<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the period ended June 27, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____________ to _____________
Commission file Number: 0-14016
MAXTOR CORPORATION
------------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 77-0123732
----------------------------- ----------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
510 Cottonwood Drive, Milpitas, CA 95035
------------------------------------- -------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
<TABLE>
<S> <C>
Registrant's telephone number, including area code: (408) 432-1700
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: 5.75% Convertible Subordinated Debentures,
due March 1, 2012
</TABLE>
Indicate by checkmark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _____
As of August 5, 1998, 91,974,998 shares of the registrant's Common Stock, $.01
par value, were outstanding.
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MAXTOR CORPORATION
FORM 10-Q
JUNE 27, 1998
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S> <C>
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS PAGE
Condensed Consolidated Balance Sheets -
June 27, 1998 and December 27, 1997 3
Condensed Consolidated Statements of Operations -
Three months and six months ended June 27, 1998,
and June 28, 1997 4
Condensed Consolidated Statements of Cash Flows -
Six months ended June 27, 1998,
and June 28, 1997 5 - 6
Notes to Condensed Consolidated Financial Statements 7 - 10
ITEM 2. Management's Discussion and analysis of
Financial Condition and Results of Operations 11 - 17
</TABLE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURE PAGE
2
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MAXTOR CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
June 27, December 27,
ASSETS 1998 1997
------------------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 15,010 $ 16,925
Accounts receivable, net of allowance for doubtful accounts
of $5,652 at June 27, 1998 and $3,573 at December 27, 1997 218,900 241,777
Accounts receivable from affiliates 3,370 5,870
Inventories 162,954 155,312
Prepaid expenses and other 34,977 20,814
--------- ---------
Total current assets 435,211 440,698
Net property, plant and equipment 102,371 99,336
Other assets 8,067 15,438
--------- ---------
$ 545,649 $ 555,472
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Short-term borrowings $ 76,154 $ 100,057
Short-term borrowings due to affiliates 55,000 65,000
Accounts payable 268,220 206,563
Accounts payable to affiliates 35,684 25,022
Accrued and other liabilities 105,957 155,563
--------- ---------
Total current liabilities 541,015 552,205
Long-term debt and capital lease obligations due after one year 219,314 224,313
Commitments and contingencies (note 5) -- --
Stockholders' deficit:
Series A Preferred Stock, $0.01 par value, 95,000,000 shares authorized;
88,059,701 shares issued and outstanding at June 27, 1998, and outstanding
at December 27, 1997; aggregate liquidation value $590,000
at June 27, 1998 and at December 27, 1997 880 880
Common Stock, $0.01 par value, 250,000,000 shares authorized;
445,148 shares issued and outstanding at June 27, 1998, and
7,563 shares issued and outstanding at December 27, 1997 4 --
Additional paid-in capital 537,370 534,765
Cumulative other comprehensive income--unrealized gain on
investments in equity securities 24,922 16,262
Accumulated deficit (777,856) (772,953)
--------- ---------
Total stockholders' deficit (214,680) (221,046)
--------- ---------
$ 545,649 $ 555,472
========= =========
</TABLE>
See accompanying notes.
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MAXTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months Six months
ended ended
June 27, June 28, June 27, June 28,
1998 1997 1998 1997
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Revenue $ 530,086 $ 273,976 $ 1,075,317 $ 512,018
Revenue from affiliates 1,179 9,118 5,565 18,084
----------- ----------- ----------- -----------
Total revenue 531,265 283,094 1,080,882 530,102
----------- ----------- ----------- -----------
Cost of revenue 467,779 271,968 951,577 517,830
Cost of revenue from affiliates 1,010 8,359 4,574 16,613
----------- ----------- ----------- -----------
Total cost of revenue 468,789 280,327 956,151 534,443
----------- ----------- ----------- -----------
Gross profit (loss) 62,476 2,767 124,731 (4,341)
----------- ----------- ----------- -----------
Operating expenses:
Research and development 36,724 25,523 70,096 51,917
Selling, general and administrative 18,392 15,347 34,315 30,408
Stock compensation expenses (4,788) -- 9,908 --
----------- ----------- ----------- -----------
Total operating expenses 50,328 40,870 114,319 82,325
----------- ----------- ----------- -----------
Income (loss) from operations 12,148 (38,103) 10,412 (86,666)
Interest expense (8,768) (8,697) (17,536) (16,624)
Interest and other income 2,125 416 2,399 2,197
----------- ----------- ----------- -----------
Income (loss) before provision for income taxes 5,505 (46,384) (4,725) (101,093)
Provision for income taxes 89 224 178 501
----------- ----------- ----------- -----------
Net Income (loss) 5,416 (46,608) (4,903) (101,594)
----------- ----------- ----------- -----------
Other comprehensive income:
Unrealized gain (loss) on investments in
equity securities (464) -- 8,660 --
----------- ----------- ----------- -----------
Comprehensive income (loss) $ 4,952 $ (46,608) $ 3,757 $ (101,594)
=========== =========== =========== ===========
Net income (loss) per share - basic (Note 2) $ 164.02 $ -- $ (202.72) $ --
Net income (loss) per share - diluted $ 0.12 $ -- $ (202.72) $ --
Shares used in per share calculation
- basic 33,020 -- 24,186 --
- diluted 44,801,870 -- 24,186 --
</TABLE>
See accompanying notes.
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MAXTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, except share and per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Six months
ended
------------------------
June 27, June 28,
1998 1997
------------------------
<S> <C> <C>
Increase (decrease) in cash and cash equivalents
Cash flows from operating activities:
Net loss $ (4,903) $(101,594)
--------- ---------
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Depreciation and amortization 31,188 26,244
Stock compensation expense 9,908
Inventory reserves for lower of cost or market (3,295)
Loss (gain) on disposal of property, plant and equipment 1,049 --
Other -- (425)
Changes in assets and liabilities:
Accounts receivable 43,125 (35,280)
Accounts receivable from affiliates 4,825 3,793
Inventories (7,642) (45,756)
Prepaid expenses and other (5,492) 767
Accounts payable 58,784 25,358
Accounts payable to affiliates 10,662 2,994
Accrued and other liabilities 1,476 (1,321)
--------- ---------
Total adjustments 147,883 (26,921)
--------- ---------
Net cash provided by (used in) operating activities 142,980 (128,515)
--------- ---------
Cash flows from investing activities:
Proceeds from sale of property and equipment 3,041 --
Purchase of property, plant and equipment (36,597) (23,955)
Other assets 8,528 3,082
--------- ---------
Net cash used in investing activities (25,028) (20,873)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of debt, including short-term borrowings 69,775 194,370
Principal payments on debt, including short-term borrowings (108,677) (64)
Net payments under accounts receivable securitization (81,204) (42,239)
Proceeds from issuance of common stock 239 --
--------- ---------
Net cash provided by (used in) financing activities (119,867) 152,067
--------- ---------
Net change in cash and cash equivalents (1,915) 2,679
Cash and cash equivalents at beginning of period 16,925 31,313
--------- ---------
Cash and cash equivalents at end of period $ 15,010 $ 33,992
========= =========
</TABLE>
See accompanying notes.
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MAXTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (CONTINUED)
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six months
ended
- --------------------------------------------------------------------------------------------------
June 27, June 28,
1998 1997
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $10,031 $11,885
Income taxes 785 514
Supplemental information on noncash investing and financing activities:
Purchase of property, plant and equipment financed by accounts payable 11,792 15,654
Purchase of property, plant and equipment financed by capital leases 28 --
Unrealized gain on equity securities 8,660 --
Stock compensation reimbursement due from an affiliate 2,325 --
- --------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
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MAXTOR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not include all
of the information and footnotes required by generally accepted accounting
principles for complete financial statements. The consolidated financial
statements include the accounts of Maxtor Corporation ("Maxtor" or the
"Company") and its wholly-owned subsidiaries. All significant intercompany
transactions have been eliminated in consolidation. From January 1996 through
July 30, 1998, Maxtor Corporation operated as a majority-owned subsidiary of
Hyundai Electronics America ("HEA"). HEA is a subsidiary of Hyundai Electronics
Co. Ltd. ("HEI"), a Korean corporation. On August 5, 1998, the Company closed
its initial public offerings of its Common Stock (collectively the "Offering")
which reduced the ownership interest of HEA to approximately 48% (see note 9).
All adjustments of a normal recurring nature which, in the opinion of
management, are necessary for a fair statement of the results for the interim
periods have been made. It is recommended that the interim financial statements
be read in conjunction with the Company's audited consolidated financial
statements and notes thereto for the fiscal year ended December 27, 1997
incorporated in the Company's annual report on Form 10-K, as amended. Interim
results are not necessarily indicative of the operating results expected for
later quarters or the full fiscal year.
2. NET INCOME (LOSS) PER SHARE:
In accordance with the disclosure requirements of SFAS 128, a reconciliation of
the numerator and denominator of basic and diluted net income (loss) per share
calculations is provided as follows (in thousands, except share and per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 27, June 28, June 27, June 28,
1998 1997 1998 1997
---------------------- -------------------------
<S> <C> <C> <C> <C>
NUMERATOR - BASIC AND DILUTED
Net income (loss)................................ $ 5,416 $ (46,608) $ (4,903) $ (101,594)
=========== ========= ======== ==========
Net income (loss) available to common
stockholders................................ $ 5,416 $ (46,608) $ (4,903) $ (101,594)
=========== ========= ======== ==========
DENOMINATOR
Basic weighted average common shares
outstanding................................. 33,020 -- 24,186 --
Effect of dilutive securities.................... 44,768,850 -- -- --
----------- --------- -------- ----------
Diluted weighted average common shares........... 44,801,870 -- 24,186 --
----------- --------- -------- ----------
Basic net income (loss) per share................ $ 164.02 $ -- $(202.72) $ --
=========== ========= ======== ==========
Diluted net income (loss) per share.............. $ 0.12 $ -- $(202.72) $ --
=========== ========= ======== ==========
</TABLE>
For the six months ended June 28, 1997, the Company operated as a wholly owned
subsidiary with no common stock outstanding. Basic net income (loss) per share
for the three and six month periods ended June 27, 1998 is not considered
meaningful due to the very limited number of common shares outstanding.
3. SUPPLEMENTAL FINANCIAL STATEMENT DATA (IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 28, 1998 DECEMBER 27, 1997
------------- -----------------
<S> <C> <C>
Inventories:
Raw materials 39,090 48,834
Work-in process 14,368 15,177
Finished goods 109,496 91,301
--------- ---------
$ 162,954 $ 155,312
</TABLE>
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4. SHORT-TERM BORROWINGS
On March 30, 1996, the Company entered into an accounts receivable
securitization program with Citicorp Securities, Inc. Under this program, the
Company could sell its qualified trade accounts receivable up to $100 million on
a non-recourse basis. The face amounts of the eligible receivables were
discounted based on the Corporate Receivables Corporation commercial paper rate
(5.60% as of June 27, 1998) plus commission and were subject to a 10% retention.
As of June 27, 1998, $86.0 million in sales of accounts receivable were included
in accounts receivable, and $19.4 million in collections of accounts receivable
not yet remitted were included in accrued and other liabilities. The Company's
asset securitization program was subject to certain conditions, among which was
a condition that all of HEI's long-term public senior debt securities achieve a
specified rating. This condition was not met in February 1998, and the Company
obtained waivers of this condition through April 8, 1998.
The Company completed a new asset securitization program dated as of April 8,
1998 (the "New Program") arranged by Citicorp to replace the existing program.
Under the New Program, the Company sells all of its trade accounts receivable
through a special purpose vehicle with a purchase limit of $100 million on a
non-recourse basis, subject to increase to $150 million, upon the fulfillment of
the conditions subsequent described below. On April 8, 1998, the uncollected
purchase price under the existing program, in the amount of approximately $100
million, was transferred to represent the purchased interest of Citicorp's
Corporate Receivables Corporation ("CRC") under the New Program. Continuance of
the New Program is subject to certain conditions, including a condition that all
of the long-term public senior debt securities of Hyundai Heavy Industries, Inc.
("HHI") achieve a specified rating. In addition, the New Program remains subject
to certain conditions subsequent related to obtaining appropriate waivers as may
be necessary from lenders of the Company's credit facilities, or effecting a
cure of any outstanding defaults under such credit facilities of the Company and
obtaining a performance guarantee from HHI of the obligations of the Company and
Maxtor Receivables Corporation under the New Program. On July 31, 1998, the
Company entered into definitive agreements with respect to a $200.0 million
asset securitization program which does not require any support from HEA or any
of its affiliates and the Company believes it will be able to close this program
and terminate its existing securitization program by August 12, 1998.
On January 31, 1996 the Company signed a one year credit facility in the amount
of $13.8 million to be used for capital equipment requirements at its Singapore
facility. This credit facility is guaranteed by HEI and all outstanding amounts
of principal and accrued interest were payable on January 30, 1998. In January
1998, this facility was retired and all principal and interest owed under this
facility have been paid.
On April 10, 1997, the Company obtained a $150 million intercompany line of
credit from HEA. This line of credit allows for draw downs up to $150 million
and interest is payable quarterly. All outstanding amounts of principal and
accrued interest were due and payable on April 10, 1998. As of June 27, 1998,
$55 million was outstanding under this facility bearing interest at 11.06%. This
line was reduced to $100 million and extended to April 10, 1999 (see Note 9).
