UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended June 28, 1998
Commission File Number 0-16852
KOMAG, INCORPORATED
(Registrant)
Incorporated in the State of Delaware
I.R.S. Employer Identification Number 94-2914864
1704 Automation Parkway, San Jose, California 95131
Telephone: (408) 576-2000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
On June 28, 1998, 53,444,282 shares of the Registrant's common stock, $0.01
par value, were issued and outstanding.
<PAGE>
Part 1. Financial Information
Item 1. Financial Statements
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------- -------------------
June 28, June 29, June 28, June 29,
1998 1997 1998 1997
--------- --------- --------- --------
<S> <C> <C> <C> <C>
Net sales $78,808 $175,121 $154,865 $342,363
Cost of sales 114,445 139,460 222,097 267,387
--------- --------- --------- --------
GROSS PROFIT (LOSS) (35,637) 35,661 (67,232) 74,976
Operating expenses:
Research, development and engineering 18,085 11,326 33,029 23,339
Selling, general and administrative 4,942 7,605 9,553 17,750
Restructuring charge 187,768 - 187,768 -
--------- --------- --------- --------
210,795 18,931 230,350 41,089
--------- --------- --------- --------
OPERATING INCOME (LOSS) (246,432) 16,730 (297,582) 33,887
Other income (expense):
Interest income 2,381 1,429 4,933 2,614
Interest expense (4,755) (2,505) (9,309) (3,972)
Other, net (409) (83) 3,914 604
--------- --------- --------- --------
(2,783) (1,159) (462) (754)
--------- --------- --------- --------
Income (loss) before income taxes,
minority interest, and equity in --------- --------- --------- --------
joint venture income (loss) (249,215) 15,571 (298,044) 33,133
Provision for income taxes 703 2,647 703 5,633
--------- --------- --------- --------
Income (loss) before minority interest
and equity in joint venture income
(loss) (249,918) 12,924 (298,747) 27,500
Minority interest in net income of
consolidated subsidiary 592 187 497 369
Equity in net income (loss) of
unconsolidated joint venture (11,374) (1,060) (20,798) 2,345
--------- --------- --------- --------
NET INCOME (LOSS) ($261,884) $11,677 ($320,042) $29,476
========= ========= ========= ========
Basic income (loss) per share ($4.95) $0.22 ($6.05) $0.57
========= ========= ========= ========
Diluted income (loss) per share ($4.95) $0.22 ($6.05) $0.55
========= ========= ========= ========
Number of shares used in basic
computation 52,916 52,060 52,866 51,948
========= ========= ========= ========
Number of shares used in
diluted computation 52,916 53,862 52,866 53,844
========= ========= ========= ========
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
KOMAG, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<TABLE>
<CAPTION>
June 28, December 28,
1998 1997
--------- ---------
(unaudited) (note)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents $79,228 $133,897
Short-term investments 70,600 32,300
Accounts receivable less allowances of
$2,621 in 1998 and $4,424 in 1997 32,928 77,792
Accounts receivable from related parties 109 4,106
Inventories:
Raw materials 27,519 33,730
Work-in-process 14,987 17,490
Finished goods 7,999 15,558
--------- ---------
Total inventories 50,505 66,778
Prepaid expenses and deposits 2,690 3,697
Income taxes receivable 2,397 24,524
Deferred income taxes 28,595 28,595
--------- ---------
Total current assets 267,052 371,689
Investment in Unconsolidated Joint Venture 6,775 30,126
Property, Plant and Equipment
Land 7,785 9,526
Building 124,621 126,405
Equipment 694,920 793,561
Furniture 10,762 11,791
Leasehold improvements 83,465 141,111
--------- ---------
921,553 1,082,394
Less allowances for depreciation and
amortization (416,333) (403,798)
--------- ---------
Net property, plant and equipment 505,220 678,596
Deposits and Other Assets 3,839 4,253
--------- ---------
$782,886 $1,084,664
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt $260,000 $ -
Trade accounts payable 31,347 40,043
Accounts payable to related parties 4,659 7,093
Accrued compensation and benefits 15,449 13,596
Other liabilities 6,629 3,605
Restructuring liability 19,032 11,253
--------- ---------
Total current liabilities 337,116 75,590
Long-term Debt, Less Current Portion - 245,000
Deferred Income Taxes 73,335 73,335
Other Long-term Liabilities 1,176 960
Minority Interest in Consolidated Subsidiary 4,092 3,595
Stockholders' Equity
Preferred stock - -
Common stock 534 528
Additional paid-in capital 405,448 401,869
Retained earnings (deficit) (38,566) 281,476
Accumulated foreign currency translation
adjustments (249) 2,311
--------- ---------
Total stockholders' equity 367,167 686,184
--------- ---------
$782,886 $1,084,664
========= =========
<FN>
Note: The balance sheet at December 28, 1997 has been derived from the
audited financial statements at that date.
