Form 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
----------------------
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Quarterly Period Ended July 4, 1998
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from _______to_______
Commission File No.1-6635
APPLIED MAGNETICS CORPORATION
(Exact name of registrant as specified in its charter)
A Delaware Corporation 95-1950506
---------------------- ----------
(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
75 Robin Hill Road, Goleta, California 93117
--------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (805) 683-5353
(No Change)
----------------------------------
Former name, former address and former fiscal year,
if changed since last report.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days. Yes ..X.. No .....
Indicate the number of shares outstanding of each of the issuer's classes of
common stock: 24,103,744 $.10 par value common stock as of August 12, 1998.
Exhibit Index on page 21
Page 1 of 26
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PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
The unaudited condensed consolidated financial statements included herein have
been prepared by Applied Magnetics Corporation and its subsidiaries (the
"Company" or "Applied Magnetics") pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The unaudited condensed consolidated financial statements
and selected notes included therein should be read in conjunction with the
audited consolidated financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended September 27,
1997.
The following unaudited condensed consolidated financial statements reflect all
adjustments, consisting only of normal and recurring adjustments, which, in the
opinion of management, are necessary to present fairly the consolidated
financial position and results of operations for the periods presented.
Page 2 of 26
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APPLIED MAGNETICS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations - Unaudited
(In thousands except per share data)
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
-------------------------- -------------------------
July 4, June 28 July 4, June 28,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 33,579 $ 124,073 $ 166,834 $ 372,011
Cost of sales 35,514 84,189 172,126 236,981
--------- --------- --------- ---------
Gross profit (loss) (1,935) 39,884 (5,292) 135,030
--------- --------- --------- ---------
Research and development expenses 30,513 15,749 82,263 37,712
Selling, general and administrative
expenses 1,504 1,910 5,079 6,242
Restructuring charge -- -- 8,400 --
Terminated merger costs -- -- -- 2,906
--------- --------- --------- ---------
Total operating expenses 32,017 17,659 95,742 46,860
--------- --------- --------- ---------
Income (Loss) from operations (33,952) 22,225 (101,034) 88,170
Interest income 1,326 2,165 4,752 6,102
Interest expense (3,285) (3,110) (9,577) (9,427)
Other income (expense) 309 305 (1,146) 742
--------- --------- --------- ---------
Income (Loss) before taxes (35,602) 21,585 (107,005) 85,587
Provision for income taxes 240 557 517 1,596
--------- --------- --------- ---------
Net income (loss) $ (35,842) $ 21,028 $(107,522) $ 83,991
========= ========= ========= =========
Net income (loss) per share:
Income (Loss) per common share $ (1.50) $ 0.89 $ (4.50) $ 3.58
========= ========= ========= =========
Income (Loss) per common
share - assuming dilution $ (1.50) $ 0.75 $ (4.50) $ 2.91
========= ========= ========= =========
Weighted average number of common
shares outstanding
Common shares 23,968 23,681 23,917 23,489
========= ========= ========= =========
Common shares - assuming dilution 23,968 30,904 23,917 30,981
========= ========= ========= =========
</TABLE>
The accompanying Selected Notes to Condensed Consolidated Financial Statements
are an integral part of these condensed consolidated statements.
Page 3 of 26
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APPLIED MAGNETICS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets - Unaudited
(In thousands except share and par value data)
July 4, September 27,
1998 1997
ASSETS ---- ----
Current Assets:
Cash and cash equivalents $ 104,904 $ 162,302
Accounts receivable, net 6,825 52,924
Inventories 20,459 51,438
Prepaid expenses and other 11,526 11,420
--------- ---------
143,714 278,084
--------- ---------
Property, plant and equipment, at cost 377,692 371,224
Less-accumulated depreciation (194,016) (181,732)
--------- ---------
183,676 189,492
--------- ---------
Other assets 14,372 10,412
--------- ---------
$ 341,762 $ 477,988
========= =========
LIABILITIES AND SHAREHOLDERS' INVESTMENT
Current Liabilities:
Current portion of long-term debt $ 1,588 $ 513
Bank notes payable 49,309 50,188
Accounts payable 15,682 49,103
Accrued payroll and benefits 9,155 11,287
Other current liabilities 12,377 5,829
--------- ---------
88,111 116,920
--------- ---------
Long-term debt, net 117,175 116,030
--------- ---------
Other liabilities 2,639 4,257
--------- ---------
Shareholders' Investment:
Preferred stock, $.10 par value, authorized
5,000,000 shares, none issued and outstanding -- --
Common stock, $.10 par value, authorized
80,000,000 shares, issued 24,103,744 shares
at July 4, 1998 and 23,976,711 shares at
September 27, 1997 2,410 2,398
Paid-in capital 191,774 191,185
Retained earnings (deficit) (58,219) 49,303
--------- ---------
135,965 242,886
Page 4 of 26
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Treasury stock, at cost (130,233 shares as
of July 4, 1998 and 128,384 shares at
September 27, 1997) (1,577) (1,554)
Unearned restricted stock compensation (551) (551)
--------- ---------
133,837 240,781
--------- ---------
$ 341,762 $ 477,988
========= =========
The accompanying Selected Notes to Condensed Consolidated Financial Statements
are an integral part of these condensed consolidated balance sheets.