On August 29, 1996, the Company established two uncollateralized, revolving
lines of credit totaling $215 million (the "Facilities") through Citibank, N.A.
and syndicated among fifteen banks. In September 1996, the Facilities were
increased $10 million to a total of $225 million. The Facilities are guaranteed
by HEI and a total of $129 million of the Facilities is a three year committed
Facility that is used primarily for general operating purposes and bears
interest at a rate based on LIBOR plus 0.53 percent. As of June 27, 1998, $129
million of borrowings under this line were outstanding. A total of $96 million
of the Facility is a 364-day committed facility, renewable annually at the
option of the syndicate banks. On August 28, 1997, this Facility was amended and
reduced to $31 million. The Facility is primarily for general operating purposes
and bears interest at a rate based on LIBOR plus 0.53 percent. As of June 27,
1998, $31 million of borrowings was outstanding under this line of credit (see
Note 9).
The Company has credit facilities from three banks, which are guaranteed by HEI
and are used primarily for general operating purposes. As of June 27, 1998,
$40 million of borrowings under these line of credit were outstanding at
interest rates ranging from 7.68% to 8.62% (see Note 9).
HEI served as guarantor for the Company's borrowings under various revolving
bank credit facilities from August 1995 through June 1998. At March 28, 1998,
aggregate indebtedness of the Company guaranteed by HEI under such facilities
was $170.0 million. Due to the economic conditions in Korea and significant
recent devaluations of the Korean won versus the U.S. dollar, HEI's reported
financial condition as of year-end 1997 was not in compliance with certain
financial covenants applicable to HEI as guarantor under such revolving credit
facilities, and such non-compliance constituted a default by the Company under
such revolving credit facilities and also a default (through a cross-default
clause) under an uncommitted credit facility of the Company that is repayable
on demand of the lender, is not guaranteed and had an outstanding principal
amount of $30.0 million as of June 27, 1998. The default under the revolving
credit facilities was waived by the lending banks in June 1998 in exchange for
Hyundai Heavy Industries Co., Ltd. ("HHI"), a partial owner of HEA, becoming a
guarantor under such facilities in place of HEI and an increase in pricing to
reflect borrowing rates based on HHI's current credit rating. As of June 27,
1998, aggregate indebtedness of $170.0 million under the revolving credit
facilities was guaranteed by HHI. To date, the lender under the demand facility
has not demanded repayment of the $30.0 million outstanding under that facility.
8
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5. CONTINGENCIES
STORMEDIA LITIGATION
The Company currently is involved in a dispute with StorMedia Incorporated
("StorMedia"), which arises out of an agreement among the Company, StorMedia and
HEI which became effective on November 17, 1995 (the "StorMedia Agreement").
Pursuant to the StorMedia Agreement, StorMedia agreed to supply disk media to
the Company. StorMedia's disk media did not meet the Company's specifications
and functional requirements as required by the StorMedia Agreement and the
Company ultimately terminated the StorMedia Agreement. After a class action
securities lawsuit was filed against StorMedia by certain of its shareholders in
September 1996 which alleged, in part, that StorMedia failed to perform under
the StorMedia Agreement, StorMedia sued HEI, Mong Hun Chung (HEI's chairman),
Dr. Chong Sup Park (HEA's President and then President of the Company who signed
the StorMedia Agreement on behalf of the Company) and K.S. Yoo (the individual
who signed the StorMedia Agreement on behalf of HEI) (collectively the "
Original Defendants") in the U.S. District Court for the Northern District of
California (the "Federal Suit"). In the Federal Suit, StorMedia alleged that at
the time HEI entered into the StorMedia Agreement, it knew that it would not and
could not purchase the volume of products which it committed to purchase, and
that failure to do so caused damages to StorMedia in excess of $206 million.
In December 1996, the Company filed a complaint against StorMedia and William
Almon (StorMedia's Chairman and Chief Executive Officer) in a Colorado state
court seeking approximately $100 million in damages and alleging, among other
claims, breach of contract, breach of implied warranty of fitness and fraud
under the StorMedia Agreement (the "Colorado Suit"). This proceeding was stayed
pending resolution of the Federal Suit. The Federal Suit was permanently
dismissed early in February 1998. On February 24, 1998, StorMedia filed a new
complaint in Santa Clara County Superior Court for the State of California for
$206 million, alleging fraud and deceit against the Original Defendants and
negligent misrepresentation against HEI and the Company (the "California Suit").
On May 18, 1998, the stay on the Colorado Suit was lifted by the Colorado state
court. The Company's motion to dismiss, or in the alternative, stay the
California Suit, is pending.
The Company believes that it has meritorious defenses against the claims alleged
by StorMedia and intends to defend itself vigorously. However, due to the nature
of litigation and because the pending lawsuits are in the very early pre-trial
stages, the Company cannot determine the possible loss, if any, that may
ultimately be incurred either in the context of a trial or as a result of a
negotiated settlement. The litigation could result in significant diversion of
time by the Company's technical personnel, as well as substantial expenditures
for future legal fees. After consideration of the nature of the claims and facts
relating to the litigation, including the results of preliminary discovery, the
Company's management believes that the resolution of this matter will not have a
material adverse effect on the Company's business, financial condition or
results of operations. However, the results of these proceedings, including any
potential settlement, are uncertain and there can be no assurance that they will
not have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has been notified of certain other claims, including claims of
patent infringement. While the ultimate outcome of these claims and the claims
described above is not determinable, the Company does not believe that
resolution of these matters will have a material adverse effect on the Company's
business, financial condition or results of operations. No amounts related to
any claims or actions have been reserved in the Company's financial statements.
6. RECENT ACCOUNTING PRONOUNCEMENTS
During the quarter ended March 28, 1998 the Company adopted the Financial
Accounting Standards Board Statement SFAS No. 130, "Reporting Comprehensive
Income." In accordance with SFAS No. 130 the Company has disclosed comprehensive
income and restated the prior periods. Comprehensive income generally represents
all changes in stockholders' equity except those resulting from investments or
contributions by stockholders.
In June 1997, the Financial Accounting Standards Board issued Statement SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information." This
statement establishes standards for disclosure about
9
<PAGE> 10
operating segments in annual financial statements and selected information in
interim financial reports. It also establishes standards for related disclosures
about products and services, geographic areas and major customers. This
statement supersedes SFAS No. 14, "Financial Reporting for Segments of a
Business Enterprise." The new standard becomes effective for fiscal years
beginning after December 15, 1997 and requires that comparative information from
earlier years be restated to conform to the requirements of this standard. The
Company is evaluating the requirement of SFAS No. 131 and the effects, if any on
the Company's current reporting and disclosures.
In June 1998, the Financial Accounting Standards Board issued statement of
Accounting Standards No. 133 (SFAS 133). "Accounting for Derivative Instruments
and Hedging Activities". SFAS 133 requires the Company to recognize all
derivatives on the balance sheet at fair value. Derivatives are not hedges and
must be adjusted to fair value through net income. If the derivative is a hedge,
depending on the nature of the hedge, changes in the fair value of derivatives
are either offset against the change in fair value of assets, liabilities, or
firm commitments through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value will be immediately recognized in earnings.
SFAS 133 is effective for years beginning after June 15, 1999, but companies can
early adopt as of the beginning of any fiscal quarter that begins after June
1998. The Company is evaluating the requirements of SFAS 133, but does not
expect this pronouncement to materially impact the Company's results of
operations.
In March 1998, the Accounting Standards Executive Committee issued Statement of
Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." SOP 98-1 provides guidance on when costs related
to software developed or obtained for internal use should be capitalized or
expensed. The SOP is effective for transactions entered into for fiscal years
beginning after December 15, 1998. The Company has reviewed the provisions of
the SOP and does not believe adoption of this standard will have a material
effect upon its results or operations, financial position or cash flows.
7. RELATED PARTY TRANSACTION
HEI has guaranteed certain debts of the Company (Note 4) and has committed to
provide the financial support necessary for the Company to continue operations
on an ongoing basis.
The cost of revenue includes certain component parts purchased from MMC
Technology, Inc., an affiliated company, amounting to $61.2 million during the
six months ended June 27, 1998.
8. STOCK COMPENSATION
The Company adopted an Amended and Restated 1996 Option Plan in February 1998 to
remove the variable features, and offered and re-issued new fixed-award options
in April 1998 for the majority of employees which had previously held variable
options. In connection therewith, the Company recorded compensation expense of
$9.9 million for the six months ended June 27, 1998 related to the difference
between the estimated fair market value of its stock and the stated value of the
Company's options. Compensation cost was reflected in accordance with financial
Accounting Standards Board Interpretation No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans."
The Company has elected to continue to follow the provisions of APB No. 25,
"Accounting for Stock Issued to Employees," for financial reporting purposes and
has adopted the disclosure only provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123. "Accounting for Stock-Based Compensation."
On May 29, 1998 the Company adopted the 1998 Employee Stock Purchase Plan (the
"Purchase Plan"). A total of 1.7 million shares of Common Stock have been
reserved for issuance under the Purchase Plan, none of which were issued as of
June 27, 1998. The Purchase Plan permits eligible employees to purchase Common
Stock at a discount, but only through accumulated payroll deductions, during
sequential 6-month offering periods. Participants will purchase shares on the
last day of each offering period. In general, the price at which shares are
purchased under the Purchase Plan is equal to 85% of the lower of the fair
market value of a share of Common Stock on (a) the first day of the offering
period, or (b) the purchase date. The initial offering period under the Purchase
Plan commenced on the closing of the Company's offering on August 5, 1998.
On May 29, 1998 the Company adopted the 1998 Restricted Stock Plan (the
"Restricted Stock Plan"). Which provides for awards of shares of Common Stock to
employees. The Board has the authority to amend or terminate the Restricted
Stock Plan. The Restricted Stock Plan's maximum share reserve is 390,000 shares
of Common Stock, all of which were awarded in June 1998. All unvested shares of
restricted stock are forfeited in the event of termination of employment with
the Company. The restricted stock shares vest and are released from the
forfeiture provision three years from the date of the restricted stock award.
Vesting of these shares is subject to acceleration upon the occurrence of a
change of control.
9. SUBSEQUENT EVENTS:
Reverse Stock Split
On May 29, 1998, the Board approved a one-for-two reverse split of the Company's
outstanding common stock, which became effective upon the Company's filing of an
amended and restated certificate of incorporation in Delaware on July 24, 1998.
All references in the financial statements to the number of the Company's common
shares and price per share amounts, as well as the conversion ratio of preferred
shares, have been retroactively restated to reflect the reverse split. The Board
of Directors also approved the increase of the Company's authorized common stock
to 250,000,000 shares.
Short-Term Borrowings from Parent
On July 31, 1998 the Company and HEA agreed to replace short-term borrowings
from HEA of $55,000,000 with a subordinated term note due in July 31, 2001,
bearing interest, due semi-annually, at LIBOR plus 2.0%. This indebtedness will
be subordinated to all other debt of the Company except for the Company's
outstanding 5.75% Convertible Subordinated Debentures. The Company will have the
right to prepay the term note, in whole or in increments of $1,000,000 or more,
without penalty.
Initial Public Offering
On August 5, 1998, the Company completed the issuance of 47,500,000 shares of
its common stock in an initial public offering. The Company received
approximately $314,000,000 net of issuance costs and underwriters' commissions.
Approximately $200,000,000 of these proceeds are intended for repayment of
certain outstanding indebtedness under credit facilities due to various banks,
of which $30,000,000 was paid as of August 10, 1998, with an additional
$170,000,000 expected to be paid on or about August 12, 1998. Upon closing of
the Offering, all outstanding shares of the Company's Series A Preferred Stock
converted into 44,029,850 shares of common stock.
10
<PAGE> 11
This Report on Form 10-Q contains forward-looking statements within the meaning
of the U.S. federal securities laws that involve risks and uncertainties. The
statements contained in this Report on Form 10-Q that are not purely historical,
including, without limitation, statements regarding the Company's expectations,
beliefs, intentions or strategies regarding the future are forward-looking
statements. In this Report on Form 10-Q, the words "anticipates," "believes,"
"expects," "intends," "future" and similar expressions also identify
forward-looking statements. The Company makes these forward-looking statements
based upon informations available on the date hereof, and assumes no obligation
to update any such forward-looking statements. The Company's actual results
could differ materially from those anticipated in this Report on Form 10-Q as a
result of certain factors including, but not limited to, those set forth in the
"Certain Factors Affecting Future Performance" and elsewhere in this Report on
Form 10-Q.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed
consolidated financial statement and related notes included elsewhere in this
report.
RESULTS OF OPERATIONS
Revenue and Gross Profit (Loss)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
- --------------------------------------------------------------------------------------------------------------
(In millions) June 28, June 27, June 28, June 27,
Fiscal quarter ended 1997 1998 Change 1997 1998 Change
- --------------------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Revenue $ 283.1 $ 531.3 $ 248.2 $ 530.1 $ 1,080.9 $ 550.8
Gross profit (loss) $ 2.8 $ 62.5 $ 59.7 $ (4.3) $ 124.7 $ 129.0
As a percentage of revenue 1.0% 11.8% (0.8%) 11.5%
Net income (loss) $ (46.6) $ 5.4 $ 52.0 $ (101.6) $ (4.9) $ 96.7
As a percentage of revenue (16.5%) 1.0% (19.2%) (0.5%)
- --------------------------------------------------------------------------------------------------------------
</TABLE>
Revenue
Revenue. Between the three months ended June 28, 1997 ("Q297") and the three
months ended June 27, 1998 ("Q298") revenue grew from $283.1 million to $531.3
million or 87.7%. Between the first six months of 1997 and the first six months
of 1998, the Company's revenue grew by 103.9%, increasing from $530.1 million in
the first six months of 1997 to $1,080.9 million the first six months of 1998.
The increases in revenue for these periods are attributable primarily to an
increase in unit shipments arising from improved time-to-market entry and
time-to-volume production and a shift in the Company's customer base to Personal
Computer ("PC") original equipment manufacturings ("OEMs"). Revenue growth from
increased unit shipments was partially offset by continued rapid price erosion
in the HDD market as a whole, which resulted in declining average selling prices
("ASPs") throughout the period. The Company believes that the effect of HDD
market ASP declines on the Company's ASPs was contained partially by the
Company's improved time-to-market entry and time-to-volume production and by a
Company trend toward shipping higher-capacity HDDs, which tend to have higher
initial ASPs.