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
----------------------
June 28, June 29,
1998 1997
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ($320,042) $29,476
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 68,496 59,172
Provision for losses on accounts receivable (1,320) 860
Equity in net (income) loss of unconsolidated
joint venture 20,798 (2,345)
(Gain) Loss on disposal of property,
plant and equipment (1,116) 1,149
Impairment charge related to property,
plant and equipment 175,000 -
Deferred rent 216 249
Minority interest in net income of
consolidated subsidiary 497 369
Changes in operating assets and liabilities:
Accounts receivable 46,184 (24,950)
Accounts receivable from related parties 3,997 (3,882)
Inventories 16,273 (5,407)
Prepaid expenses and deposits 1,000 (2,422)
Trade accounts payable (8,696) (34,006)
Accounts payable to related parties (2,434) 1,552
Accrued compensation and benefits 1,853 (1,060)
Other liabilities 2,971 2,832
Income taxes receivable 22,180 14,442
Restructuring liability 7,779 -
--------- ---------
Net cash provided by operating activities 33,636 36,029
INVESTING ACTIVITIES
Acquisition of property, plant and equipment (74,329) (125,198)
Purchases of short-term investments (38,300) (29,685)
Proceeds from disposal of property, plant and
equipment 5,325 470
Deposits and other assets 414 (528)
Dividend distribution from unconsolidated
joint venture - 1,535
--------- ---------
Net cash used in investing activities (106,890) (153,406)
FINANCING ACTIVITIES
Increase in long-term obligations 15,000 75,000
Sale of Common Stock, net of issuance costs 3,585 7,429
--------- ---------
Net cash provided by financing activities 18,585 82,429
Decrease in cash and cash equivalents (54,669) (34,948)
Cash and cash equivalents at beginning of year 133,897 90,741
--------- ---------
Cash and cash equivalents at end of period $79,228 $55,793
========= =========
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
<PAGE>
KOMAG, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 28, 1998
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete
financial statements. In the opinion of Management, all adjustments
(consisting of normal recurring accruals and the writedown of long-
lived assets to reflect the impairment of those assets) considered
necessary for a fair presentation have been included. Operating
results for the three- and six-month periods ended June 28, 1998 are
not necessarily indicative of the results that may be expected for
the year ending January 3, 1999.
For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 28, 1997 and Form 10-
Q for the quarter ended March 29, 1998.
The Company uses a 52-53 week fiscal year ending on the Sunday
closest to December 31. The three- and six-month reporting periods
for the comparable years included in this report are comprised of
thirteen and twenty-six weeks, respectively.
NOTE 2 - INVESTMENT IN DEBT SECURITIES
The Company invests its excess cash in high-quality, short-term
debt and equity instruments. None of the Company's investments in
debt securities have maturities greater than one year. The following
is a summary of the Company's investments by major security type at
amortized cost which approximates fair value:
June 28, December 28,
1998 1997
(in thousands) --------- ----------
Corporate debt securities $30,141 $56,837
Mortgage-backed securities 49,793 79,419
Municipal auction rate preferred stock 70,600 32,300
--------- ----------
$150,534 $168,556
========= ==========
Amounts included in cash and cash equivalents $79,934 $136,256
Amounts included in short-term investments 70,600 32,300
--------- ----------
$150,534 $168,556
========= ==========
The Company utilizes zero-balance accounts and other cash
management tools to invest all available funds including bank
balances in excess of book balances.