Page 5 of 26
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APPLIED MAGNETICS CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows - Unaudited
(In thousands)
For the nine months ended
July 4, June 28,
1998 1997
---- ----
Cash Flows from Operating Activities:
Net income (loss) $(107,522) $ 83,991
Adjustments to derive cash flows:
Depreciation and amortization 33,749 27,758
Restructuring charge 8,400 --
Changes in assets and liabilities
Accounts receivable, net 46,099 (7,340)
Inventories 30,979 (16,253)
Prepaid expenses and other (99) (1,422)
Accounts payable (33,421) 14,804
Accrued payroll and benefits (2,132) 1,019
Other assets and liabilities (1,181) (164)
--------- ---------
Net cash flows (used in) provided by
operating activities (25,128) 102,393
--------- ---------
Cash Flows from Investing Activities:
Additions to property, plant and equipment (33,208) (66,026)
Notes receivable 88 81
--------- ---------
Net cash flows used in investing activities (33,120) (65,945)
--------- ---------
Cash Flows from Financing Activities:
Proceeds from issuance of debt 201,259 171,121
Repayment of debt (199,918) (169,737)
Proceeds from stock options exercised, net 578 3,830
--------- ---------
Net cash flows provided by financing activities 1,919 5,214
--------- ---------
Effect of Exchange Rate Changes on Cash
and Cash Equivalents (1,069) (401)
--------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents (57,398) 41,261
--------- ---------
Cash and Cash Equivalents at Beginning of Period 162,302 127,400
--------- ---------
Cash and Cash Equivalents at End of Period $ 104,904 $ 168,661
========= =========
The accompanying Selected Notes to Condensed Consolidated Financial Statements
are an integral part of these condensed consolidated statements.
Page 6 of 26
<PAGE>
Selected Notes to Condensed Consolidated Financial Statements
Unaudited
(July 4, 1998)
Note A: Inventories
- -------------------
Inventories are stated at the lower of cost (first-in, first-out) or
market. Inventory costs consist of purchased materials and services, direct
production labor and manufacturing overhead expense. The components of inventory
are as follows (in thousands):
July 4, September 27,
1998 1997
---- ----
Purchased parts and
manufacturing supplies $ 7,890 $24,187
Work in process 9,774 25,434
Finished goods 2,795 1,817
------- -------
$20,459 $51,438
======= =======
Note B: Restructure Charge
- --------------------------
During the first quarter of fiscal 1998, the Company recorded a pre-tax
restructuring charge of approximately $8.4 million primarily in connection with
the planned shut down of its production facility in Ireland and write down of
certain tooling and equipment. The Company used $7.3 million of the reserve
during the first nine months of fiscal 1998 and expects completion by fiscal
year end.
Note C: Credit Facilities
- -------------------------
During the second quarter of fiscal 1998, one of the Company's Malaysian
subsidiary credit facility agreements with a bank in Malaysia was cancelled by
the bank due to non-use. The Company did not use the credit line due to its high
interest rate. The total amount available to borrow under this facility was
approximately $1.3 million. The remaining five Malaysian bank credit facilities
allow for borrowings of up to $69.6 million of which $49.3 million was
outstanding as of July 4, 1998. All the Malaysian credit facilities are callable
on demand, have no termination date and are guaranteed by the Company. Credit
facilities with one bank are secured by the Company's real property holdings in
Malaysia and include financial covenants and certain covenants which preclude
the Company from granting liens and security interests in other assets in
Malaysia. Credit facilities with the four other banks are unsecured.
The Company also has a secured, asset-based revolving line of credit of
up to $35.0 million from CIT Group/Business Credit, Inc. As of July 4, 1998,
there were no borrowings outstanding under this line of credit and the balance
available to borrow was approximately $0.5 million
Page 7 of 26
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Note D: Terminated Merger Costs
- -------------------------------
Terminated merger costs of $2.9 million for the nine months ended June
28, 1997, include legal and accounting fees, financial advisory fees and
miscellaneous other expenses related to the February 1997 proposed business
combination between the Company and Read-Rite Corporation that was subsequently
withdrawn by the Company on March 14, 1997.
Note E: Earnings (Loss) Per Share Computation
- ---------------------------------------------
Effective in fiscal 1998, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128
replaces the presentation of primary income (loss) per share ("EPS") with the
presentation of basic EPS. Income (loss) per common share is computed by
dividing net income (loss) by the weighted average number of shares of common
stock outstanding during the period. Income (loss) per common share assuming
dilution is computed based on weighted average number of shares of common stock
and common stock equivalents outstanding during the period and as if the
Company's 7.0% Convertible Subordinated Debentures due March 15, 2006 (the
"Convertible Debentures") were converted into common stock at the beginning of
the period after giving retroactive effect to the elimination of interest
expense, net of income tax effect, applicable to the Convertible Debentures.
During a loss period, the assumed exercise of in-the-money stock options and
conversion of Convertible Debentures has an antidilutive effect. As a result,
these shares are not included in the weighted average shares outstanding of
23,968,488 used in the calculation of basic and fully diluted loss per common
share at July 4, 1998. Prior year EPS has been conformed to current year
presentation.
Page 8 of 26
<PAGE>
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations
The disk drive industry entered into a general slowdown late in the
first quarter of fiscal 1998 and simultaneously accelerated the transition from
disk drives using advanced inductive thin film recording heads to
magnetoresistive ("MR") recording heads. The Company's largest customer at the
time, Western Digital Corporation ("Western Digital"), sharply reduced its
production schedules as a reaction to the hard disk drive oversupply in the
industry's distribution channel. As a result, the Company experienced
significant cancellations, production reschedules and price reductions that have
continued to impact revenue, operating and financial results during the first
nine months of fiscal 1998.
