto provides for
the indemnification of the Registrant's directors and officers in certain
circumstances as provided therein.
Item 15. Recent Sales of Unregistered Securities.
(a) Since June 30, 1996, the Registrant has issued and sold (without payment
of any selling commission to any person) the following unregistered securities:
(1) Between January 1997 and June 30, 1999, the Registrant granted
1,203,794 shares of Common Stock to employees and consultants of the
Registrant pursuant to option exercises under the Registrant's 1997
Stock Option Plan for an aggregate exercise price of $256,575.
(2) On January 22, 1997, the Registrant issued and sold 2,000 shares of
Common Stock to a total of one investor for an aggregate purchase price
of $200.00.
II-1
<PAGE>
(3) From February 4, 1997 to March 11, 1998, the Registrant issued and sold
its shares of its Series A Preferred Stock convertible into an
aggregate of 15,764,535 shares of Common Stock to a total of 22
investors for an aggregate purchase price of $ 37,739,993.91.
(4) On February 4, 1997, the Registrant issued a warrant convertible into
389,918 shares of Common Stock at a purchase price of $0.10 per share
to a total of one investor.
(5) On July 23, 1997, the Registrant issued a warrant convertible into
179,816 shares of Common Stock at a purchase price of $2.39 per share
to a total of one investor.
There was no underwriter involved in connection with the transactions set
forth above. The issuance of the securities set forth in paragraph 1 of this
Item 15 was deemed to be exempt from registration under the Securities Act in
reliance upon Rule 701 promulgated thereunder. The issuance of the securities
set forth in paragraphs 2, 3, 4, and 5 of this Item 15 were deemed to be exempt
from registration pursuant to Section 4(2) of the Securities Act and/or
Regulation D promulgated thereunder as a transaction by an issuer not involving
a public offering.
In all of such transactions, the recipients of securities represented their
intention to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof, and appropriate
legends were affixed to the securities issued. All recipients received
adequate information about the Registrant at the time of the acquisition of
such securities or had access, through employment or other relationships, with
the Registrant, to such information.
Item 16. Exhibits and Financial Statement Schedules.
(a) The following exhibits are filed herewith:
<TABLE>
<CAPTION>
Number Exhibit Title
------ -------------
<C> <S>
1.1+ Form of Underwriting Agreement.
Agreement of Merger by and between Registrant and Headway
2.1+ Reorganization Subsidiary, Inc.
3.1+ Registrant's Certificate of Incorporation.
3.2+ Registrant's Bylaws.
4.1* Form of Specimen Certificate for Registrant's common stock.
4.2+ Registration and Information Rights Agreement by and between Registrant
and the purchasers of the Registrant's Series A preferred stock named
therein.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, P.C. regarding legality of
the securities being registered.
10.1+ Patent License Agreement between Registrant and Seagate Technology,
Inc.
10.2** Cross-License and Know-How Transfer Agreement between Registrant and
Seagate Technology, Inc., dated May 19, 1995.
10.3** Cross License and Know-How Transfer Agreement between Registrant and
Seagate Technology Inc., dated April 27, 1998.
10.4** Strategic Alliance Agreement between Registrant and SAE Magnetics
(H.K.) Ltd.
10.5** Master Technology License Agreement by and among Registrant, Hewlett-
Packard Company, Komag, Incorporated and Asahi America, Inc., and
Amendment thereto.
10.6+ Shareholders Agreement among Registrant, MRST Limited and SFI
Investment Ltd.
10.7+ Standard Industrial/Commercial Single-Tenant Lease-Net between
Registrant and Joseph Rubino and Dorothy Rubino Intervivos Trust, et.
al., and Lease Addendum No. 1 thereto.
10.8+ Sublease Agreement between Registrant, Sanjaylyn Company and Komag,
Inc., and First Amendment thereto.
10.9+ Loan and Security Agreement between Registrant and Silicon Valley Bank.
</TABLE>
II-2
<PAGE>
<TABLE>
<C> <S>
10.10+ Master Lease Agreement between Registrant and General Electric Capital
Corporation, and addendum thereto.
10.11+ Promissory Note by and between Registrant and David Begin.
10.12+ Promissory Note by and between Registrant and Western Digital
Corporation.
10.13+ Promissory Note by and between Registrant and Maxtor Corporation.
10.14** License Agreement between Registrant and International Business
Machines Corporation.
10.15+ Registrant's 1997 Stock Option Plan and related documents.
10.16+ Registrant's 1999 Employee Stock Purchase Plan and related documents.
10.17+ Registrant's 1999 Director Stock Option Plan and related documents.
10.18** Volume Supply Agreement between Registrant and SAE Magnetics (H.K.)
Ltd.
10.19** Technology Transfer Agreement between Registrant and International
Business Machines Corporation.
21.1+ Subsidiaries of the Registrant.
23.1* Consent of Wilson Sonsini Goodrich & Rosati, P.C. (included in Exhibit
5.1).
23.2 Consent of Ernst & Young LLP, independent auditors.
24.1+ Power of Attorney.
27.1+ Financial Data Schedule.
</TABLE>
- --------
* To be supplied by amendment.
** Confidential treatment has been requested with regard to certain portions of
this document. Such portions have been omitted from this filing and have
been filed separately with the Securities and Exchange Commission.
+ previously filed
Item 17. Undertakings.
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement on Form S-1 to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Milpitas, in the State of California, on October 8, 1999.