NOTE 3 - INCOME TAXES
The Company's income tax provision of $0.7 million for the first
half of 1998 represents income taxes on certain transactions exempt
from the various tax holidays in effect at the Company's Malaysian
operations. No additional income tax provision or benefit has been
recorded in the first half of 1998 due to a projected 1998 pre-tax
loss at the Company's U.S. operations and the effect of the tax
holidays and investment allowances at the Malaysian operations. In
the first half of 1997, the Company recorded a 17% estimated tax
rate. The estimated tax rate at the end of the first half of 1997
anticipated taxable income in fiscal year 1997 for the Company's U.S.
operations and the effect of tax holidays at the Company's Malaysian
operations. In the third quarter of 1997, the Company revised its
tax rate estimate in anticipation of a loss for fiscal year 1997 and
recorded a tax benefit representing the utilization of available loss
carrybacks associated with its U.S. operations. No additional
utilization of loss carrybacks is available for the U.S. operations.
The Company's wholly-owned thin-film media operation, Komag USA
(Malaysia) Sdn. ("KMS"), has operated under an initial five-year tax
holiday for its first plant site. This five-year tax holiday expired
in July 1998 and is currently under application for extension for an
additional five-year period by the Malaysian government. KMS has
also been granted a ten-year tax holiday for its second and third
plant sites in Malaysia. The commencement date for this new tax
holiday has not been determined as of July 20, 1998.
NOTE 4 - TERM DEBT AND LINES OF CREDIT
The Company's credit facilities total $345,000,000 and are
comprised of five agreements: a five-year term loan that expires in
2002, two separate revolving line of credit agreements that expire in
2002 and two separate four-year revolving line of credit agreements
that expire in 1999 and 2000. None of these credit facilities is
secured by any of the assets of the Company. The size of the
Company's second quarter net loss has resulted in a default under
certain financial covenants contained in the Company's various bank
credit facilities. The Company is not in payment default under any
of these facilities. The Company currently has $260,000,000 of bank
borrowings outstanding. The remaining $85,000,000 of unutilized
credit is currently unavailable due to the technical default. The
Company's borrowing capacity is subject to the successful re-
negotiation of the terms of these agreements and/or the negotiation
of new financing arrangements.
As a result of the technical default, the $260,000,000
outstanding under the Company's credit facilities has been
reclassified to current liabilities on the accompanying consolidated
balance sheet.
NOTE 5 - COMPREHENSIVE INCOME (LOSS)
As of the beginning of fiscal year 1998, the Company has adopted
Statement of Financial Accounting Standards No. 130 ("SFAS 130"),
"Reporting Comprehensive Income." SFAS 130 establishes new rules for
the reporting and display of comprehensive income and its components;
however, the adoption of this statement had no impact on the
Company's net income (loss) or stockholders' equity. SFAS 130
requires the Company's foreign currency translation adjustments,
which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive income (loss).
The following are the components of comprehensive income (loss):
Three Months Ended Six Months Ended
-------------------- --------------------
June 28, June 29, June 28, June 29,
1998 1997 1998 1997
(in thousands) --------- --------- --------- ---------
Net income (loss) ($261,884) $11,677 ($320,042) $29,476
Foreign currency translation
adjustments (633) 2,506 (2,560) 950
--------- --------- --------- ---------
Comprehensive income (loss) ($262,517) $14,183 ($322,602) $30,426
========= ========= ========= =========
Accumulated foreign currency translation adjustments on the
accompanying Consolidated Balance Sheets account for all of the
Company's accumulated other comprehensive income (loss) at June 28,
1998 and December 28, 1997.
NOTE 6 - RESTRUCTURING LIABILITY
In the middle of the second quarter of 1998 several customers
reduced orders for the Company's products in response to downward
adjustments in their disk drive production build schedules. In light
of the order reductions and the Company's expectation that the media
industry's supply/demand imbalance will extend into 1999, the Company
adjusted its expectations for the utilization of its installed
production capacity. As a result of this evaluation, the Company
implemented a restructuring plan in June 1998 and recorded a charge
of $187.8 million. This one-time charge included an asset impairment
charge and provisions for facility closure expenses and severance-
related costs. The cash component of the total charge was $12.8
million. The Company will cease operations at its oldest San Jose,
California plant before the expiration of the building lease in July
1999 and reduce its U.S. and Malaysian workforce by approximately
10%. The restructuring charge included $4.1 million for severance
costs associated with approximately 170 terminated employees,
primarily in the U.S. Additional employees will be terminated in the
last half of 1998 through the continuation of a reduction in force
program and attrition. The restructuring charge also included $5.8
million related to equipment order cancellations and other equipment
related costs, and $2.9 million for facility closure costs. The
asset impairment component of the charge was $175.0 million and
effectively reduced asset valuations to reflect the economic effect
of recent industry price erosion for disk media and the projected
underutilization of the Company's production equipment and
facilities. Production equipment and leasehold improvements at the
Company's U.S. and Malaysian facilities with a net book value of
$562.8 million were written down to their fair value as a result of
the impairment. The fair value of these assets was determined based
upon the estimated future cash flows to be generated by the assets,
discounted at a market rate of interest. Non-cash items in the
restructuring/impairment charge totaled $175.0 million. At
June 28, 1998, $10.5 million related to the 1998 restructuring
activities remained in current liabilities. The Company has
made cash payments totaling approximately $2.3 million primarily
for severance and equipment-related costs. The majority
of the remaining 1998 restructuring liability, primarily
related to equipment and facility closure-related costs, is
expected to be settled by the first half of 1999.