In response to reductions in production schedules, the Company reduced
expenditures, including capital spending, in order to realign costs to the
current level of business. In addition, the Company shut down its manufacturing
facility in Ireland in order to consolidate foreign manufacturing operations. A
pre-tax restructuring charge of $8.4 million was recorded during the first
quarter of fiscal 1998, primarily relating to the costs associated with the shut
down of the Ireland facility. Included in the charge was the write-down of
certain tooling and equipment. The Company used $7.3 million of the reserve
during the first nine months of fiscal 1998 and expects completion of all
transactions by fiscal year end.
As inductive thin film products reach end of life, revenue from these
products continued to decline during the first nine months of fiscal 1998.
However, the Company continues to ship inductive thin film disk heads and has
initiated production of its newest 2.1 gigabyte per 3.5" disk product. Revenue
for this product is expected to continue through the first quarter of fiscal
1999.
The Company continues to make excellent progress in accelerating its
development of advanced MR products and has delivered qualification units at
both the 3.4 and 4.3 gigabyte per 3.5" disk capacity points. Upon receipt of
orders, volume production for these products is planned to begin in FQ199. MR
head shipments have not been a significant source of revenue during the first
nine months of fiscal 1998 and will not be a significant source in FQ498. Weak
OEM demand for products at the 2.1 and 2.8 gigabyte per 3.5" disk capacity
points precluded the need by several drive companies for additional head
products from the Company. The Company believes that its new products compare
favorably to the performance of the other head suppliers' offerings. Future
revenues and operating results will be dependent on the successful qualification
and timely production ramp of new MR products. While the Company is devoting
significant engineering and manufacturing resources to these efforts, there can
be no assurances that the Company will realize satisfactory competitive product
and process development results. To the extent that the Company is unable to do
so, there would be a continued material adverse effect on the Company's
operating results and liquidity.
Page 9 of 26
<PAGE>
Three Months Ended July 4, 1998
- -------------------------------
Net Sales. Net sales of $33.6 million in the third quarter of fiscal 1998
decreased 72.9% from net sales of $124.1 million in the third quarter of fiscal
1997 as inductive thin film products reach end of life. Due to production
process problems with new MR products and a general slowdown in the disk drive
industry, the Company has been unable to maintain sales volumes experienced with
inductive thin film products during the same period in the prior year.
Gross Profit. As a percentage of net sales, gross profit was a negative 5.8% and
32.1%, for the third quarter of fiscal 1998 and the third quarter of fiscal
1997, respectively. The decrease in gross profit in the third quarter of fiscal
1998 as compared to the same quarter in the prior fiscal year was due to the
reasons discussed under "Net Sales".
Research and Development. Research and development ("R&D") expenses as a
percentage of net sales were 90.9% and 12.7% for the third quarter of fiscal
1998 and the third quarter of fiscal 1997, respectively. Expenses in dollars in
the third quarter of fiscal 1998 of $30.5 million increased $14.8 million from
$15.7 million in the third quarter of fiscal 1997. The Company has been focusing
the majority of its technical resources on its new production program
qualifications utilizing MR head technology and on development of giant
magnetoresistive ("GMR") head technology. As a result, there continues to be a
significant increase in R&D expenses during fiscal 1998 as the Company continues
its transition from products with inductive thin film technology to products
with MR technology. The Company made its first delivery of GMR evaluation units
in FQ398.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of net sales were 4.5% and 1.5% for the
third quarter of fiscal 1998 and the third quarter of fiscal 1997, respectively.
The percentage increase was due to lower net sales. Expenses in dollars of $1.5
million in the third quarter of fiscal 1998 decreased $0.4 million from $1.9
million in the third quarter of fiscal 1997.
Interest Income and Expense. Interest income of $1.3 million in the third
quarter of fiscal 1998 decreased $0.9 million compared to interest income of
$2.2 million the third quarter of fiscal 1997 due to lower average cash
balances. Interest expense of $3.3 million in the third quarter of fiscal 1998
increased slightly by $0.2 million compared to $3.1 million in the third quarter
of fiscal 1997 due to varying interest rates.
Other Income and Expense. Other income was $0.3 million for the third quarter of
fiscal 1998 and the third quarter of fiscal 1997, respectively. The balances
represent primarily foreign currency exchange gains and losses. The Company has
manufacturing operations in Asia that have been experiencing a volatility in
exchange rates during fiscal 1998 which is expected to continue during the
remainder of the fiscal year.
Page 10 of 26
<PAGE>
Nine Months Ended July 4, 1998
- ------------------------------
Net Sales. Net sales of $166.8 million in the first nine months of fiscal 1998
decreased 55.2% from net sales of $372.0 million in the same period of the prior
fiscal year as inductive thin film products reach end of life. Due to production
process problems with new MR products and a general slowdown in the disk drive
industry, the Company has been unable to maintain sales volumes experienced with
inductive thin film products during the same period in the prior year.
Gross Profit. As a percentage of net sales, gross profit was a negative 3.2% for
the first nine months of fiscal 1998 compared to 36.3% in the same period of the
prior fiscal year. The decrease in gross profit for the comparable periods was
due to the reasons discussed under "Net Sales".
Research and Development. Research and development expenses as a percentage of
net sales were 49.3 % and 10.1% for the first nine months of fiscal 1998 and
fiscal 1997, respectively. Expenses in dollars of $82.3 million for the first
nine months of fiscal 1998 increased $44.6 million from $37.7 million in the
same period of the prior fiscal year. The Company has been focusing the majority
of its technical resources on its new production program qualifications
utilizing MR technology and on development of GMR technology. As a result, there
continues to be a significant increase in R&D expenses during fiscal 1998 as the
Company continues its transition from products with inductive thin film
technology to products with MR technology.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses as a percentage of net sales were 3.0% and 1.7% for the
first nine months of fiscal 1998 and fiscal 1997, respectively. The percentage
increase was due to lower net sales. Expenses in dollars of $5.1 million for the
first nine months of fiscal 1998 decreased $1.1 million from $6.2 million for
the first nine months of fiscal 1997.