HEADWAY TECHNOLOGIES, INC.
/s/ Thomas A. Surran
By: _________________________________
Thomas A. Surran
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Mike Y. Chang President, Chief Executive October 8, 1999
____________________________________ Officer and Director
Mike Y. Chang (Principal Executive
Officer)
/s/ Thomas A. Surran Chief Financial Officer October 8, 1999
____________________________________ (Principal Financial
Thomas A. Surran Officer and Principal
Accounting Officer)
Kochan Ju* Vice President of Technology October 8, 1999
____________________________________ and Director
Kochan Ju
Ta-Lin Hsu* Director October 8, 1999
____________________________________
Ta-Lin Hsu
Irwin Federman* Director October 8, 1999
____________________________________
Irwin Federman
Heinrich Sussner* Director October 8, 1999
____________________________________
Heinrich Sussner
Tu Chen* Director October 8, 1999
____________________________________
Tu Chen
David Tsang* Director October 8, 1999
____________________________________
David Tsang
</TABLE>
/s/ Mike Y. Chang
*By: ______________________
Mike Y. Chang
Attorney-in-fact
II-4
<PAGE>
HEADWAY TECHNOLOGIES, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions
---------------------
Balance at Charged to Charged to Balance at
beginning of costs and other Deductions-- end of
period expenses accounts write-offs period
------------ ---------- ---------- ------------ ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Allowance for doubtful
accounts
Year ended December 29,
1996.................. $ -- $ 5 $ -- $ -- $ 5
Year ended December 28,
1997.................. 5 530 -- (5) 530
Year ended January 2,
1999.................. 530 -- -- -- 530
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Number Exhibit Title
------ -------------
<C> <S>
1.1+ Form of Underwriting Agreement.
Agreement of Merger by and between Registrant and Headway
2.1+ Reorganization Subsidiary, Inc.
3.1+ Registrant's Certificate of Incorporation.
3.2+ Registrant's Bylaws.
4.1* Form of Specimen Certificate for Registrant's common stock.
4.2+ Registration and Information Rights Agreement by and between
Registrant and the purchasers of the Registrant's Series A preferred
stock named therein.
5.1* Opinion of Wilson Sonsini Goodrich & Rosati, P.C. regarding legality
of the securities being registered.
10.1+ Patent License Agreement between Registrant and Seagate Technology,
Inc.
10.2** Cross-License and Know-How Transfer Agreement between Registrant and
Seagate Technology, Inc., dated May 19, 1995.
10.3** Cross License and Know-How Transfer Agreement between Registrant and
Seagate Technology Inc., dated April 27, 1998.
10.4** Strategic Alliance Agreement between Registrant and SAE Magnetics
(H.K.) Ltd.
10.5** Master Technology License Agreement by and among Registrant, Hewlett-
Packard Company, Komag, Incorporated and Asahi America, Inc., and
Amendment thereto.
10.6+ Shareholders Agreement among Registrant, MRST Limited and SFI
Investment Ltd.
10.7+ Standard Industrial/Commercial Single-Tenant Lease-Net between
Registrant and Joseph Rubino and Dorothy Rubino Intervivos Trust, et.
al., and Lease Addendum No. 1 thereto.
10.8+ Sublease Agreement between Registrant, Sanjaylyn Company and Komag,
Inc., and First Amendment thereto.
10.9+ Loan and Security Agreement between Registrant and Silicon Valley
Bank.
10.10+ Master Lease Agreement between Registrant and General Electric Capital
Corporation, and addendum thereto.
10.11+ Promissory Note by and between Registrant and David Begin.
10.12+ Promissory Note by and between Registrant and Western Digital
Corporation.
10.13+ Promissory Note by and between Registrant and Maxtor Corporation.
10.14** License Agreement between Registrant and International Business
Machines Corporation.
10.15+ Registrant's 1997 Stock Option Plan and related documents.
10.16+ Registrant's 1999 Employee Stock Purchase Plan and related documents.
10.17+ Registrant's 1999 Director Stock Option Plan and related documents.
10.18** Volume Supply Agreement between Registrant and SAE Magnetics (H.K.)
Ltd.
10.19** Technology Transfer Agreement between Registrant and International
Business Machines Corporation.
21.1+ Subsidiaries of the Registrant.
23.1* Consent of Wilson Sonsini Goodrich & Rosati, P.C. (included in Exhibit
5.1)
23.2 Consent of Ernst & Young LLP, independent auditors
24.1+ Power of Attorney.
27.1+ Financial Data Schedule.
</TABLE>
- --------
* To be supplied by amendment.
** Confidential treatment has been requested with regard to certain portions of
this document. Such portions have been omitted from this filing and have
been filed separately with the Securities and Exchange Commission.
+ Previously filed
<PAGE>
EXHIBIT 23.2
Consent of Ernst & Young LLP, Independent Auditors
We consent to the reference to our firm under the captions "Selected
Consolidated Financial Data" and "Experts" and to the use of our report dated
February 26, 1999, except for paragraph 1 of Note 11 as to which the date is
April 26, 1999, in Amendment No. 1 to the Registration Statement (Form S-1) and
related Prospectus of Headway Technologies, Inc. dated October 8, 1999.
Our audits also included the financial statement schedule of Headway
Technologies, Inc. listed in Item 14(a). This schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion based on
our audits. In our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
San Jose, California
October 8, 1999