During the third quarter of 1997, the Company implemented a
restructuring plan based on an evaluation of the size and location of
its existing production capacity relative to the short-term market
demand outlook. Under the 1997 restructuring plan, the Company
consolidated its U.S. manufacturing operations onto its new campus in
San Jose, California and closed two older factories in Milpitas,
California. The first of the two Milpitas factories was closed at
the end of the third quarter of 1997 and the second factory was
closed in January 1998. The 1997 restructuring actions resulted in a
charge of $52.2 million and included reducing headcount, vacating
leased facilities, consolidating operations and disposing of assets.
The restructuring charge included $3.9 million for severance costs
associated with approximately 330 terminated employees, $33.0 million
for the write-down of the net book value of equipment and leasehold
improvements, $10.1 million related to equipment order cancellations
and other equipment-related costs, and $5.2 million for facility
closure costs. Non-cash items included in the restructuring charge
totaled approximately $33.0 million. At June 28, 1998, $8.5 million
related to the restructuring activities remained in current
liabilities. The Company has made cash payments totaling
approximately $10.7 million primarily for severance and equipment-
related costs. The majority of the remaining restructuring liability,
primarily related to equipment order cancellations and facility
closure costs, is expected to be settled in 1998.
Over time the Company expects that its Malaysian manufacturing
operations will account for an increasing portion of the Company's
production output. These facilities are closer to customers' disk
drive assembly plants in Southeast Asia and enjoy certain cost
advantages over the Company's U.S. manufacturing facilities.
NOTE 7 - STOCKHOLDERS' EQUITY
In June 1998, the Company's Board of Directors adopted, subject
to stockholder approval at a Special Meeting of Stockholders to be
held July 22, 1998, a proposal to amend the Company's Restated
Certificate of Incorporation. Stockholder approval, if received,
will increase the amount of Common Stock the Company is authorized to
issue from 85,000,000 to 150,000,000 shares.
The Company is also seeking authorization from stockholders at
the Special Meeting to sell and issue up to $350,000,000 of Common
Stock in equity or equity-linked private transactions from time to
time during the next twelve months at a price below book value but at
or above the then current market value of the Company's Common Stock.
NOTE 8 - STOCK OPTION PLAN REPRICING
In June 1998, the Company's Board of Directors authorized the
repricing of outstanding stock options held by all employees,
including executive officers, to the current market price of the
Common Stock. Options held by nonemployee directors were not
repriced. Immediately prior to the repricing, the Company's
employees, including executive officers, held options to purchase
approximately 8.5 million shares of Common Stock at exercise prices
ranging from $7.06 to $34.13 per share. The weighted average
exercise price of these options was approximately $15.19 per share.
Approximately 7.7 million shares were repriced to $5.35 per share on
July 1, 1998.
NOTE 9 - EARNINGS (LOSS) PER SHARE
In 1997, the Financial Accounting Standards Board issued
Statement No. 128 (FAS 128), "Earnings per Share", which the Company
adopted for its fiscal year ending December 28, 1997. FAS 128
replaced the calculation for primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share excludes any dilutive
effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported primary
earnings per share. Earnings per share amounts for all periods
presented have been restated to conform to FAS 128 requirements.