Terminated Merger Costs. Merger costs of $2.9 million for the first nine months
of fiscal 1997 include legal and accounting fees, financial advisory fees and
miscellaneous other expenses related to the February 1997 proposed business
combination between the Company and Read-Rite Corporation that was subsequently
withdrawn by the Company on March 14, 1997.
Interest Income and Expense. Interest income of $4.8 million in the first nine
months of fiscal 1998 decreased $1.3 million compared to $6.1 million in the
first nine months of fiscal 1997 due to lower average cash balances. Interest
expense of $9.6 million in the first nine months of fiscal 1998 increased
slightly by $0.2 million compared to $9.4 million for the first nine months of
fiscal 1997, due to varying interest rates.
Other Income and Expense. Other expense was $1.1 million for the first nine
months of fiscal 1998 compared to other income of $0.7 million for the first
nine months of fiscal 1997. The balances represent primarily foreign currency
exchange gains and losses. The Company has manufacturing operations in Asia that
have been experiencing a volatility in exchange rates during fiscal 1998 which
is expected to continue during the remainder of the fiscal year.
Page 11 of 26
<PAGE>
Provision for Income Taxes. The Company's provision for income taxes for the
nine months ended July 4, 1998, is primarily related to state minimum taxes and
foreign taxes. The Company has no income tax provision, other than minimum tax,
due to the utilization of the Company's net operating losses in the United
States, and the fact that the Company operates in Malaysia where it has a tax
holiday until 1999. The Company is exploring other tax incentives available in
Malaysia after its current tax holiday expires. If the Company is unsuccessful
in obtaining tax incentives or extending the tax holiday, the foreign earnings
would be taxed at Malaysian statutory rates.
Liquidity and Capital Resources
- -------------------------------
At July 4, 1998, the Company's cash and cash equivalents decreased to
$104.9 million from $162.3 million at September 27, 1997. Total debt, including
notes payable, amounted to $168.1 million, an increase of $1.4 million from the
balance outstanding at September 27, 1997, primarily due to an increase in
capital lease debt. Total debt included $115.0 million of 7.0% Convertible
Subordinated Debentures, due 2006. Also included in total debt at July 4, 1998,
was $49.3 million in Malaysian bank borrowings. All the Malaysian credit
facilities are callable on demand, have no termination date and are guaranteed
by the Company. Credit facilities with one bank, which have been in place since
June 1990, are secured by the Company's real property holdings in Malaysia and
include certain financial covenants and certain covenants which preclude the
Company from granting liens and security interests in other assets in Malaysia.
Credit facilities with four other banks, established in fiscal 1997, are
unsecured. Additional borrowings available under all of the existing facilities
were approximately $20.3 million at July 4, 1998. Should all or any significant
portion of the Malaysian credit facilities become unavailable for any reason,
the Company would need to pursue alternative financing sources. During the
second quarter of fiscal 1998, one of the Company's Malaysian subsidiary credit
facility agreements with a bank in Malaysia was cancelled by the bank due to
non-use. The Company did not use the credit line due to its high interest rate.
The total amount that was available to borrow under this facility was
approximately $1.3 million. The Company was in compliance with all of its
covenants at July 4, 1998.
The Company has a secured, asset-based revolving line of credit of $35.0
million from CIT Group/Business Credit, Inc. which has been in place since
January 1995. As of July 4, 1998 there were no borrowings outstanding and the
balance available to borrow under this line of credit was approximately $0.5
million.
In response to reductions in production schedules during the first
quarter of fiscal 1998, the Company reduced its capital spending plan, in order
to realign capacity requirements to the current level of business. For fiscal
1998, the Company reduced its capital plan from approximately $170.0 million to
$90.0 million, which includes equipment to be obtained through operating leases.
The capital plan is primarily related to continued development and production of
MR technologies and products and development of GMR technology. Capital
expenditures for the nine months ended July 4, 1998, were $33.2 million. In
addition, the Company leased $38.4 million of production equipment through
operating leases. Purchase commitments were approximately $10.3 million at July
4, 1998.
Page 12 of 26
<PAGE>
During the fourth quarter of fiscal 1998, the Company believes that it
will have sufficient cash flows from cash reserves, existing credit facilities
and equipment lease financing alternatives to meet its operating and capital
expenditure requirements. The Company's shipment and revenue growth and
profitability have been impacted by the industry acceleration of the transition
from inductive thin film to MR technology products and the Company's inability
to qualify on new MR products with its customers. Future revenue and
profitability will depend on the Company's ability to achieve qualification
status with its customers, achievement of satisfactory production yields and
successful execution of planned production ramps on its new products. While the
Company is devoting significant engineering and manufacturing resources to these
efforts, there can be no assurances that the Company will realize satisfactory
product and process development results. To the extent that the Company is
unable to do so, there would be a continued material adverse effect on the
Company's operating results and liquidity. This may require the Company to
either obtain additional capital from external sources or to curtail its
capital, research and development and working capital expenditures. Such
curtailment could have a material adverse affect on the Company's future years'
operations and competitive position.