From Q297 to Q298, revenue from sales to PC OEMs increased from 50.2% to 72.2%
of the Company's revenue. During this period, sales to three of the largest PC
OEMs, Compaq Computer Corporation, Dell Computer Corporation, and International
Business Machine Corporation increased from 23.2% to 54.1% of the Company's
revenue. From the first six months of 1997 to the first six months of 1998,
revenue from sales to PC OEMs increased from 52.2% to 74.1% of the Company's
revenue. During this period, sales to three of the largest PC OEMs, Compaq
Computer Corporation, Dell Computer Corporation and International Business
Machine Corporation, increased from 24.0% to 53.0% of the Company's revenue.
Gross Profit (Loss). Gross profit improved from $2.8 million for Q297 to $62.5
million in Q298; and gross profit (loss) improved from a loss of $4.3 million
for the first six months of 1997 to a profit of $124.7 million in the first six
months of 1998. Gross margin increased from 1.0% to Q297 to 11.8% in Q298; and
gross margin increased from (0.8)% in the first six months of 1997 to 11.5% in
the first six months of 1998. The improvement in gross margin during these
periods is due to the timely introduction of new, higher margin products which
achieved market acceptance and higher manufacturing yields. During these periods
gross margin also was favorably affected by improved product designs which led
to improved manufacturing yields and lower
11
<PAGE> 12
component costs. During these periods growth of the Company's gross margin,
however, was constrained partially by continued rapid price erosion in the HDD
market as a whole, which resulted in declining ASPs for the Company's products.
<TABLE>
<CAPTION>
OPERATING EXPENSES
Three Months Ended Six Months Ended
- --------------------------------------------------------------------------------------------------------
(In millions) June 28, June 28, June 27, June 28,
1997 1998 Change 1997 1998 Change
- --------------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Research and development $ 25.5 $ 36.7 $ 11.2 $ 51.9 $ 70.1 $ 18.2
As a percentage of revenue 9.0% 6.9% 9.8% 6.5%
Selling, general and administrative $ 15.4 $ 18.4 $ 3.0 $ 30.5 $ 34.3 $ 3.8
As a percentage of revenue 5.5% 3.5% 5.8% 3.2%
Stock compensation expense $ - $ (4.8) $ (4.8) $ - $ 9.9 $ 9.9
As a percentage of revenue (0.9%) 0.9%
- --------------------------------------------------------------------------------------------------------
</TABLE>
Research and Development Expense. R&D expense as a percentage of revenue
decreased from 9.0% in Q297 to 6.9% in Q298, while the absolute dollar level of
R&D spending during the same periods increased from $25.5 million to $36.7
million. Further, R&D expense as a percentage of revenue decreased from 9.8% in
the first six months of 1997 to 6.5% in the first six months of 1998, while the
absolute dollar level of R&D spending during the same periods increased from
$51.9 million to $70.1 million. The increase in absolute dollars during these
periods was due to the Company's efforts to develop new products for the desktop
PC market and future products in other HDD market segments.
Selling, General and Administrative Expense. SG&A expense as a percentage of
revenue declined from 5.5% in Q297 to 3.5% in Q298, while the absolute dollar
level of SG&A increased from $15.4 million to $18.4 million, respectively.
Further, SG&A expense as a percentage of revenue declined from 5.8% in the first
six months of 1997 to 3.2% during the first six months of 1998, while the
absolute dollar level of SG&A expenses increased slightly from $30.5 million to
$34.3 million, respectively. The decrease in SG&A expenses as a percentage of
revenue between these periods was due to the increase in the Company's revenues
combined with the Company's ongoing cost control efforts.
Stock Compensation Expense. In 1996 the Company adopted the 1996 Stock Option
Plan (the "Plan"), pursuant to which substantially all of the Company's domestic
employees and certain international employees received options which were
required to be accounted for as variable options. As a consequence, the Company
recorded a non-cash compensation expense of $14.7 million in the first quarter
of 1998, related to the difference between the estimated fair market value of
its stock as of March 28, 1998 and the exercise price of the options granted
under the Plan between May 1996 and October 1997. If this expense were not
incurred in the first quarter of 1998, the Company would have realized net
income of $4.4 million in such period. The Company amended and restated the Plan
to remove the features which resulted in variable accounting. In the second
quarter, the Company remeasured the compensation element upon the termination of
the variable features of the Plan, resulting in a benefit of $4.8 million,
absent which net income for that period would have been $0.6 million. The
Company will incur non-cash stock compensation expense in connection with the
Amended Plan through the end of fiscal year 2001 in amounts expected to decrease
from a high of approximately $1.2 million in the third quarter of 1998 to a low
of approximately $0.1 million in the second quarter of 2001, assuming all
options remain in effect. After that point, no further stock compensation
expenses will be incurred in connection with the Amended Plan. MMC has agreed to
reimburse the Company for any stock compensation expenses arising from grants
made to MMC employees under the Plan.
<TABLE>
<CAPTION>
INTEREST EXPENSE AND INTEREST INCOME
Three Months Ended Six Months Ended
- --------------------------------------------------------------------------------------------------------
(IN MILLIONS) June 28, June 27, June 28, June 27,
1997 1998 Change 1997 1998 Change
- --------------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Interest expense $ 8.7 $ 8.7 $ 0.0 $ 16.6 $ 17.5 $ 0.9
Interest and other income $ 0.4 $ 2.1 $ 1.7 $ 2.2 $ 2.4 $ 0.2
- --------------------------------------------------------------------------------------------------------
</TABLE>
Interest Expense. Interest expense as a percentage of revenue declined from
3.1% in Q297 to 1.6% in Q298, while the absolute dollar level of interest
remained constant at $8.7 million in these periods; and declined from 3.1%
in the first six months of 1997 to 1.6% in the first six months of 1998, while
the absolute dollar level of interest expense increased from $16.6 million in
the first six months of 1997 to $17.5 million in the first six months of 1998.
The increase in the absolute dollar amount of the Company's interest expense
between the first six months of 1997 and the first six months of 1998 was, due,
in part, to higher interest rates applied to the Company's intercompany loan
from HEA and bank credit facilities,
12
<PAGE> 13
in each case as a result of the higher cost of borrowing resulting from changes
in the economic environment in Korea. The Company had $349.2 million of
short-term and $224.0 million of long-term credit borrowings outstanding at June
28, 1997, as compared to $131.2 million of short-term and $219.3 million of
long-term credit borrowings outstanding at June 27, 1998.
Interest and other income. Interest and other income increased from $0.4 million
in Q297 to $2.1 million in Q298; and increased slightly from $2.2 million to
$2.4 million between the first six months of 1997 and the first six months of
1998. The increase between Q297 and Q298 was primarily due to the recovery of
$1.8 million interest receivable on a note payable to the Company from
International Manufacturing Services, Inc.
<TABLE>
<CAPTION>
PROVISION FOR INCOME TAXES
Three Months Ended Six Months Ended
- ------------------------------------------------------------------------------------------------------
(In millions) June 28, June 27, June 28, June 27,
1997 1998 Change 1997 1998 Change
- ------------------------------------------------------------------------------------------------------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
Provision for income taxes $ 0.2 $ 0.1 $ (0.1) $ 0.5 $ 0.2 $ (0.3)
- ------------------------------------------------------------------------------------------------------
</TABLE>
The provision for income taxes consists primarily of foreign taxes. The decrease
of $0.3 million is due to lower Korean taxes as a result of implementing certain
tax planning strategies in 1998.
The Company's effective tax rate for the periods 1998 and 1997 differs from the
combined federal and state rates due to the repatriation of foreign earnings
absorbed by current year domestic losses, and the Company's U.S. operating
losses not providing current tax benefits, offset in part by the tax savings
associated with the Company's Singapore operations and valuation of temporary
differences. Income from the Singapore operation is not taxable as a result of
the Company's pioneer tax status in Singapore.
Due to the Company's operating losses, its NOL carryforwards and its favorable
tax status in Singapore, the Company's tax expense has historically represented
only a small percentage of the Company's expenses. The Company's foreign and
U.S. tax liability will increase substantially in future periods if the Company
attains profitability.
In December 1997, Maxtor Singapore was granted pioneer tax status in Singapore,
thus exempting it from paying Singapore income taxes until June 30, 2003,
subject to the satisfaction of certain ongoing conditions. Maxtor Singapore is
eligible for up to two additional two-year extensions of this pioneer tax
status, subject to the satisfaction of certain additional conditions. There can
be no assurance that Maxtor Singapore will be able to satisfy or, if satisfied,
to maintain compliance with, the required conditions. If Maxtor Singapore is
unable to satisfy and maintain compliance with the required conditions and is
unable to obtain a waiver of any such failure, it would lose its pioneer tax
status, or would be ineligible for such extensions, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Since 1996, the Company has been a member of the HEA Tax Group for U.S. federal
income tax purposes. On December 27, 1997, for federal income tax purposes, the
Company had NOL carryforwards of approximately $616.7 million and tax credit
carryforwards of approximately $18.8 million which will expire beginning in
fiscal year 1999. Of the approximately $616.7 million federal income tax NOL
carryforwards, approximately $253.0 million were generated before the Company
became part of the HEA Tax Group (the "Pre-Affiliation NOL") and approximately
$363.7 million were generated after the Company became part of the HEA Tax Group
the "Post-Affiliation NOL").
Due to the Company's NOL carryforwards and operating losses, the Company has not
incurred any significant federal or state income taxes for any of the Company's
recent fiscal periods. In June 1998, the Company caused Maxtor Singapore to pay
a $400.0 million dividend which will utilize a substantial portion of the
Company's NOL carryforwards. In addition, a substantial portion of the remaining
NOL carryforwards likely will be utilized by the HEA Tax Group for the 1998 tax
year and in connection with amendments to returns for prior years. As a result,
there will be a significant reduction in, and potential elimination of, the NOL
carryforwards available to the Company for federal income tax purposes for
subsequent tax years.
As a result of the Company's acquisition by HEA, utilization of approximately
$253.0 million of the Company's NOL carryforwards and the deduction equivalent
of approximately $18.3 million of tax credit carryforwards is limited to
approximately $22.4 million per year. After the Offering, the amount of the
Company's U.S. federal taxable income for any tax year ending after the date of
the Offerings which may be offset by the Company's NOL carryforwards remaining
after deconsolidation from the HEA Tax Group will be limited to an amount equal
to the aggregate value of the Common Stock and the Series A Preferred Stock
immediately before the ownership change multiplied by the long-term tax exempt
rate then in effect (e.g., 5.15% for ownership changes occurring during July
1998).
While, for financial reporting purposes, the Company's tax loss for the period
during which the Company was a member of the HEA Tax Group is computed on a
separate tax return basis, utilization and payment for the Company's NOL
carryforwards by the HEA Tax Group is governed by the Tax Allocation Agreement.
Under the Tax Allocation Agreement, neither HEA nor the Company shall reimburse
the other for any utilization of the other member's NOLs or other tax attributes
in the consolidated or combined income tax returns, except that each party shall
reimburse the other for any use of the other party's tax attributes as a result
of any return or amended return filed after September 15, 1999 or by a taxing
authority adjustment after September 15, 1999.
For periods during which the Company was a member of the HEA Tax Group, the
Company and its subsidiaries have filed or will file separate tax returns and
consolidated or combined tax returns as part of the HEA Tax Group. As a
consequence of the Offering, the Company has ceased to be a member of the HEA
Tax Group. However, the Company will remain liable for its allocable share of
the consolidated or combined tax return liability and for tax deficiencies of
the entire HEA Tax Group which relate to the period during which the Company was
a member of the HEA Tax Group. There can be no assurance that the HEA Tax Group
will satisfy all tax obligations for such periods or that additional liabilities
will not be assessed for such periods. In addition, there can be no assurance
that the Company's share of the consolidated or combined tax liability will not
be increased as a result of subsequent events, such as taxing authority audit
adjustments or the filing of amended returns affecting either the Company's
items of gain, income, loss, deduction or credit or another member's items of
gain, income, loss, deduction or credit. The Company has agreed to indemnify and
reimburse HEA if any member of the HEA Tax Group is required to pay any tax,
interest or penalty to any taxing authority related to any additional Company
separate tax return liability and if there is any increase in the consolidated
or combined tax return liability resulting from revisions to the Company's
taxable income or revisions to another HEA Tax Group member's taxable income,
except to the extent such revisions to another HEA Tax Group member's taxable
income are made after September 15, 1999. HEA has agreed to indemnify and
reimburse the Company if the Company or any of its subsidiaries is required to
pay any tax, interest or penalty to any taxing authority related to any separate
tax return of any member of the HEA Tax Group other than the Company or its
subsidiaries, and if the Company or any of its subsidiaries is required to pay
to any taxing authority any amount in excess of the Company's share of the
consolidated or combined tax return liability.
INFORMATION SYSTEMS AND YEAR 2000 COMPLIANCE
The Company is preparing to implement a new enterprise-wide information system
(the "SAP System") in the fourth quarter of 1998. The SAP System is designed to
automate more fully the Company's business processes and will affect most
functional areas, including, without limitation, finance, procurement, inventory
control, collections, order processing and manufacturing, and its implementation
will require certain upgrades in the Company's existing computer hardware
systems. Historically, there have been substantial delays in the implementation
of such systems at other companies. Unlike most companies, which implement new
information systems in stages over time, the Company has chosen to install and
activate the SAP System across most functional areas of the Company
simultaneously. The Company believes it is among the first to undertake such a
broad, simultaneous implementation of the SAP System. This approach may
substantially increase the risk of delay or failure in the system
implementation.