Three Months Ended Six Months Ended
-------------------- --------------------
June 28, June 29, June 28, June 29,
1998 1997 1998 1997
--------- --------- --------- ---------
(in thousands, except per share amounts)
Numerator: Net income (loss) ($261,884) $11,677 ($320,042) $29,476
--------- --------- --------- ---------
Denominator for basic
income (loss) per share-
weighted-average shares 52,916 52,060 52,866 51,948
--------- --------- --------- ---------
Effect of dilutive securities:
Employee stock options - 1,802 - 1,896
--------- --------- --------- ---------
Denominator for diluted
income (loss) per share 52,916 53,862 52,866 53,844
--------- --------- --------- ---------
Basic income (loss) per share ($4.95) $0.22 ($6.05) $0.57
--------- --------- --------- ---------
Diluted income (loss) per share ($4.95) $0.22 ($6.05) $0.55
========= ========= ========= =========
NOTE 10 - USE OF ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could
differ from those estimates.
<PAGE>
KOMAG, INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations:
The following discussion contains predictions, estimates and other
forward-looking statements that involve a number of risks and
uncertainties. While this outlook represents the Company's current
judgment on the future direction of the business, such risks and
uncertainties could cause actual results to differ materially from any
future performance suggested herein. Factors that could cause actual
results to differ include the following: availability of sufficient cash
resources; changes in the industry supply-demand relationship and
related pricing for enterprise and desktop disk products; timely and
successful product qualification of next-generation products; timely and
successful deployment of new process technologies into manufacturing;
utilization of manufacturing facilities; changes in manufacturing
efficiencies, in particular product yields; extensibility of process
equipment to meet more stringent future product requirements; vertical
integration and consolidation within the Company's limited customer
base; increased competition; structural changes within the disk media
industry such as combinations, failures, and joint venture arrangements;
availability of certain sole-sourced raw material supplies; and the risk
factors listed in the Company's other SEC filings, including its Form
10-K for the fiscal year ended December 28, 1997 filed in March 1998.
The Company undertakes no obligation to publicly release the result of
any revisions to these forward-looking statements which may be made to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
Overview
Operating results for the first half of 1998 were significantly
lower than the first half of 1997. Adverse market conditions, which
began late in the second quarter of 1997, intensified in the first half
of 1998. Late in the second quarter of 1997, demand for thin-film media
products fell abruptly as an excess supply of enterprise-class disk
drives caused drive manufacturers to reduce build plans for this class
of drives. The decrease in demand for enterprise-class media, combined
with a major expansion of media production capacity at both independent
media suppliers and captive media operations of disk drive
manufacturers, resulted in an excess supply of enterprise-class media.
Orders for the Company's enterprise-class media products were reduced in
the third quarter of 1997 as drive manufacturers reduced drive
production and relied more heavily on their own captive media
operations. Net sales decreased sharply to $129.7 million in the third
quarter of 1997, down sequentially from $175.1 million in the second quarter
of 1997. The gross margin percentage fell to 0.2% in the third quarter
of 1997, down from 20.4% in the second quarter of 1997. Net sales and
the gross margin percentage improved to $159.0 million and 11.6%,
respectively, for the fourth quarter of 1997.
In December 1997, several disk drive manufacturers initiated
cutbacks in their desktop product manufacturing plans for early 1998 in
response to supply and demand imbalances within that industry segment.
Weakened demand for desktop media products, combined with the continuing
slow recovery of the enterprise-class market segment, lowered media
demand at independent media suppliers as captive media operations
supplied a larger share of the industry's media requirements. The
resulting excess supply of media heightened price competition among
independent media suppliers. Net sales in the first quarter of 1998
dropped 52% sequentially to $76.1 million as a result of both a lower
unit sales volume and a decrease of approximately 10% in the overall
average selling price for the Company's products. Low utilization of
the Company's factories during the first quarter of 1998 pushed unit
production costs up substantially as fixed costs were spread over fewer
production units. The combination of the lower overall average selling
price and significantly higher average unit production cost resulted in
a negative gross margin percentage of 41.5% for the first quarter of
1998.
The second quarter of 1998 was negatively impacted by the
continuation of weak merchant market demand for disk media. Net sales
in the second quarter of 1998 increased slightly on a sequential basis
to $78.8 million, the net effect of an 9% increase in unit sales volume
and a 5% decrease in the overall average selling price. The
combination of the lower overall average selling price, increased
inventory writedowns and continued low production volumes resulted in a
negative gross margin percentage of 45.2% in the second quarter of 1998.