Certain Additional Business Factors
- -----------------------------------
Technology Transitions
The magnetic recording head industry has been characterized by rapidly
changing technology, short product life cycles and price erosion, as recently
experienced with the faster acceleration from inductive thin film to MR disk
head technology. The Company estimates that the industry product life cycle is
currently running as short as 9 to 12 months. The demand for greater data
storage capacity requires disk drive and disk head manufacturers to continue to
build greater performance into their respective products. There is no assurance
that the Company's products will achieve such performance or that the Company
will continue to qualify as a supplier for disk drive manufacturers' programs.
During fiscal 1996 and 1997, the Company experienced increased customer demand
and significant revenue growth and profitability. This success was due primarily
to continued timely production ramps on a number of inductive thin film programs
and continued successful transition to advanced inductive thin film disk head
products as a result of achievement of profitable yields. During fiscal 1998,
the Company is going through another technology transition from inductive thin
film to MR disk head technology. While advanced inductive thin film production
may continue longer than expected, the Company is still working to achieve MR
program qualifications and satisfactory production yields during fiscal 1998.
There can be no assurance that the Company will continue to qualify for disk
head manufacturing programs or that it will not continue to experience
manufacturing and product quality problems in the future. The Company's future
success depends in large part on its ability to develop and qualify new products
on a timely basis and to manufacture them in sufficient quantities that compete
effectively on the basis of price and performance.
Fluctuations in Quarterly and Annual Operating Results
The Company's operating results have fluctuated and may continue to
fluctuate from quarter to quarter and year to year. The Company's sales are
generally made pursuant to individual purchase orders and customer-specific
materials are ordered on the basis of such purchase orders. As customer programs
Page 13 of 26
<PAGE>
reach end of life, the Company may have to write-down inventory and equipment.
In addition, the Company must qualify on future programs to sell its products.
The Company, on occasion, and as recently as the first quarter of fiscal 1998,
experienced cancellations and rescheduling of orders and reductions in
quantities ordered as customer requirements changed. Cancellations, rescheduling
and reductions of orders resulted in under utilization of production capacity
and had a material adverse effect on the Company's results for the first nine
months of fiscal 1998. The fourth quarter of fiscal 1998 operating results will
continue to be impacted as the Company reaches end of life with its advanced
inductive thin film products and works with its customers to qualify on their MR
disk head technology products. The Company's operating results have in the past
been and likely will in the future be adversely affected during periods when
production capacity is underutilized.
Dependence on Cyclical Hard Disk Drive Industry
Multimedia personal computers and high-end computer applications such as
network servers (Internet and Intranet), workstations and mainframes are driving
the demand for greater storage capacity and performance. In addition, the market
growth of laptop, notebook and sub-notebook computers has increased the demand
for smaller form factor disk drives. As a result, the Company experienced
significant customer demand for its advanced inductive thin film products during
fiscal 1997. However, due to continued industry trends towards even greater
storage capacity and performance, customer demand began to shift from inductive
thin film product technology to MR technology. By the end of fiscal 1997, many
of the Company's customers had discontinued development of new products based on
inductive thin film disk head technology. MR and GMR disk heads, which generally
permit greater storage capacities per disk and provide higher data transfer
rates than inductive thin film disk heads, now represent the fastest growing
segments of the recording head industry. Demand for inductive thin film disk
heads peaked during fiscal 1997. Fiscal 1998 continues to be a year of
significant technology transition, as the Company's customer demand is expected
to go from predominantly inductive thin film to MR technology.
In recent years, the disk drive industry has experienced significant
growth and the Company has expanded its capacity during the last two fiscal
years to meet that growth. However, the disk drive industry is cyclical and
historically has experienced periods of oversupply and reduced production
levels, resulting in significantly reduced demand for disk heads, as well as
pricing pressures. The effect of these cycles on suppliers, including the
Company, has been magnified by hard disk drive manufacturers' practice of
ordering components, including disk heads, in excess of their needs during
periods of rapid growth, which increases the severity of the drop in the demand
for components during periods of reduced growth or contraction. The disk drive
industry entered into an oversupply condition in early 1998 and, as a result,
head suppliers, including the Company, are experiencing competitive pricing
pressures for their inductive thin film and MR heads. A continued decline in
demand for hard disk drives, as experienced by the industry during the first
nine months of fiscal 1998, has had a material adverse impact on the Company's
operating results. A continued decline in demand for older products and the
failure to bring new products to the market would have a material adverse effect
on the Company's future operating results.
Significant Capital Needs
The recording disk head industry is capital intensive and requires
significant expenditures for research and development in order to develop and
Page 14 of 26
<PAGE>
take advantage of technological improvements and new technologies. The Company
believes that, in order to achieve its objectives, it will need significant
additional resources over the next several years for capital expenditures,
working capital and research and development. Capital expenditures for the nine
months ended July 4, 1998 were $33.2 million. In addition, the Company leased
$38.4 million of production equipment through operating leases during the same
period. During fiscal 1998, the Company plans to spend approximately $90.0
million on capital expenditures, which includes operating lease commitments. The
Company believes that it will be able to fund future expenditures from a
combination of existing cash balances, existing credit facilities and equipment
lease financing arrangements. The Company may need additional sources of capital
to meet requirements in future years. There is no assurance that such additional
funds will be available to the Company or, if available, upon terms and
conditions acceptable to the Company. If the Company were unable to obtain
sufficient capital, it would need to curtail its operating and capital
expenditures, which could have a material adverse affect on the Company's future
operating results.