Implementation of the SAP System will be complex, expensive and time intensive
and its successful implementation could be adversely affected by various
factors, including: (i) any failure to provide adequate training to employees;
(ii) any failure to retain skilled members of the implementation team or find
suitable replacements for such personnel; (iii) the scope of the implementation
plan being expanded by unanticipated changes in the Company's business; (iv) any
inability to extract data from the Company's existing information system and
convert that data into a format that can be accepted by the SAP System; (v) any
failure to devise and run appropriate testing procedures that accurately reflect
the demands that will be placed on the new system following its implementation;
and (vi) any failure to develop and implement adequate fall-back procedures in
the event that difficulties or delays arise during the initial start-up phase of
the SAP System.
In connection with the implementation of the SAP System, the Company may
experience functional and performance problems, including problems relating to
the SAP System's response time and data integrity. In addition, resolution of
any such problems could entail additional costs. Moreover, as a result of the
Company's simultaneous implementation approach, the Company will not have an
operational backup information system in the event of a failure of the SAP
System. There can be no assurance that the Company will be able to implement the
SAP System successfully on a timely and cost effective basis or that the SAP
System will not fail or prove to be unsuitable for the Company's needs. The
inability of the Company to implement or resolve problems with the SAP System in
a timely manner could have a material adverse effect on the Company's business,
financial condition and results of operations. No amounts have been accrued in
the Company's consolidated financial statements included elsewhere in this
Prospectus for any probable expenses or lost revenue that could result from
problems in implementing the SAP System.
Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. Beginning in the year
2000, these date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used by many companies,
including Maxtor, will need to be upgraded to comply with such "Year 2000"
requirements. Because of the Company's change in its fiscal year end in 1996,
the Company's current information systems will need to be upgraded by January
1999 to avoid Year 2000 problems. While the SAP System is expected to resolve
this potential problem, there can be no assurance that the SAP System can be
implemented successfully and on a timely basis. Moreover, the Company could be
adversely impacted by Year 2000 issues faced by major distributors, suppliers,
customers, vendors and financial service organizations with which the Company
interacts. Any disruption in the Company's operations as a result of Year 2000
noncompliance, whether by the Company or a third party, could have a material
adverse effect on the Company's business, financial condition and results of
operations.
LIQUIDITY AND CAPITAL RESOURCES
At June 27, 1998, the Company had $15.0 million in cash and cash equivalents as
compared to $16.9 million at December 27, 1997. Operating activities provided
net cash of $143.0 million for the six month period ended June 27, 1998 as
compared to utilizing net cash of $128.5 million for the six month period ended
June 28, 1997. Cash provided by operating activities for the six months ended
June 27, 1998 was generated principally by operations and supplemented by a
decrease in working capital. The increase in cash generated from operations was
primarily due to increased sales and improved margins. Investing activities used
$25.0 million. During the six months ended June 27, 1998, the Company paid down
debt of $38.9 million.
On August 5, 1998, the Company completed the issuance of 47,500,000 shares of
its common stock in an initial public offering. The Company received
approximately $314,000,000 net of issuance costs and underwriters' commissions.
Approximately $200,000,000 of these proceeds are intended for repayment of
certain outstanding indebtedness under credit facilities due to various banks,
of which $30,000,000 was paid as of August 10, 1998, with an additional
$170,000,000 expected to be paid on or about August 12, 1998. Upon closing of
the Offering, all outstanding shares of the Company's Series A Preferred Stock
converted into 44,029,850 shares of common stock.
At June 27, 1998, the Company had $350.5 million of short-term and long-term
unsecured debt comprised principally of $200.0 million of credit facilities from
various banks, $55.0 million of inter-company debt from HEA and $95.0 million of
publicly-traded convertible debt. The Company will use part of the net proceeds
from the Offerings to repay all of the outstanding indebtedness under the
Company's bank credit facilities. The remaining amount of the proceeds will be
available for capital expenditures, working capital and general corporate
purposes.
The Company's outstanding 5.75% Convertible Subordinated Debentures due March 1,
2012 are entitled to annual sinking fund payments of $5.0 million which
commenced March 1, 1998.
13
<PAGE> 14
HEI served as guarantor for the Company's borrowings under various revolving
bank credit facilities from August 1995 through June 1998. At March 28, 1998,
aggregate indebtedness of the Company guaranteed by HEI under such facilities
was $170.0 million. Due to the economic conditions in Korea and significant
recent devaluations of the Korean won versus the U.S. dollar, HEI's reported
financial condition as of year-end 1997 was not in compliance with certain
financial covenants applicable to HEI as guarantor under such revolving credit
facilities, and such non-compliance constituted a default by the Company under
such revolving credit facilities and also a default (through a cross-default
clause) under an uncommitted credit facility of the Company that is repayable on
demand of the lender, is not guaranteed and had an outstanding principal amount
of $30.0 million as of June 27, 1998. The default under the revolving credit
facilities was waived by the lending banks in June 1998 in exchange for HHI
becoming the guarantor under such facilities in place of HEI and an increase in
pricing to reflect borrowing rates based on HHI's current credit rating. As of
June 27, 1998, aggregate indebtedness of $170.0 million under the revolving
credit facilities was guaranteed by HHI. The $30.0 million outstanding under the
demand facility has been repaid from proceeds of the Offering. The Company
intends to use $170.0 million of the proceeds of the Offering to pay down in
full all outstanding amounts under each of its bank revolving credit facilities
and thereafter to terminate such revolving credit facilities. The Company
intends to obtain replacement revolving credit facilities following the Offering
that do not depend on any Hyundai entity guarantees. However, the Company
believes that current market conditions for such facilities are not as favorable
as they have been at certain times in the past, and that for various reasons the
number of potential lenders actively providing credit facilities to companies in
the data storage industry may have decreased recently, and that the terms on
which the remaining potential lenders are willing to offer such facilities have
become significantly more restrictive and/or costly. Consequently, there can be
no assurance that the Company will be able to obtain any such replacement
facility or as to the terms and amount of any such facility that it is able to
obtain. Any failure to obtain adequate credit facilities on acceptable terms
would have a material and adverse effect on the Company's business, financial
condition and results of operations. In addition, the Company and HEA have
agreed on July 31, 1998 to replace the Company's revolving line of credit from
HEA, which has an outstanding principal balance of $55.0 million, with a
long-term, subordinated note in the same principal amount.
The Company also has an asset securitization program under which the Company
sells its accounts receivable on a non-recourse basis. At June 27, 1998, $100.0
million of accounts receivable was securitized under the program. Continuance of
the program is subject to certain conditions, including a condition that all of
the long-term public senior debt securities of HHI not fall below a specified
rating. The Company has entered into definitive agreements with respect to a
$200.0 million asset securitization program which does not require any support
from HEA or any of its affiliates. The Company believes it will be able to close
this program and terminate its existing program by August 12, 1998. Failure of
the Company to close the replacement asset securitization program or obtain
alternative financing would have a material adverse impact on the Company's
business, financial condition and results of operations.
The Company has been investing significant amounts of capital to increase the
capacity and enhance the productivity of its Singapore manufacturing facility.
In the six month period ended June 27, 1998, the Company made capital
expenditures of $36.6 million. For fiscal year 1998, capital expenditures are
expected to be approximately $100.0 million, to be used principally for adding
manufacturing capacity and implementing the SAP System and other related
information technology systems. The Company anticipates that it may need
additional manufacturing capacity as early as the beginning of the year 2000. In
anticipation of that need, in the summer of 1997, HEI began construction of a
450,000 square foot manufacturing facility in Dalian, China (the "Dalian
Facility"). The Dalian Facility is only partially completed and construction is
continuing at a reduced pace. HEI has expended approximately $23.0 million on
the construction to date. An estimated additional $60.0 million investment will
be required to complete the Dalian Facility to the point where manufacturing
lines can be installed, and an estimated additional $25.0 million of machinery
and equipment will be required to make the facility ready for its initial phase
of operations. The Company and HEI have agreed to discuss the terms under which
the Dalian Facility will be completed and by which the Company would either buy
or lease the Dalian Facility from HEI, and the Company intends to utilize the
Dalian Facility if acceptable terms can be agreed upon. There can be no
assurance that the Company will be able to successfully negotiate any such
agreement with HEI or that the Dalian Facility will be completed by the time
Maxtor requires additional capacity. The terms of any agreement with regard to
the Dalian Facility are subject to the approval of the Affiliated Transactions
Committee of the Board. Moreover, any such
14
<PAGE> 15
agreement would be conditioned on the transfer of HEI's business license for the
Dalian Facility and the transfer of HEI's tax holiday status and other
regulatory concessions in Dalian to the Company. If the Company is unable to
reach agreement with HEI on acceptable terms or obtain the tax holiday status
and other regulatory concessions and the applicable business license, the
Company may need to acquire additional manufacturing capacity at other sites. In
addition to the Dalian Facility, the Company currently is investigating other
manufacturing facilities within Asia. Although the Company believes that
alternative manufacturing facilities will be available, a failure by the Company
to obtain, on a timely basis, a facility or facilities which allow the Company
to meet its customers' demands will limit the Company's growth and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company believes that the proceeds received from the Offering, together with
cash generated from operations and borrowing capacity, will be sufficient to
fund its operations through at least the next 12 months. The Company requires
substantial working capital to fund its business, particularly to finance
accounts receivables and inventory, and to invest in property and equipment. The
Company may seek long-term financing arrangements, including a line of credit to
fund its future capacity expansion plans, as necessary. However, the Company's
cash needs will depend on, among other things, demand in the desktop HDD market
and pricing conditions. There can be no assurance that lower than expected
revenue, increased expenses, decisions to increase capacity or other events,
including the acquisition of technology, products or businesses, will not cause
the Company to seek more capital, or to seek capital sooner than currently
expected. If the Company needs additional capital, there can be no assurance
that such additional financing can be obtained, or, if obtained, that it will be
available on satisfactory terms. The failure to obtain additional financing on
satisfactory terms would also hinder the Company's ability to invest in capital
expenditures or in R&D and would have a material adverse effect on the Company's
business, financial condition and results of operations.
15
<PAGE> 16
CERTAIN FACTORS AFFECTING FUTURE PERFORMANCE
HISTORY OF OPERATING AND NET LOSSES; ACCUMULATED DEFICIT
During each of the 19 consecutive quarters ended September 27, 1997, the
Company incurred significant operating losses ranging from $125.5 million to
$3.1 million per quarter, with net losses ranging from $130.2 million to $4.5
million, primarily as a result of delayed product introductions, product
performance and quality problems, low manufacturing yields and under-utilization
of manufacturing capacity, high operating expenses and overall market conditions
in the HDD industry, including fluctuations in demand and declining average
selling prices ("ASPs"). As of December 27, 1997, the Company had a
stockholders' deficit of approximately $663.1 and as of June 27, 1998, the
Company had a stockholders' deficit of approximately $777.9 million. While the
Company achieved operating profits and positive net income for the quarter ended
December 27, 1997, it recorded operating and net losses for the fiscal year
ended December 27, 1997. There can be no assurance that the factors that led to
the Company's history of operating losses have been overcome or that the Company
will achieve profitability on either an operating or net income basis in any
future quarterly or annual periods. Consequently, recent operating results
should not be considered indicative of future financial performance. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS; AVERAGE SELLING PRICE EROSION;
MANAGEMENT OF GROWTH
The Company has experienced, and expects to continue to experience,
fluctuations in sales and operating results from quarter-to-quarter. As a
result, the Company believes that period-to-period comparisons of its operating
results are not necessarily meaningful, and that such comparisons cannot be
relied upon as indicators of future performance. The Company's operating results
may be subject to significant quarterly fluctuations as a result of a number of
factors, including: (i) the Company's ability to be among the first-to-volume
production with competitive products; (ii) fluctuations in HDD product demand as
a result of the cyclical and seasonal nature of the personal computer ("PC")
industry; (iii) the availability and extent of utilization of manufacturing
capacity; (iv) changes in product or customer mix; (v) entry of new competitors;
(vi) the complex and difficult process of qualifying the Company's products with
its customers; (vii) cancellation or rescheduling of significant orders; (viii)
deferrals of customer orders in anticipation of new products or enhancements;
(ix) the impact of price protection measures and return privileges granted by
the Company to certain distributors and retailers; (x) component and raw
material costs and availability, particularly with respect to components
obtained from sole or limited sources; (xi) the availability of adequate capital
resources; (xii) increases in research and development expenditures to maintain
the Company's competitive position; (xiii) changes in the Company's strategy;
(xiv) personnel changes; and (xv) other general economic and competitive
factors. Moreover, since a large portion of the Company's operating expenses,
including rent, salaries, capital lease and debt payments and equipment
depreciation, are relatively fixed and difficult to reduce or modify, the
adverse effect of any decrease in revenue as a result of fluctuations in product
demand or
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otherwise will be magnified by the fixed nature of such operating expenses and
could have a material adverse effect on the Company's business, financial
condition and results of operations.
In addition, the HDD industry is characterized by rapidly declining ASPs
over the life of a product even for those products which are competitive and
timely-to-market. The Company anticipates that this market characteristic will
continue for the foreseeable future. In general, the ASP for a given product in
the desktop HDD market decreases over time as increases in the supply of
competitive products and cost reductions occur and as technological advancements
are achieved. The rate of ASP decline accelerates when, as is currently the case
in the HDD industry, some competitors lower prices to absorb excess capacity,
liquidate excess inventories, restructure or attempt to gain market share. The
Company expects ASPs to continue to decline for the second quarter of 1998 and
the remainder of the year. This continuing price erosion could have a material
adverse effect on the Company's business, financial condition and results of
operations.