Short-Term Borrowings
At July 4, 1998, the Company had approximately $49.3 million of
short-term borrowings outstanding in floating rate demand loan facilities from
banks in Malaysia, where it has substantial manufacturing operations. The
facilities are callable on demand, have no termination date and are guaranteed
by the Company. The loan facilities are used for the purchase of manufacturing
equipment and for working capital purposes. While the Company has no reason to
believe the loan facilities will be called, there is no assurance that the banks
will continue to make this credit available.
Concentration of Revenues
The disk head industry is intensely competitive and largely dependent on
sales to a limited number of major disk drive manufacturers. The Company had one
customer, Western Digital, that accounted for 79% of the Company's net sales in
fiscal 1997. The Company's ability to obtain new customers depends on its
ability to anticipate technological changes, develop products to meet
individualized customer requirements and to achieve delivery of products that
meet customer specifications at competitive prices. In addition, the disk drive
industry is also intensely competitive and disk drive manufacturers may quickly
lose market share as a result of successful deployment of new technologies by
their competitors or various other factors. A significant reduction in orders,
the loss of a major customer or the inability to increase the customer base,
which could occur for any variety of reasons, could have a material adverse
effect on the Company's operating results.
On April 30, 1998, Western Digital and IBM entered into a letter of
intent for a broad-based hard drive component supply and technology licensing
agreement. IBM plans to supply Western Digital with its GMR heads and other
components for desktop hard drives. Western Digital expects to introduce desktop
hard drives based on IBM products and designs in the first half of calendar year
1999. However, the agreement does not preclude other head suppliers, such as the
Company, from competing on future non-IBM desktop programs at Western Digital,
as well as on all Enterprise Storage Group ("ESG") programs.
Page 15 of 26
<PAGE>
The Company believes that disk drive manufacturers that are not
vertically integrated represent significant sales opportunities for the
Company's disk head products. Moreover, the Company believes that certain
vertically integrated companies will continue to rely on independent suppliers
of disk heads as alternative sources of supply, or in some cases, as primary
sources of supply for individual disk drive programs.
Competition
The Company competes with other independent recording head suppliers, as
well as disk drive manufacturers that produce magnetic recording heads used in
their own products. Fujitsu Ltd., Hitachi Ltd., IBM, Quantum/MKE and Seagate
produce some or all inductive thin film, MR, and/or GMR heads for their own use.
All these companies have significantly greater financial, technical and
marketing resources than the Company. IBM also makes its recording head products
available in the original equipment manufacturers ("OEM") market to competing
drive manufacturers, in direct competition with the Company. For further
discussion regarding IBM, refer to "Concentration of Revenues".
Read-Rite Corporation ("Read-Rite") has had substantially greater sales
of inductive thin film and MR disk head products than the Company and has been
the largest domestic competitor among independent inductive thin film and MR
disk head manufacturers. Read-Rite and Sumitomo Metal Industries, Ltd. ("SMI")
have a joint venture in Japan to make inductive thin film and/or MR wafers.
Another domestic supplier of MR recording heads is Headway Technologies.
Several large Japanese companies, some with considerably more resources
than the Company, compete in the independent head market. Alps Electric
Corporation, Ltd., TDK Corporation (and its SAE Magnetics, Ltd. subsidiary) and
Yamaha Corporation continue to aggressively develop and market recording heads.
Further Consolidation of the Disk Drive Industry
In recent years, the disk drive industry has gone through periods of
consolidation. Certain disk drive manufacturers, such as Quantum, have acquired
or merged with magnetic disk head companies in an effort to produce magnetic
disk heads for their own use. In fiscal 1997, Quantum announced the sale of a
majority interest in its recording head group to Matsushita-Kotobuki Electronics
Industries, Ltd. ("MKE"), Quantum's contract manufacturing partner for disk
drives. The resulting venture, MKE-Quantum Components ("MKQC"), in which Quantum
retains 49% interest, supplies recording heads to MKE for use in Quantum disk
drives. Applied Magnetics revenue from Quantum during fiscal 1997 was less than
2% of total revenues. The Company does not expect a material impact to its
future revenue due to the MKQC venture. Seagate, a major manufacturer of both
disk drives and recording heads, and Conner Peripherals, Incorporated,
("Conner"), completed the merger of their companies in fiscal 1996. Conner was
the Company's largest customer in fiscal 1995. Revenues from Conner declined
materially during fiscal 1996. There can be no assurance that disk drive and
systems companies will not continue to vertically integrate and acquire the
ability to produce disk heads for their own use.
In fiscal 1997, NEC announced plans to discontinue internally developed
NEC drives and engage in a contract manufacturing relationship with IBM. Revenue
from NEC during fiscal 1997 was less than 10% of total revenues. The Company is
Page 16 of 26
<PAGE>
not producing disk heads for NEC during fiscal 1998. During the first quarter of
fiscal 1998, Singapore Technologies announced plans to shut down its disk drive
subsidiary, Micropolis, due to unfavorable financial and market conditions. At
the time of the shutdown, the Company had no active or planned production
programs with Micropolis.
Further consolidation of the disk drive industry may reduce the number
of disk drive programs requiring the Company's products and may increase
business risks for the Company due to the concentration of its customers. As a
result, there is no assurance that further vertical integration of disk drive
and system companies and consolidation within the disk drive industry will not
have a material adverse effect on the Company's future operating results.
Dependence on Foreign Operations
The Company conducts substantially all of its slider production,
assembly and test operations in its facilities in Korea, Malaysia and the
People's Republic of China ("PRC"). In addition, the Company has contractual
relationships with unaffiliated parties who conduct manufacturing and assembly
operations for the Company in Malaysia and the PRC. The Company's operations in
Korea have, from time to time in recent years, been affected by labor
disruptions and slow downs. The Company's production facility in Malaysia faced
potential labor shortages during fiscal 1996 and may face potential labor
shortages in the future, as other disk drive and component manufacturers expand
their production facilities in Malaysia. In addition to risks of labor
disruption, civil unrest and political instability, the Company's foreign
operations may be subject to delays in obtaining governmental permits and
approvals, currency exchange fluctuations, currency and trade restrictions and
transportation problems.
Intellectual Property
The Company regards elements of its manufacturing processes, product
designs, and equipment as proprietary and seeks to protect its proprietary
rights through a combination of employee and third party non-disclosure
agreements, internal procedures and patent protection. The Company has been
issued a number of United States Patents and has additional patent applications
pending. There is no assurance that patents will be issued with respect to such
applications or that any patents issued to the Company will protect the
Company's competitive position.
The Company believes that its success depends on the innovative skills
and technological competence of its employees and upon proper protection of its
intellectual properties. The Company has, from time to time, been notified of
claims that it may be infringing patents owned by others. If it appears
necessary or desirable, the Company may seek licenses under patents that it is
allegedly infringing. Although patent holders commonly offer such licenses, no
assurance can be given that licenses will be offered or that the terms of any
offered licenses will be acceptable to the Company. The failure to obtain a key
patent license from a third party could cause the Company to incur substantial
liabilities and/or to suspend the manufacture of the products utilizing the
patented invention.
Page 17 of 26
<PAGE>
Volatility of Stock Price
The market price of the Company's Common Stock has been volatile, with
daily closing market prices ranging from $17.38 to $60.50 per share during
fiscal 1997 and ranging from $4.00 to $33.25 during the first nine months of
fiscal 1998. The trading price of the Company's Common Stock has fluctuated in
response to quarter-to-quarter operating results, industry conditions, awards of
orders to the Company or its competitors, new product or product development
announcements by the Company or its competitors, general market and economic
conditions and other events or factors. In addition, the volatility of the stock
markets in recent years has caused wide fluctuations in trading prices of stocks
of technology companies independent of their individual operating results. The
market price of the Company's Common Stock at any given time may be adversely
affected by factors independent of the Company's operating results. The
volatility of the stock price may reduce the ability of the Company to raise
additional operating funds through equity offerings.
Forward-Looking Information
- ---------------------------
When used in Management's Discussion and Analysis, the words "believe",
"anticipate", "expect" and similar expressions are intended to identify
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). These forward-looking statements speak only as of the date
hereof. All of the forward looking statements are based on estimates and
assumptions made by management of the Company, which, although believed to be
reasonable, are inherently uncertain and difficult to predict; therefore, undue
reliance should not be placed upon such estimates. Such statements are subject
to certain risks and uncertainties inherent in the Company's business that could
cause actual results to differ materially from those projected. These factors
include, but are not limited to: successful transition to volume production of
MR and GMR disk head products with profitable yields; the limited number of
customers and customer changes in short range and long range plans; dependence
on continued customer demand for the Company's inductive thin film products for
the second half of calendar 1998; competitive pricing pressures; changes in
business conditions affecting the Company's financial position or results of
operations which significantly increase the Company's working capital needs; the
Company's inability to generate or obtain sufficient capital to fund its working
capital needs; the Company's ability to control inventory levels; domestic and
international competition in the Company's product areas; risks related to
international transactions; and general economic risks and uncertainties.
Page 18 of 26
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
10 Amendment dated June 25, 1998 to Letter Agreement of
November 14, 1994 between the Company and the CIT
Group/Business Credit, Inc.
11 Statement re computation of per share information.
27 Financial Data Schedule
(b) Reports on Form 8-K. None.
Page 19 of 26
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
APPLIED MAGNETICS CORPORATION
Dated: August 17, 1998 /s/Craig D. Crisman
-------------------------------
Craig D. Crisman
Chairman of the Board and
Chief Executive Officer
(Principal Financial Officer)
Dated: August 17, 1998 /s/Peter T. Altavilla
---------------------
Peter T. Altavilla
Corporate Controller
(Principal Accounting Officer)
Page 20 of 26
<PAGE>
EXHIBIT INDEX
Exhibit No. Description Page
- --------------------------------------------------------------------------------
10 Amendment dated June 25, 1998 to Letter Agreement of
November 14, 1994 between the Company and the CIT
Group/Business Credit, Inc. 22
11 Statement re computation of per share information. 24
27 Financial Data Schedule 26
Page 21 of 26
<PAGE>
EXHIBIT 10
The CIT Group/
Business Credit, Inc.
3rd Floor
300 South Grand Avenue
Los Angeles, CA 90071
Tel: 213 613-2575
Fax: 213 613-2588
June 25, 1998
Applied Magnetics Corporation
75 Robin Hill Road
Goleta, CA 93117
Dear Sirs:
We refer to the Financing Agreement, dated January 11, 1995 (as
amended, the "Agreement") between Applied Magnetics
Corporation, a Delaware corporation (the "Company") and The CIT
Group/Business Credit, Inc., a New York corporation ("CITBC").
Capitalized terms not otherwise defined herein shall be as
defined in the Agreement.
The Company and CITBC hereby agree that the Agreement is
amended, as follows:
1. The definition of "Availability Reserve" set forth in
Section 1 of the Agreement is hereby amended by (a)
deleting the word "and" after the semicolon and
before the "ii)"; and (b) by deleting the period at
the end of the definition, and inserting the
following:
"; and (iii) the lesser of (a) $2,500,000.00 or
(b) Excess Availability (without taking this
reserve into consideration), for so long as the
Company is leasing equipment pursuant to the
Master Lease Agreement, dated June 1, 1998
between the Company, as lessee and CITBC's
affiliate, The CIT Group/Equipment Financing,
Inc., as lessor."