In July 1996, the Company began to modify its management and operational
structures. From the first quarter of 1997 to the first quarter of 1998, the
Company's timely introduction and volume production of competitive products
resulted in quarterly revenue growth. Such restructuring activities and revenue
growth placed and are expected in the future to place a significant strain on
the Company's personnel and resources. The Company's ability to maintain the
advantages of the restructuring and to manage future growth, if any, will depend
on its ability to: (i) continue to implement and improve its operational,
financial and management information and control systems on a timely basis; (ii)
hire, train, retain and manage an expanding employee base; and (iii) maintain
effective cost controls, all while being among the first-to-volume production
with competitive products. The inability of the Company's management to maintain
the advantages of the restructuring, to manage future growth effectively and to
continue to be among the first-to-volume production with competitive products
could have a material adverse effect on the Company's business, financial
condition and results of operations.
See "-- Risks of Failed Execution; Changing Customer Business Models" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
RISKS OF FAILED EXECUTION; CHANGING CUSTOMER BUSINESS MODELS
PC original equipment manufacturers ("OEMs") compete in a market that is
consolidating market share among the top ten PC OEMs, which accounted for
greater than 50% of all PC units shipped during 1997 and the first six months of
1998. A majority of the Company's HDDs are sold to PC OEMs, which accounted for
72.2% of the Company's revenues for the second quarter of 1998. The process of
qualifying the Company's products with these PC OEM customers can be complex and
difficult. These PC OEMs use the quality, storage capacity and performance
characteristics of HDDs to select their HDD providers. PC OEMs typically seek to
qualify three or four providers for a given HDD product generation. To qualify
consistently with PC OEMs and thus succeed in the desktop HDD industry, an HDD
provider must consistently execute on its product development and manufacturing
processes in order to be among the first-to-market entry and first-to-volume
production at leading storage capacity per disk with competitive prices. Once a
PC OEM has chosen its qualified HDD vendors for a given PC product, it generally
will purchase HDDs from those vendors for the life of that product. If a
qualification opportunity is missed, the Company may not have another
opportunity to do business with that PC OEM until the next generation of the
Company's products is introduced. The effect of missing a product qualification
opportunity is magnified by the limited number of high volume PC OEMs. Failure
to reach the market on time or to deliver timely volume production usually
results in significantly decreased gross margins due to rapidly declining ASPs
and dramatic losses in market share. Failure to obtain significant PC OEM
customer qualifications for new or existing products in a timely manner would
have a material adverse effect on the Company's business, financial condition
and results of operations.
In addition to developing and qualifying new products, the Company must
address the increasingly changing and sophisticated business needs of its
customers. For example, PC OEMs and other PC suppliers are starting to adopt
build-to-order manufacturing models which reduce their component inventories and
related costs and enable them to tailor their products more specifically to the
needs of their customers. Various PC OEM customers also are considering or have
implemented a "channel assembly" model in which the PC OEM ships a minimal
computer system to the dealer or other assembler, and component suppliers
(including
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<PAGE> 18
HDD manufacturers such as the Company) ship parts directly to the dealer or
other assembler for installation at its location. Finally, certain PC suppliers
have adopted just-in-time inventory management processes which require component
suppliers to maintain inventory at or near the PC supplier's production
facility. Together, these changing models increase the Company's capital
requirements and costs, complicate the Company's inventory management
strategies, and make it more difficult to match manufacturing plans with
projected customer demand, thereby increasing the risk of inventory obsolescence
and ASP erosion as a result of later shipments to customers. The Company's
failure to manage its manufacturing output or inventory in response to these new
customer demands and other similar demands that may arise in the future as
customers further change their ordering and assembly models could lead to a
decline in the demand for the Company's products and a loss of existing or
potential new customers and could have a material adverse effect on the
Company's business, financial condition and results of operations.
See "-- Customer Concentration" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
HIGHLY COMPETITIVE INDUSTRY
Although the Company's share of the desktop HDD market has increased
steadily since the first quarter of 1997, this market segment and the HDD market
in general are intensely competitive and characterized by rapid technological
change, rapid rates of product and technology obsolescence, changing customer
requirements, dramatic shifts in market share and significant erosion of ASPs.
Consequently, there can be no assurance that the Company will be able to improve
on, or prevent the erosion of, the Company's present share of the desktop HDD
market.
The Company competes primarily with manufacturers of 3.5-inch HDDs,
including Fujitsu Limited ("Fujitsu"), Quantum Corporation ("Quantum"), Samsung
Company Limited ("Samsung"), Seagate Technology, Inc. ("Seagate") and Western
Digital Corporation ("Western Digital"), many of which have a larger share of
the desktop HDD market than the Company. Other companies, such as International
Business Machines Corporation ("IBM"), will be significant competitors of the
Company in one or more of the markets into which the Company plans to expand its
product portfolio, and could be significant competitors of the Company in its
current market should they choose to commit significant resources to providing
desktop HDDs.
Most of the Company's competitors offer a broader array of product lines
and have significantly greater financial, technical, manufacturing and marketing
resources than the Company. Unlike the Company, certain of the Company's
competitors manufacture a significant number of the components used in their
HDDs and thus may be able to achieve significant cost advantages over the
Company. Certain competitors have preferred vendor status with many of the
Company's customers, extensive marketing power and name recognition, and other
significant advantages over the Company. In addition, such competitors may
determine, for strategic reasons or otherwise, to consolidate, lower the prices
of their products or bundle their products with other products. The Company's
competitors have established and may in the future establish financial or
strategic relationships among themselves or with existing customers, resellers
or other third parties. New competitors or alliances could emerge and rapidly
acquire significant market share.
The Company believes that important competitive factors in the HDD market
are quality, storage capacity, performance, price, time-to-market entry,
time-to-volume production, PC OEM product qualifications, breadth of product
lines, reliability, and technical service and support. The Company believes it
generally competes favorably with respect to these factors. The failure of the
Company to develop and market products that compete successfully with those of
other suppliers in the HDD market would have a material adverse effect on the
Company's business, financial condition and results of operations.
FLUCTUATION IN PRODUCT DEMAND; FOCUS ON SINGLE MARKET
The Company presently offers a single product family which is designed for
the desktop PC segment of the HDD industry. The demand for the Company's HDD
products is therefore dependent to a large extent on
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<PAGE> 19
the overall market for desktop PCs which, in turn, is dependent on PC life
cycles, demand by end-users for increased PC performance and functionality at
lower prices (including increased storage capacity), availability of substitute
products, including laptop PCs, and overall foreign and domestic economic
conditions. The desktop PC and HDD markets are characterized by periods of rapid
growth followed by periods of oversupply, and by rapid price and gross margin
erosion. This environment makes it difficult for the Company and its PC OEM
customers to reliably forecast demand for the Company's products. The Company
does not enter into long-term supply contracts with its PC OEM customers, and
such customers often have the right to defer or cancel orders with limited
notice and without significant penalty. If demand for desktop PCs falls below
the customers' forecasts, or if customers do not manage inventories effectively,
they may cancel or defer shipments previously ordered from the Company.
Moreover, while there has been significant growth in the demand for desktop PCs
over the past several years, according to International Data Corporation
("IDC"), the growth rate in the desktop PC market has slowed in recent quarters.
Because of the Company's reliance on the desktop segment of the PC market, the
Company will be more strongly affected by changes in market conditions for
desktop PCs than would a company with a broader range of products. Any decrease
in the demand for desktop PCs could lead in turn to a decrease in the demand for
the Company's HDD products, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
Although the desktop PC segment is currently the largest segment of the HDD
market, the Company believes that over time, market demand may shift to other
market segments that may experience significantly faster growth. In addition,
the Company believes that to remain a significant provider of HDDs to major PC
OEMs, the Company will need to offer a broader range of HDD products for the
existing and new product categories of its PC OEM customers. For these reasons,
the Company will need to develop and manufacture new products which address
additional HDD market segments and emerging technologies to remain competitive
in the HDD industry. Examples of potentially important market segments that the
Company's current products are not positioned to address include: (i) the
client-server market, which may continue to grow in part as a result of the
emerging market trend toward "network computers" (which utilize central servers
for data storage and thereby reduce the need for desktop storage); (ii) lower
cost (typically below $1,000), lower performance PC systems principally for the
consumer marketplace; and (iii) laptop PCs. Significant technological innovation
and re-engineering will be required for the Company to produce products that
effectively compete in these and other new or growing segments of the HDD
market, and there can be no assurance that the Company will be able to design or
produce such new products on a timely or cost-effective basis, if at all, while
maintaining the required product quality or that such products or other future
products will attain market acceptance. Certain of the Company's competitors
have significant advantages over the Company in one or more of these and other
potentially significant new or growing market segments.
See "-- Highly Competitive Industry," "-- Customer Concentration" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
RAPID TECHNOLOGICAL CHANGE AND PRODUCT DEVELOPMENT
The HDD industry is characterized by rapid technological change, rapid
rates of product and technology obsolescence, changing customer requirements,
dramatic shifts in market share and significant erosion of ASPs, any of which
may render the Company's products obsolete. The Company's future results of
operations will depend on its ability to enhance current products and to develop
and introduce volume production of new competitive products on a timely and
cost-effective basis. To succeed, the Company also must keep pace with and
correctly anticipate technological developments and evolving industry standards
and methodologies.
Both in the desktop HDD market for which the Company's current products are
designed and in any other HDD market segments in which the Company may compete
in the future, advances in magnetic, optical or other technologies, or the
development of entirely new technologies, could result in the creation of
competitive products that have better performance and/or lower prices than the
Company's products. Examples of such new technologies include "giant
magneto-resistive" ("GMR") head technology (which already has been introduced by
IBM and which Western Digital reportedly will use in its products pursuant to an
agreement with IBM) and optically-assisted recording technologies (which
currently are being developed by companies such as TeraStor Corporation and
Seagate). Currently, the Company intends to incorporate
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<PAGE> 20
GMR head technology into future products and is evaluating the various
approaches to and timing of such a transition. The Company has decided not to
pursue optically-assisted recording technologies at this time.
There can be no assurance that the Company's existing markets will not be
eroded by technological developments; that the Company will be successful in
developing, manufacturing and marketing product enhancements or new products
that respond to and anticipate technological change, such as the transition to
GMR head technology and changing customer requirements; or that its new products
and product enhancements will be introduced or manufactured in volume on a
timely basis and will adequately meet the requirements of the marketplace and
achieve any significant degree of market acceptance. Inability to introduce or
achieve volume production of competitive products on a timely basis has in the
past and could in the future have a material adverse effect on the Company's
business, financial condition and results of operations.
Unlike some of its competitors, the Company does not manufacture any of the
components used in its HDDs, including key components such as heads, disks and
PCBs. The Company's product development process therefore involves incorporating
components designed by and purchased from third party suppliers. As a
consequence, the success of the Company's products is in great part dependent on
the Company's ability to gain access to and integrate components which utilize
leading-edge technology. The successful management of these integration projects
depends on the timely availability and quality of key components, the
availability of appropriately skilled personnel, the ability to integrate
different products from a variety of vendors effectively, and the management of
difficult scheduling and delivery problems. There can be no assurance that the
Company will be able to manage successfully the various complexities encountered
in integration projects. The Company's success will depend in part on its
relationships with key component suppliers, and there can be no assurance that
such relationships will develop, that the Company will identify the most
advantageous suppliers with which to establish such relationships, or that
existing or future relationships with component suppliers will continue for any
significant time period.
See "-- Dependence on Suppliers of Components and Sub-Assemblies" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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<PAGE> 21
DEPENDENCE ON AND INTEGRATION OF KEY PERSONNEL; HIRING ADDITIONAL SKILLED
PERSONNEL
The Company's success depends upon the continued contributions of its key
management, engineering and other technical personnel many of whom, and in
particular Michael R. Cannon, the Company's President and Chief Executive
Officer, would be extremely difficult to replace. The Company does not have
employment contracts with any of its key personnel other than Mr. Cannon; Paul
J. Tufano, its Vice President, Finance and Chief Financial Officer; William F.
Roach, its Senior Vice President, Worldwide Sales and Marketing; Dr. Victor B.
Jipson, its Senior Vice President, Engineering; Phillip C. Duncan, its Vice
President, Human Resources; and K.H. Teh, its Vice President, Worldwide
Manufacturing. Furthermore, the Company does not maintain key person life
insurance on any of its personnel. In addition, the majority of the Company's
senior management and a significant number of its other employees have been with
the Company for less than two years. The Company's inability to retain its
existing personnel and effectively manage the integration of new personnel could
have a material adverse effect on the Company's business, financial condition
and results of operations.
To maintain its current market position and support future growth, the
Company will need to hire, train, integrate and retain significant numbers of
additional highly skilled managerial, engineering, manufacturing, sales,
marketing, support and administrative personnel. Competition worldwide for such
personnel is extremely intense, and there can be no assurance that the Company
will be able to attract and retain such additional personnel. The Company
believes that certain competitors recently have made targeted efforts to recruit
personnel from the Company, and such efforts have resulted in the Company losing
some skilled managers. There can be no assurance that such personnel losses will
not continue or increase in the future. Delays in hiring or the inability to
hire, train, integrate or retain required personnel, particularly engineers,
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, companies in the HDD industry
whose employees accept positions with competitive companies frequently claim
that their competitors have engaged in unfair hiring practices. There can be no
assurance that the Company will not receive such claims in the future as it
seeks to hire qualified personnel or that such claims will not involve the
Company in litigation. Consequently, the Company could incur substantial costs
in defending itself against any such claims, regardless of their merits.