2. The following definition of "Liquidity" is hereby
inserted in Section 1 of the Agreement between the
definitions of "Line of Credit Fee" and "Loan
Facility Fee":
"Liquidity shall mean the sum of i) the
Company's cash and cash equivalents, ii) the
Availability, and iii) the maximum availability
to the Company and Applied Magnetics Malaysia
under the Maybank Agreement."
3. Paragraph 12 of Section 7 of the Agreement is hereby
amended by deleting the words "Intentionally Omitted"
and inserting the following in lieu thereof:
-1-
Page 22 of 26
<PAGE>
"The Company, and the Foreign Entities shall
maintain, at all times, on a consolidated basis,
a Liquidity of not less than $80,000,000.00".
4. Notwithstanding anything to the contrary set forth in
the Agreement, CITBC hereby consents to the
following:
i) The sale by the Company of certain
equipment to CITBC's affiliate, The CIT
Group/Equipment Financing, Inc. and the
lease by the Company of the same and
additional equipment from The CIT
Group/Equipment Financing, Inc.;
ii) The retention by the Company of the sale
proceeds of the equipment sold to The CIT
Group/Equipment Financing, Inc.; and
iii) The granting by the Company of a lien to
The CIT Group/Equipment Financing, Inc. on
the Collateral, which lien shall be junior
to CITBC's lien on such Collateral.
5. Upon execution hereof by both parties hereto, this
letter amendment shall be deemed effective from and
after June 25, 1998.
Except as otherwise hereinabove provided, no other amendment or
modification of the Agreement is hereby intended or implied.
If the foregoing is in accordance with your understanding,
please so indicate by signing and returning to us the enclosed
copy of this letter.
Very truly yours,
The CIT Group/Business Credit, Inc.
By: /s/ William Shiao
-------------------------
William Shiao
Title: Assistant Vice President
Acknowledged and Agreed
Applied Magnetics Corporation
By: /s/Peter T. Altavilla
---------------------
Title: Controller
---------------------
-2-
Page 23 of 26
<PAGE>
EXHIBIT 11
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
(in thousands, except per share data)
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
July 4, June 28, July 4, June 28,
-------------------------- -------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income (Loss) Per Share:
Net income (loss) $ (35,842) 21,028 $(107,522) $ 83,991
========= ========= ========= =========
Common shares outstanding 23,968 23,681 23,917 23,489
========= ========= ========= =========
Income (Loss) per common share $ (1.50) 0.89 $ (4.50) $ 3.58
========= ========= ========= =========
Income (Loss) Per Common Share - Assuming
Dilution:
Net income (loss) before adjustment (35,842) 21,028 (107,522) 83,991
Add back subordinated debentures interest -- 2,012 -- 6,038
Add back subordinated debentures amortization -- 107 -- 321
Less tax impact -- (84) -- (254)
--------- --------- --------- ---------
Net income (loss) as adjusted $ (35,842) 23,063 $(107,522) $ 90,096
========= ========= ========= =========
Shares
Weighted average common shares outstanding 23,968 23,681 23,917 23,489
Dilutive effect of stock options -- 1,040 -- 1,309
Assuming conversion of convertible
subordinated debentures -- 6,183 -- 6,183
--------- --------- --------- ---------
Common shares - assuming dilution 23,968 30,904 23,917 30,981
========= ========= ========= =========
Income (Loss) per common share
assuming dilution: $ (1.50) 0.75 $ (4.50) $ 2.91
========= ========= ========= =========
</TABLE>
Page 24 of 26
<PAGE>
Income (loss) per common share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding during the period.
Income (loss) per common share - assuming dilution is computed based on the
weighted average number of shares of common stock and common stock equivalents
outstanding during the period and as if the Company's Convertible Subordinated
Debentures ("Convertible Debentures") were converted into common stock at the
beginning of the period after giving retroactive effect to the elimination of
interest expense, net of income tax effect, applicable to the Convertible
Debentures. During a loss period, the assumed exercise of in-the-money stock
options and conversion of Convertible Debentures have an antidilutive effect. As
a result, those shares are not included in the weighted average shares
outstanding used in the calculation of basic and fully diluted loss per common
share as of July 4, 1998.
Page 25 of 26
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheet as of July 4, 1998 and the Consolidated
Statement of Operations for the nine months ended July 4, 1998 and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-03-1998
<PERIOD-END> JUL-03-1998
<CASH> 104,904
<SECURITIES> 0
<RECEIVABLES> 6,825
<ALLOWANCES> 0
<INVENTORY> 20,459
<CURRENT-ASSETS> 143,714
<PP&E> 377,692
<DEPRECIATION> (194,016)
<TOTAL-ASSETS> 341,762
<CURRENT-LIABILITIES> 88,111
<BONDS> 0
0
0
<COMMON> 2,410
<OTHER-SE> 131,427
<TOTAL-LIABILITY-AND-EQUITY> 341,762
<SALES> 166,834
<TOTAL-REVENUES> 166,834
<CGS> 172,126
<TOTAL-COSTS> 172,126
<OTHER-EXPENSES> 95,742
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (9,577)
<INCOME-PRETAX> (107,005)
<INCOME-TAX> 517
<INCOME-CONTINUING> (107,522)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (107,522)
<EPS-PRIMARY> (4.50)
<EPS-DILUTED> (4.50)
</TABLE>