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<PAGE> 22
CONTROL BY AND DEPENDENCE ON HYUNDAI
Five out of the seven members of the Company's Board of Directors (the
"Board") are currently employees of HEA or one of its affiliates. HEA currently
has the contractual right to designate one person for nomination to serve as a
director in each of the three classes of the Board. Accordingly, HEA will be
able to influence or control major decisions of corporate policy and to
determine the outcome of any major transaction or other matter submitted to the
Company's stockholders or directors, including borrowings, issuances of
additional Common Stock and other securities of the Company, the declaration and
payment of any dividends on Common Stock, potential mergers or acquisitions
involving the Company, amendments to the Company's Amended and Restated
Certificate of Incorporation (the "Amended and Restated Certificate of
Incorporation") and Bylaws (the "Bylaws") and other corporate governance issues.
In particular, the affirmative vote of two-thirds of the outstanding voting
stock is required to approve certain types of amendments to the Amended and
Restated Certificate of Incorporation. Consequently, HEA will be able to block
approval of any such amendments that may be proposed in the future as long as it
owns at least one-third of the Common Stock and may be able to make it difficult
to achieve approval of any such amendment for as long as it owns a significant
amount of Common Stock even if its ownership falls below one-third. The Company
has granted HEA the contractual right to maintain its ownership interest at 30%
through 2000. Stockholders other than HEA therefore are likely to have little or
no influence on decisions regarding such matters. HEA and the Company have
entered into a Stockholder Agreement under which the Company has granted HEA
certain rights to require the Company to register HEA's shares of Common Stock
and the right to designate for nomination up to three members of the Board so
long as ownership by HEA and certain of its affiliates is between 50% and 10% of
the outstanding voting securities of the Company. In a Stockholder Agreement by
and among HEI, HEA and the Company (the "Stockholder Agreement"), HEA has agreed
to certain restrictions on its rights to solicit proxies, to acquire additional
shares of Common Stock and to compete with the Company.
Conflicts of interest may arise from time to time between the Company and
HEA or its affiliates in a number of areas relating to their past and ongoing
relationships, including potential competitive business activities, corporate
opportunities, tax matters, intellectual property matters, indemnity agreements,
registration rights, sales or distributions by HEA of all or any portion of its
ownership interest in the Company or HEA's ability to control the management and
affairs of the Company. There can be no assurance that HEA and the Company will
be able to resolve any potential conflict or that, if resolved, the Company
would not receive more favorable resolution if it were dealing with an
unaffiliated party. The Amended and Restated Certificate of Incorporation
specifies certain circumstances in which a transaction between the Company and
HEA or an affiliated entity will be deemed fair to the Company and its
stockholders, and prescribes guidelines under which HEA and its affiliates will
be deemed not to have breached any fiduciary duty or duty of loyalty to the
Company, or to have usurped a corporate opportunity available to the Company, if
specified conditions are met.
HEI served as guarantor for the Company's borrowings under various
revolving bank credit facilities from August 1995 through June 1998. At December
27, 1997, aggregate indebtedness of the Company guaranteed by HEI under such
facilities was $170.0 million. Due to the economic conditions in Korea and
significant recent devaluations of the Korean won versus the U.S. dollar, HEI's
reported financial condition as of year-end 1997 was not in compliance with
certain financial covenants applicable to HEI as guarantor under such revolving
credit facilities, and such non-compliance constituted a default by the Company
under such revolving credit facilities and also a default (through a
cross-default clause) under an uncommitted credit facility of the Company that
is repayable on demand of the lender, is not guaranteed and had an outstanding
principal amount of $30.0 million as of December 27, 1997. The default under the
revolving credit facilities was waived by the lending banks in June 1998 in
exchange for Hyundai Heavy Industries Co., Ltd. ("HHI"), a partial owner of HEA,
becoming the guarantor under such facilities in place of HEI and an increase in
pricing to reflect borrowing rates based on HHI's current credit rating. As of
June 27, 1998, aggregate indebtedness of $170.0 million under the revolving
credit facilities was guaranteed by HHI. The $30.0 million outstanding under the
demand facility has been repaid from proceeds of the Offering.
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<PAGE> 23
The Company intends to obtain replacement credit facilities that do not depend
on any Hyundai guarantees. However, the Company believes that current market
conditions for such facilities are not as favorable as they have been at certain
times in the past, that for various reasons the number of potential lenders
actively providing credit facilities to companies in the data storage industry
may have decreased recently, and that the terms on which the remaining potential
lenders are willing to offer such facilities have become significantly more
restrictive and/or costly. Consequently, there can be no assurance that the
Company will be able to obtain or retain adequate credit facilities or as to the
terms and amount of any such facilities. Any failure to obtain or retain
adequate credit facilities on acceptable terms would have a material adverse
effect on the Company's business, financial condition and results of operations.
In addition, as a majority-owned subsidiary of HEA, the Company had the benefit
of a letter of support from HEI under which HEI agreed to provide sufficient
financial support to ensure that the Company would continue as a going concern.
The Company believes that it will no longer have the benefit of the support
letter.
HEA could decide to sell or otherwise dispose of all or a portion of its
shares of Common Stock at some future date, and there can be no assurance that
HEI or HEA will maintain any past or future relationships or arrangements with
the Company following any transfer by HEA of a controlling or substantial
interest in the Company or that other holders of Common Stock will be allowed to
participate in such transaction. Sales by HEA of substantial amounts of Common
Stock in the public market could adversely affect prevailing market prices for
the Common Stock.
Since 1996, the Company has been a member of the HEA U.S. consolidated tax
group for U.S. federal income tax purposes. Certain material tax consequences
result from such affiliation.
HEI and IBM are parties to a patent cross license agreement (the "IBM
License Agreement"), under which HEI and its subsidiaries, including the
Company, are licensed with respect to certain IBM patents. HEI is required under
the IBM License Agreement to pay IBM a license fee, payable in installments
through 2007. HEI has entered into a sublicense with the Company (the
"Sublicense Agreement") pursuant to which the Company is obligated to pay IBM a
portion of the license fee otherwise due from HEI under the IBM License
Agreement, payable in annual installments, when such amounts are due from HEI to
IBM. Under the IBM License Agreement, if Maxtor ceases to be a majority-owned
subsidiary of HEA, the Company can obtain a royalty-free license under the same
terms from IBM upon the joint request of HEI and the Company and the fulfillment
of certain conditions. Pursuant to the Sublicense Agreement, HEI has agreed to
cooperate to obtain such a license for the Company once the Company ceases to be
a majority-owned subsidiary, and the Company has agreed to continue to pay IBM
the Company's allocated portion of the license fee following the grant of such a
license from IBM. The Company intends to obtain such a license if the Company no
longer is a majority owned subsidiary of HEA. HEI and the Company have
indemnified each other for certain liabilities arising from their acts or
omissions relating to the IBM License Agreement.
As discussed more fully above, the Company is preparing to implement the
SAP System. The Company's rights to the SAP System are governed by a license
agreement between Hyundai Information Technology Co., Ltd. ("HIT"), an affiliate
of HEI, and SAP, AG, which provides that the Company will have the right to use
existing software releases so long as the Company remains an affiliate of HIT.
The Company currently is discussing with SAP, AG the terms under which the
Company could obtain a direct license with SAP, AG. In the event the Company is
no longer a majority-owned subsidiary of HEA and is not able to obtain a direct
license with SAP, the Company will not be entitled to receive new releases of
SAP's information system software or expand the system for other functions. As a
result, the Company would not be able to effectively utilize its new information
system in the future, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
See "-- Risks Associated with Leverage," "-- Certain Tax Risks" and
"--Single Manufacturing Facility; Future Need for Additional Capacity."
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CERTAIN TAX RISKS
Due to the Company's operating losses, its net operating loss ("NOL")
carryforwards and its favorable tax status in Singapore, the Company's tax
expense historically has represented only a small percentage of the Company's
expenses. The Company's foreign and U.S. tax liability will increase
substantially in future periods if the Company attains profitability.
In December 1997, Maxtor Singapore was granted pioneer tax status in
Singapore, thus exempting it from paying Singapore income taxes until June 30,
2003, subject to the ongoing satisfaction of certain conditions. Maxtor
Singapore is eligible for up to two additional two-year extensions of this
pioneer tax status, subject to the satisfaction of certain additional
conditions. There can be no assurance that Maxtor Singapore will be able to
satisfy or, if satisfied, to maintain compliance with, the required conditions.
If Maxtor Singapore is unable to satisfy and maintain compliance with the
required conditions and is unable to obtain a waiver of any such failure, it
would lose its pioneer tax status, or would be ineligible for such extensions,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
Since 1996, the Company has been a member of the HEA Tax Group for U.S.
federal income tax purposes. On December 27, 1997, for federal income tax
purposes, the Company had NOL carryforwards of approximately $616.7 million and
tax credit carryforwards of approximately $18.8 million which will expire
beginning in fiscal year 1999. In June, 1998 the Company caused Maxtor Singapore
to pay a $400.0 dividend which will utilize a substantial portion of the
Company's NOL carryforwards. In addition, a substantial portion of the remaining
NOL carryforwards likely will be utilized by the HEA Tax Group for the 1998 tax
year and in connection with amendments to returns for prior years. As a result,
there will be a significant reduction in the NOL carryforwards available to the
Company for federal income tax purposes for subsequent tax years. Utilization
and payment for the Company's NOL carryforwards by the HEA Tax Group is governed
by the Tax Allocation Agreement. Under the Tax Allocation Agreement, neither HEA
nor the Company shall reimburse the other for any utilization of the other
member's NOLs or other tax attributes in the consolidated or combined income tax
returns, except that each party shall reimburse the other for any use of the
other party's tax attributes as a result of any return or amended return filed
after September 15, 1999 or by a taxing authority adjustment after September 15,
1999.
As a result of the Company's acquisition by HEA, utilization of
approximately $253.0 million of the Company's NOL carryforwards and the
deduction equivalent of approximately $18.3 million of tax credit carryforwards
is limited to approximately $22.4 million per year. If more than 50% of the
Company's outstanding capital stock is acquired, then the amount of the
Company's U.S. federal taxable income for any tax year ending after the date of
such acquisition which may be offset by the Company's NOL carryforwards
remaining after deconsolidation from the HEA Tax Group will be limited to an
amount equal to the aggregate value of the Common Stock and the Series A
Preferred Stock immediately before the ownership change multiplied by the
long-term tax exempt rate then in effect (e.g., 5.15% for ownership changes
occurring during July 1998).
For periods during which the Company was a member of the HEA Tax Group, the
Company and its subsidiaries have filed or will file tax returns as part of the
HEA Tax Group. As a consequence of the Offering, the Company ceased to be a
member of the HEA Tax Group; however, the Company will remain liable for its
allocable share of the consolidated or combined tax return liability and for tax
deficiencies of the entire HEA Tax Group which relate to the period during which
the Company was a member of the HEA Tax Group. There can be no assurance that
the HEA Tax Group will satisfy all tax obligations for such periods or that
additional liabilities will not be assessed for such periods. In addition, there
can be no assurance that the Company's share of the consolidated or combined tax
liability will not be increased as a result of subsequent events, such as taxing
authority audit adjustments or the filing of amended returns affecting either
the Company's items of gain, income, loss, deduction or credit or another
member's items of gain, income, loss, deduction or credit. The Company has
agreed to indemnify and reimburse HEA if any member of the HEA Tax Group is
required
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to pay any tax, interest or penalty to any taxing authority related to any
additional Company separate tax return liability and if there is any increase in
the consolidated or combined tax return liability resulting from revisions to
the Company's taxable income or revisions to another HEA Tax Group Member's
taxable income, except to the extent such revisions to another HEA Tax Group
Member's taxable income are made after September 15, 1999. HEA has agreed to
indemnify and reimburse the Company if the Company or any of its subsidiaries is
required to pay any tax, interest or penalty to any taxing authority related to
any separate tax return of any member of the HEA Tax Group other than the
Company or its subsidiaries, and if the Company or any of its subsidiaries is
required to pay to any taxing authority any amount in excess of the Company's
share of the consolidated or combined tax return liability.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
RISKS ASSOCIATED WITH LEVERAGE
The Company historically has operated with significant amounts of debt as
compared to its equity. At June 27, 1998, the Company had outstanding
approximately $350.5 million in principal amount of indebtedness. In the first
six months of 1998 and for the fiscal year ended December 31, 1997 and nine
months ended December 28, 1996, the Company's interest payments were $10.0
million, $26.5 million and $13.4 million, respectively. During the first quarter
of 1998, the Company repaid $5.0 million of principal under long term debt
agreements. As of August 10, 1998, the Company has repaid $30.0 million of the
outstanding debt with proceeds from the Offering and expects to repay an
additional $170.0 million of such debt by August 12, 1998. The Company also has
an asset securitization program under which the Company sells its accounts
receivable on a non-recourse basis. At June 27, 1998, $100.0 million of
accounts receivable was securitized under the program. Continuance of the
program is subject to certain conditions, including a condition that all of the
long-term public senior debt securities of HHI not fall below a specified
rating. The Company has entered into definitive agreements with respect to a
$200 million asset securitization program which does not require any support
from HEA or any of its affiliates and the Company believes it will be able to
close this program and terminate its existing securitization program by August
12, 1998. Failure of the Company to close the replacement asset securitization
program or to obtain alternative financing would have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company will continue to be subject to the risks associated with
leverage, which include: (i) principal and interest repayment obligations which
require the expenditure of substantial amounts of cash, the availability of
which will be dependent on the Company's future performance; (ii) the inability
to repay principal or interest when due or violation of loan covenants, which
could result in a default on the debt, acceleration of its principal amount and
legal actions against the Company; and (iii) adverse effects of interest
expense on the Company's business, financial condition and results of
operations.
See "-- Control By and Dependence on Hyundai," "-- Single Manufacturing
Facility; Future Need for Additional Capacity," "-- Need for Additional Capital"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources.
SINGLE MANUFACTURING FACILITY; FUTURE NEED FOR ADDITIONAL CAPACITY
The Company's volume manufacturing operations currently are based in a
single facility in Singapore. A fire, flood, earthquake or other disaster or
condition affecting the Company's facility could disable such facility. Any
damage to, or condition interfering with the operation of, the Company's
manufacturing facility could have a material adverse effect on the Company's
business, financial condition and results of operations.
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<PAGE> 26
The Company anticipates that it may need additional manufacturing capacity
as early as the beginning of the year 2000. In anticipation of that need, in the
summer of 1997, HEI began construction of a 450,000 square foot manufacturing
facility in Dalian, China (the "Dalian Facility") for the purpose of making
additional manufacturing capacity available to Maxtor. The Dalian Facility is
only partially completed and construction is continuing at a reduced pace. HEI
has expended approximately $23.0 million on the construction to date. An
additional estimated $60.0 million investment will be required to complete the
Dalian Facility to the point where manufacturing lines can be installed, and an
estimated additional $25.0 million of machinery and equipment will be required
to make the facility ready for its initial phase of operation. The Company and
HEI have agreed to discuss the terms under which the Dalian Facility will be
completed and by which the Company would either buy or lease the Dalian Facility
from HEI, and the Company intends to utilize the Dalian Facility if acceptable
terms can be agreed upon. There can be no assurance that the Company will be
able to successfully negotiate any such agreement with HEI or that the Dalian
Facility will be completed by the time Maxtor requires additional capacity. The
terms of any agreement with regard to the Dalian Facility are subject to the
approval of the Affiliated Transactions Committee of the Board. Moreover, any
such agreement would be conditioned on the transfer of HEI's business license
for the Dalian Facility and the transfer of HEI's tax holiday status and other
regulatory concessions in Dalian to the Company. If the Company is unable to
reach agreement with HEI on acceptable terms or obtain the tax holiday status
and other regulatory concessions and the applicable business license, the
Company may need to acquire additional manufacturing capacity at other sites. In
addition to the Dalian Facility, the Company currently is investigating other
manufacturing facilities within Asia. Although the Company believes that
alternative manufacturing facilities will be available, a failure by the Company
to obtain, on a timely basis, a facility or facilities which allow the Company
to meet its customers' demands will limit the Company's growth and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company is experiencing space constraints at its Longmont, Colorado
facility and is exploring opportunities to obtain additional space at a new
facility in the Longmont area. There can be no assurance that the Company will
be able to obtain additional space that can accommodate its needs or that,
if obtained, such additional space will be available to the Company on terms at
least as favorable as the terms governing its current lease.
See "-- Need for Additional Capital," "-- Dependance on International
Operation; Risks from International Sales" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
NEED FOR ADDITIONAL CAPITAL
The HDD industry is capital intensive. The Company will require substantial
additional working capital to fund its business. The Company's future capital
requirements will depend on many factors, including the rate of sales growth, if
any, the level of profitability, if any, the timing and extent of spending to
support facilities upgrades and product development efforts, the timing and size
of business or technology acquisitions, the timing of introductions of new
products and enhancements to existing products. Any future equity financing will
decrease existing stockholders' percentage equity ownership and may, depending
on the price at which the equity is sold, result in significant economic
dilution to such stockholders. Moreover, in connection with future equity
offerings, the Company may issue preferred stock with rights, preferences or
privileges senior to those of the Common Stock. Pursuant to the Amended and
Restated Certificate of Incorporation, the Board has authority to issue up to 95
million shares of preferred stock and to fix the rights, preferences and
privileges of such shares (including voting rights) without any further action
or vote by the stockholders.
In the future the Company may require alternative sources of liquidity. The
unavailability of, or delays in obtaining, any necessary financing could prevent
or delay the continued development and marketing of the Company's products and
may require curtailment of various operations of the Company and, if adequate
funds were not available from operating profits, would have a material adverse
effect on the Company's business, financial condition and results of operations.
26
<PAGE> 27
See "-- Control by and Dependence on Hyundai," "-- Risks Associated with
Leverage," "-- Single Manufacturing Facility; Future Need for Additional
Capacity" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
CUSTOMER CONCENTRATION
The Company focuses its marketing efforts on and sells its HDDs to a
limited number of PC OEMs, distributors and retailers. During the six months
ended June 27, 1998, two customers, Dell and IBM, accounted for approximately
27% and 17% respectively, of the Company's revenues, and the Company's top ten
customers accounted for approximately 74% of the Company's revenue. During the
fiscal year ended December 27, 1997, two PC OEM customers, Compaq and Dell,
accounted for approximately 21% and 10%, respectively, of the Company's revenue,
and the Company's top ten customers accounted for approximately 60% of the
Company's revenue. During the fiscal year ended December 28, 1996, one customer,
SED International Holdings, Inc. ("SED"), a distributor, accounted for
approximately 11% of the Company's revenue and the Company's top ten customers
accounted for approximately 68% of the Company's revenue. During the fiscal year
ended March 30, 1996, while no customer accounted for more than 10% of the
Company's revenue, the Company's top ten customers accounted for approximately
51% of the Company's revenue.
The Company anticipates that a relatively small number of customers will
continue to account for a significant portion of its revenue for the foreseeable
future, and that the proportion of its revenue derived from such customers may
continue to increase in the future. The ability of the Company to maintain
strong relationships with its principal customers, including in particular its
PC OEM customers, is essential to the ongoing success and profitability of the
Company. Although the Company believes its relationships with key customers
generally are good, in order to maintain its customer relationships,
particularly with PC OEMs, the Company must be among the first-to-volume
production with competitive products. The concentration of sales in a relatively
small number of major customers represents a business risk that loss of one or
more accounts, or a decrease in the volume of products sold to such accounts,
could have a material adverse effect on the Company's business, financial
condition and results of operations.
Due to the intense competition in the HDD market, customers may choose from
various suppliers and therefore can make substantial demands on their chosen
suppliers. The Company's customers generally are not obligated to purchase any
minimum volume and generally are able to terminate their relationship with the
Company at will. Consequently, major customers have significant leverage over
the Company and may attempt to change the terms, including pricing and delivery
terms, upon which the Company sells its products. Moreover, as the Company's PC
OEM, distributor and retail customers are pressured to reduce prices in response
to competitive factors, the Company may be required to reduce the prices of its
products before it knows how, or if, internal cost reductions can be obtained.
If the Company is forced to change the terms, including pricing, upon which the
Company sells its products or is unable to achieve required cost reductions in
connection with reductions in the prices of its products, the Company's
operating margins could decline and such decline could have a material adverse
effect on the Company's business, financial condition and results of operations.
See "-- Risks of Failed Execution; Changing Customer Business Models," "-
Fluctuation in Product Demand; Focus on a Single Market" and "-- Dependence on
International Operations; Risks from International Sales."
DEPENDENCE ON SUPPLIERS OF COMPONENTS AND SUB-ASSEMBLIES
The Company does not manufacture any of the components used in its HDDs and
therefore is dependent on qualified suppliers for the components that are
essential for manufacturing the Company's products, including heads, head stack
assemblies, media and integrated circuits. A number of the key components used
by the Company in its products are available from only one or a limited number
of outside suppliers. Currently, the Company purchases DSP/controller and
spin/servo integrated circuits only from Texas
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<PAGE> 28
Instruments, Inc. ("TI") and purchases channel integrated circuits only from
Lucent Technologies, Inc. ("Lucent"). Some of the components required by the
Company may periodically be in short supply, and the Company has, on occasion,
experienced temporary delays or increased costs in obtaining components. As a
result, the Company must allow for significant lead times when procuring certain
components. In addition, cancellation by the Company of orders for components
due to cut-backs in production precipitated by market oversupply, reduced
demand, transition to new products or technologies or otherwise can result in
payment by the Company of significant cancellation charges to suppliers. The
Company orders the majority of its components on a purchase order basis and only
has limited long-term volume purchase agreements with certain existing
suppliers. Any inability of the Company to obtain sufficient quantities of
components meeting the Company's specifications, or to develop in a timely
manner alternative sources of component supply if and as required in the future,
could adversely affect the Company's ability to manufacture its products and
deliver them on a timely basis, which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Because the Company does not manufacture any of the components used in its
HDDs, the Company's product development process involves incorporating
components designed by and purchased from third party suppliers. As a
consequence, the success of the Company's products is in great part dependent on
the Company's ability to gain access to and integrate components which utilize
leading-edge technology. The successful management of these integration projects
depends on the timely availability and quality of key components, the
availability of appropriately skilled personnel, the ability to integrate
different products from a variety of vendors effectively, and the management of
difficult scheduling and delivery problems. There can be no assurance that the
Company will be able to manage successfully the various complexities encountered
in integration projects. The Company's success will depend in part on its
relationships with key component suppliers, and there can be no assurance that
such relationships will develop, that the Company will identify the most
advantageous suppliers with which to establish such relationships, or that
existing or future relationships with component suppliers will continue for any
significant time period.
See "-- Rapid Technological Change and Product Development."
LIMITED PROTECTION OF INTELLECTUAL PROPERTY; RISK OF THIRD PARTY CLAIMS OF
INFRINGEMENT
The Company has patent protection on certain aspects of its technology and
also relies on trade secret, copyright and trademark laws, as well as
contractual provisions to protect its proprietary rights. There can be no
assurance that the Company's protective measures will be adequate to protect the
Company's proprietary rights; that others, including competitors with
substantially greater resources, have not developed or will not independently
develop or otherwise acquire equivalent or superior technology; or that the
Company will not be required to obtain licenses requiring it to pay royalties to
the extent that the Company's products may use the intellectual property of
others, including, without limitation, Company products that may also be subject
to patents licensed by the Company. There can be no assurance that any patents
will be issued pursuant to the Company's current or future patent applications,
or that patents issued pursuant to such applications or any patents the Company
owns or has licenses to use will not be invalidated, circumvented or challenged.
Moreover, there can be no assurance that the rights granted under any such
patents will provide competitive advantages to the Company or be adequate to
safeguard and maintain the Company's proprietary rights. Litigation may be
necessary to enforce patents issued or licensed to the Company, to protect trade
secrets or know-how owned by the Company or to determine the enforceability,
scope and validity of the proprietary rights of the Company or others. The
Company could incur substantial costs in seeking enforcement of its issued or
licensed patents against infringement or the unauthorized use of its trade
secrets and proprietary know-how by others or in defending itself against claims
of infringement by others, which could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the laws of certain countries in which the Company's products are manufactured
and sold, including various countries in Asia, may not protect the Company's
products and intellectual property rights to the same extent as the laws of the
United States, and there can be no assurance that such laws will be enforced in
an effective manner. The failure of the Company to enforce and protect its
intellectual property rights could have a material adverse effect on the
Company's business, financial condition and results of operations.
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As a majority-owned subsidiary of HEA, the Company has had the benefit of
certain third party intellectual property rights on terms that may have been
more favorable than would have been available to the Company if it were not a
majority-owned subsidiary of HEA. There can be no assurance that the Company
will be able to obtain similar rights in the future on terms as favorable as
those currently available to it.
The HDD industry, like many technology-based industries, is characterized
by frequent claims and litigation involving patent and other intellectual
property rights. The Company, its component suppliers and certain users of the
Company's products have from time to time received, and may in the future
receive, communications from third parties asserting patent infringement against
the Company, its component suppliers or its customers which may relate to
certain of the Company's products. If the Company is notified of such a claim,
it may have to obtain appropriate licenses or cross-licenses, modify its
existing technology or design non-infringing technology. There can be no
assurance that the Company can obtain adequate licenses or cross-licenses on
favorable terms or that it could modify its existing technology or design
non-infringing technology and, in either case, the failure to do so could have a
material adverse effect on the Company's business, financial condition and
results of operations. Although the Company to date has not been a party to any
material intellectual property litigation, certain of its competitors have been
sued on patents having claims related to HDDs and there can be no assurance that
third parties will not initiate infringement actions against the Company or that
the Company could defend itself against such claims. If there is an adverse
ruling against the Company in an infringement lawsuit, it could result in the
issuance of an injunction against the Company or its products and/or the payment
of monetary damages equal to a reasonable royalty or recovered lost profits or,
in the case of a finding of a willful infringement, treble damages. Accordingly,
such an adverse ruling could have a material adverse effect on the Company's
business, financial condition and results of operations.
Similar to certain other providers of HDDs, the Company has received
correspondence from Papst-Motoren GmbH and Papst Licensing (collectively
"Papst") claiming infringement of at least 13 HDD motor patents. The patents
relate to motors that the Company purchases from motor vendors and the use of
such motors in HDDs. While the Company believes that it has meritorious defenses
against a lawsuit if filed, the results of litigation are inherently uncertain
and there can be no assurance that Papst will not assert other infringement
claims relating to current patents, pending patent applications and future
patents or patent applications; will not initiate a lawsuit against the Company;
or that the Company will be able to successfully defend itself against such a
lawsuit. A favorable outcome for Papst in such a lawsuit could result in the
issuance of an injunction against the Company or its products and/or the payment
of monetary damages equal to a reasonable royalty or recovered lost profits or,
in the case of a finding of a willful infringement, treble damages and could
have a material adverse effect on the Company's business, financial condition
and results of operations.
See "-- Dependence on International Operations; Risks of International
Sales."
DEPENDENCE ON INTERNATIONAL OPERATIONS; RISKS FROM INTERNATIONAL SALES
The Company conducts all of its volume manufacturing and testing operations
and purchases a substantial portion of its key components outside of the U.S. In
addition, the Company derives a significant portion of its revenue from sales of
its products to foreign distributors and retailers. Dependence on revenue from
international sales and managing international operations each involve a number
of inherent risks, including economic slowdown and/or downturn in the computer
industry in such foreign markets, international currency fluctuations, general
strikes or other disruptions in working conditions, political instability, trade
restrictions, changes in tariffs, the difficulties associated with staffing and
managing international operations, generally longer receivables collection
periods, unexpected changes in or impositions of legislative or regulatory
requirements, reduced protection for intellectual property rights in some
countries, potentially adverse taxes, delays resulting from difficulty in
obtaining export licenses for certain technology and other trade barriers.
International sales also will be impacted by the specific economic conditions in
each country. For example, the Company's international contracts are denominated
primarily in U.S. dollars. Significant fluctuations in currency exchange rates
against the U.S. dollar, particularly the recent significant depreciation in the
currencies of Japan, Korea, Taiwan and Singapore relative to the U.S. dollar,
have caused the Company's products to become relatively more expensive to
distributors and retailers in those countries, and
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<PAGE> 30
thus have caused, and may continue to cause, deferrals, delays and cancellations
of orders. The Company attempts to minimize the impact of foreign currency
exchange rate changes on certain underlying assets, liabilities and anticipated
cash flows for operating expenses denominated in foreign currencies by entering
into short-term, foreign exchange (primarily forward purchase and sale)
contracts. There can be no assurance that all foreign currency exposures will be
adequately covered, and these factors, as well as other unanticipated factors,
could have a material adverse effect on future international sales of the
Company's products and consequently, on the Company's business, financial
condition and results of operations. See "-- Dependence on Suppliers of
Components and Sub-Assemblies" and "-- Limited Protection of Intellectual
Property; Risk of Third Party Claims of Infringement."
STORMEDIA; LEGAL PROCEEDINGS
The Company currently is involved in a dispute with StorMedia, which arises
out of an agreement among the Company, StorMedia and HEI which became effective
on November 17, 1995. Pursuant to the StorMedia Agreement, StorMedia agreed to
supply disk media to the Company. StorMedia's disk media did not meet the
Company's specifications and functional requirements as required by the
StorMedia Agreement and the Company ultimately terminated the StorMedia
Agreement. After a class action securities lawsuit was filed against StorMedia
by certain of its shareholders in September 1996 which alleged, in part, that
StorMedia failed to perform under the StorMedia Agreement, StorMedia sued the
Original Defendants in the U.S. District Court for the Northern District of
California. In the Federal Suit, StorMedia alleged that at the time HEI entered
into the StorMedia Agreement, it knew that it would not and could not purchase
the volume of products which it committed to purchase, and that failure to do so
caused damages to StorMedia in excess of $206 million.
In December 1996, the Company filed a complaint against StorMedia and
William Almon (StorMedia's Chairman and Chief Executive Officer) in a Colorado
state court seeking approximately $100 million in damages and alleging, among
other claims, breach of contract, breach of implied warranty of fitness and
fraud under the StorMedia Agreement. This proceeding was stayed pending
resolution of the Federal Suit. The Federal Suit was permanently dismissed early
in February 1998. On February 24, 1998, StorMedia filed a new complaint in Santa
Clara County Superior Court for the State of California for $206 million,
alleging fraud and deceit against the Original Defendants and negligent
misrepresentation against HEI and the Company. On May 18, 1998, the stay on the
Colorado Suit was lifted by the Colorado state court. The Company's motion to
dismiss, or in the alternative, stay the California Suit, is pending.
The Company believes that it has meritorious defenses against the claims
alleged by StorMedia and intends to defend itself vigorously. However, due to
the nature of litigation and because the pending lawsuits are in the very early
pre-trial stages, the Company cannot determine the possible loss, if any, that
may ultimately be incurred either in the context of a trial or as a result of a
negotiated settlement. The litigation could result in significant diversion of
time by the Company's technical personnel, as well as substantial expenditures
for future legal fees. After consideration of the nature of the claims and facts
relating to the litigation, including the results of preliminary discovery, the
Company's management believes that the resolution of this matter will not have a
material adverse effect on the Company's business, financial condition or
results of operations. However, the results of these proceedings, including any
potential settlement, are uncertain and there can be no assurance that they will
not have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company has been notified of certain other claims, including claims of
patent infringement. While the ultimate outcome of these claims and the claims
described above is not determinable, the Company does not believe that
resolution of these matters will have a material adverse effect on the Company's
business, financial condition and results of operations. No amounts related to
any claims or actions have been reserved in the Company's financial statements.
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<PAGE> 31
See "-- Limited Protection of Intellectual Property; Risk of Third Party
Claims of Infringement."
WARRANTY EXPOSURE
Products offered by the Company may contain defects in hardware, firmware
or workmanship that may remain undetected or that may not become apparent until
after commercial shipment. The Company generally provides a standard three year
warranty on its products. This standard warranty contains a limit on damages and
an exclusion of liability for consequential damages and for negligent or
improper use of the product. The Company establishes a reserve, at the time of
product shipment, in an amount equal to its estimated warranty expenses. The
Company had warranty reserves of $22.7 million and $26.2 million as of December
27, 1997 and June 27, 1998, respectively. While the Company believes that its
warranty reserves will be sufficient to cover its warranty expenses, there can
be no assurance that such reserves will be sufficient or that the limitations on
liability contained in the Company's warranty will be enforceable. The Company's
failure to maintain sufficient warranty reserves or the unenforceability of such
liability limitations could have a material adverse effect on the Company's
business, financial condition and results of operations.
ENVIRONMENTAL MATTERS
Although the Company uses only a limited variety of chemicals in its
manufacturing and research operations, the Company is still subject to a wide
range of environmental protection regulations in the U.S. and Singapore. While
the Company has not experienced any material adverse effect on its operations as
a result of such laws, there can be no assurance that future regulations would
not have a material adverse effect on the Company's business, financial
condition and results of operations. The Company believes that its activities
conform to all present environmental regulations in all material aspects. In the
U.S., environmental regulations often require parties to fund remedial action
regardless of fault. As a consequence, it is often difficult to estimate the
future impact of environmental matters, including potential liabilities. There
can be no assurance that the amount of capital expenditures and other expenses
which might be required to complete remedial actions and to continue to comply
with applicable environmental laws will not have a material adverse effect on
the Company's business, financial condition and results of operations.
EXPECTED VOLATILITY OF STOCK PRICE
In recent years the stock market in general, and the market for shares of
high technology and HDD companies in particular, have experienced extreme price
fluctuations which have often been unrelated to the operating performance of
the affected companies. The trading price of the Common Stock may be subject to
extreme fluctuations both in response to business-related issues (e.g.,
quarterly fluctuations in operating results, announcements of new products by
the Company or its competitors, and the gain or loss of significant PC OEM or
other customers) and in response to stock market-related influences (e.g.,
changes in analysts' estimates, the presence or absence of short-selling of the
Common Stock and events affecting other companies that the market deems
comparable to the Company). The trading price of the Common Stock also may be
affected by events relating to HEA and HEI, including sales of Common Stock by
HEA or the perception that such sales may occur (due to the financial condition
of HEA or otherwise). Further, the trading price of the Common Stock may be
subject to extreme fluctuations in response to general economic conditions in
the U.S., Korea, Southeast Asia and elsewhere, such as interest rates,
inflation rates, exchange rates, unemployment rates, and trade surpluses and
deficits.
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EFFECT OF ANTITAKEOVER PROVISIONS
The Company is subject to the provisions of Section 203 of the Delaware
General Corporation Law ("Section 203"), which prohibits a publicly held
Delaware corporation from engaging in any "business combination" with an
"interested stockholder" for three years following the date that such
stockholder became an interested stockholder, unless: (i) prior to such date,
the corporation's board of directors approved either the business combination or
the transaction that resulted in the stockholder becoming an interested
stockholder; (ii) upon consummation of the transaction that resulted in the
stockholder becoming an interested stockholder, the interested stockholder owned
at least 85% of the voting stock of the corporation outstanding at the time the
transaction commenced (excluding shares owned by management directors and
certain employee stock plans); or (iii) on or subsequent to such date, the
business combination is approved by the corporation's board of directors and
authorized at an annual or special meeting of stockholders, and not by written
consent, by the affirmative vote of at least two-thirds of the outstanding
voting stock not owned by the interested stockholder. Generally, a "business
combination" includes a merger, asset or stock sale, or other transaction
resulting in a financial benefit to the interested stockholder. An "interested
stockholder" is a person who, together with affiliates and associates, owns, or
within three years prior did own, 15% or more of the corporation's voting stock.
In addition, pursuant to the Amended and Restated Certificate of
Incorporation, the Board has authority to issue up to 95 million shares of
preferred stock and to fix the rights, preferences, privileges and restrictions,
including voting rights, of these shares without any further vote or action by
the stockholders. The rights of the holders of the Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any preferred
stock that may be issued in the future. The issuance of preferred stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could have the effect of making it more difficult for
a third party to acquire a majority of the outstanding voting stock of the
Company, thereby delaying, deferring or preventing a change in control of the
Company. Furthermore, such preferred stock may have other rights, including
economic rights, senior to the Common Stock, and as a result, the issuance of
such preferred stock could have a material adverse effect on the market price of
the Common Stock. The Company has no present plan to issue shares of preferred
stock.
The Amended and Restated Certificate of Incorporation provides that the
Board will be divided into three classes of directors serving staggered
three-year terms. As a result, only one of the three classes of the Board will
be elected each year. The directors are removable only for cause upon the
affirmative vote of the holders of at least a majority of the voting power of
all outstanding shares of voting stock, voting as a single class. The Board has
the exclusive right to set the authorized number of directors and to fill
vacancies on the Board. The Amended and Restated Certificate of Incorporation
requires that any action required or permitted to be taken by stockholders of
the Company must be effected at a duly called annual or special meeting of the
stockholders and may not be effected by a consent in writing. In addition,
special meetings of the stockholders of the Company may be called only by the
Board, the Chairman of the Board, or the Chief Executive Officer of the Company.
Advance notice is required for stockholder proposals or director nominations by
stockholders. These provisions may be amended only by the affirmative vote of at
least two-thirds of the outstanding voting stock of the Company, voting as a
single class. In addition, the Company has entered into a Stockholder Agreement
with HEA which grants HEA certain rights to designate directors for nomination,
requires HEA to vote in favor of other Board nominees so long as HEA's rights to
designate nominees are honored, and restricts HEA's right to solicit proxies or
acquire additional shares of Common Stock.
These provisions could discourage potential acquisition proposals and could
delay or prevent a change in control of the Company. Such provisions could
diminish the opportunities for a holder of Common Stock to participate in tender
offers, including tender offers at a price above the then current market price
of the Common Stock. Such provisions also may inhibit fluctuations in the market
price of the Common Stock that could result from takeover attempts.
32
<PAGE> 33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
STORMEDIA LITIGATION
(PLEASE REFER TO NOTE 3 TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS - CONTINGENCIES)
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(SEE INDEX TO EXHIBITS ON PAGE 20 OF THIS REPORT.)
There were no reports field on Form 8-K during the reporting period ended June
28, 1998.
ITEMS 2, 3, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
33
<PAGE> 34
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
MAXTOR CORPORATION
By /s/ Paul J. Tufano
---------------------------
Paul J. Tufano
Vice President, Finance and
Chief Financial Officer
Date: August 11, 1998
34
<PAGE> 35
INDEX TO EXHIBITS
Sequentially
Exhibit No Description Numbered Pages
- --------------------------------------------------------------------------------
10.163 (40) Intercompany Loan Agreement, dated as of
April 10, 1997, between Maxtor Corporation
and Hyundai Electronics America
10.164 (41) Debt Payment and Stock Purchase Agreement,
dated as of December 12, 1997, between Maxtor
Corporation and Hyundai Electronics America
10.165 (41) Amendment to August 29, 1996 364-Day Credit
Agreement, dated August 27, 1997, among
Maxtor Corporation, Citibank, N.A. and
Syndicate Banks
10.166 (41) Amended and Restated 1996 Stock Option Plan,
effective October 1, 1997
27 Financial Data Schedule
- --------------------------------------------------------------------------------
(40) Incorporated by reference to exhibits of Form 10-Q filed May 12, 1997
(41) Incorporated by reference to exhibits of Form 10-K filed April 10, 1998
35
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-26-1998
<PERIOD-START> DEC-27-1997
<PERIOD-END> JUN-27-1998
<CASH> 15,010
<SECURITIES> 0
<RECEIVABLES> 227,922
<ALLOWANCES> 5,652
<INVENTORY> 162,954
<CURRENT-ASSETS> 435,211
<PP&E> 286,396
<DEPRECIATION> 184,025
<TOTAL-ASSETS> 545,649
<CURRENT-LIABILITIES> 541,015
<BONDS> 95,000
0
880
<COMMON> 0
<OTHER-SE> (214,680)<F1>
<TOTAL-LIABILITY-AND-EQUITY> 545,649
<SALES> 1,080,882
<TOTAL-REVENUES> 1,080,882
<CGS> 956,151
<TOTAL-COSTS> 956,151
<OTHER-EXPENSES> 114,319<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 17,536
<INCOME-PRETAX> (4,725)
<INCOME-TAX> 178
<INCOME-CONTINUING> (4,903)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,903)
<EPS-PRIMARY> (202.72)
<EPS-DILUTED> (202.72)
<FN>
<F1>OTHER SE INCLUDES ADDITIONAL PAID-IN CAPITAL OF $538,254 UNREALIZED GAIN ON
INVESTMENTS IN EQUITY SECURITIES OF $24,922 AND ACCUMULATED DEFICIT OF
$777,856.
<F2>OTHER EXPENSES INCLUDE RESEARCH AND DEVELOPMENT OF $70,096 AND SELLING, GENERAL
AND ADMINISTRATIVE COSTS OF $34,315, AND STOCK COMPENSATION EXPENSE OF $9,908.
</FN>
</TABLE>