Entering the second quarter of 1998, the Company had expected that
net sales for the second quarter would increase sequentially to $100-
$125 million. In the middle of the second quarter several customers
reduced orders for the Company's products in response to downward
adjustments in their disk drive production build schedules. In light of
the order reductions and the Company's expectation that the media
industry's supply/demand imbalance will extend into 1999, the Company
adjusted its expectations for the utilization of its installed
production capacity. As a result of this evaluation, the Company
implemented a restructuring plan in June 1998 and recorded a charge of
$187.8 million. This one-time charge included an asset impairment charge
and provisions for facility closure expenses and severance-related
costs. The asset impairment component of the one-time charge was $175.0
million and effectively reduced asset valuations to reflect the economic
effect of recent industry price erosion for disk media and the projected
underutilization of the Company's production equipment and facilities.
The Company will also cease operations at its oldest San Jose,
California manufacturing facility before expiration of the building
lease in July 1999 and reduce its U.S. and Malaysian workforce by
approximately 10%.
Revenue
Net sales decreased 55% in the second quarter of 1998 relative to
the second quarter of 1997. The year-over-year decrease was due to a
combination of a 46% decrease in unit sales volume and an 18% decrease
in the overall average selling price. Second quarter 1998 unit sales
declined to 7.8 million disks from a record 14.5 million disks in the
second quarter of 1997. The majority of the decrease in the overall
average selling price occurred between the fourth quarter of 1997 and
the second quarter of 1998 due to the adverse market conditions for both
desktop and enterprise-class media products discussed above. Price
reductions are common on individual product offerings in the thin-film
media industry. The Company has traditionally prevented significant
reductions in its overall average selling price through transitions to
higher-priced, more technologically advanced product offerings. In the
second quarter of 1998, the effect of significant pricing pressures
generated by the imbalance in supply and demand for thin-film media more
than offset the effect of transitions to more advanced product
offerings. Net sales in the first half of 1998 also decreased 55%
relative to the first half of 1997. Percentage decreases in unit sales
volumes and the overall average selling price were comparable to those
percentage decreases discussed in the quarterly comparison.
In addition to sales of internally produced disk products, the
Company has historically resold products manufactured by its Japanese
joint venture, Asahi Komag Co., Ltd. (AKCL). Distribution sales of
thin-film media manufactured by AKCL were negligible in both the second
quarter of 1998 and second quarter of 1997. Distribution sales in the
first half of 1998 were $2.4 million compared to $2.7 million in the
first half of 1997. The Company expects that distribution sales of AKCL
product will be relatively low throughout 1998.
During the second quarter of 1998 four customers accounted for
approximately 97% of consolidated net sales: Western Digital Corporation
(40%), International Business Machines (25%), Maxtor Corporation (21%),
and Seagate Technologies, Inc. (11%). The Company expects that it will
continue to derive a substantial portion of its sales from relatively
few customers. The distribution of sales among customers may vary from
quarter to quarter based on the match of the Company's product
capabilities with specific disk drive programs of the customers.
Gross Margin
The Company incurred a negative gross margin percentage of 45.2%
in the second quarter of 1998 compared to a gross margin of 20.4% in the
second quarter of 1997. The Company incurred a negative gross margin
percentage of 43.4% in the first half of 1998 compared to a gross margin
of 21.9% in the first half of 1997. The combination of the lower
overall average selling price, higher unit production costs related to
underutilized capacity, and higher inventory writedowns resulted in the
negative gross margin percentages for the second quarter and first half
of 1998.
Unit production decreased to 8.9 million disks in the second
quarter of 1998 from 14.8 million disks in the second quarter of 1997.
Unit production decreased to 15.4 million disks in the first half of
1998 from 28.4 million units in the first half of 1997. The Company
operated well below capacity in the three- and six-month periods of 1998
in order to match unit production to the sharply lower demand for its
products.
Operating Expenses
Research and development ("R&D") expenses increased 59.7% ($6.8
million) and 41.5% ($9.7 million) in the three-and six-month periods of
1998 relative to the comparable periods of 1997. Increased R&D
staffing, higher facility and equipment costs, and additional operating
supplies accounted for most of the increase in both the three-and six-
month comparisons. The additional R&D efforts were directed toward the
introduction of new product generations, process changes to manufacture
such products, process improvements to increase yields of products
currently in volume production, and increased development efforts to
qualify new products and reflects the Company's commitment to innovation
notwithstanding the Company's recent financial difficulties.
Selling, general and administrative ("SG&A") expenses decreased
approximately 35.0% ($2.7 million) in the second quarter of 1998
relative to the second quarter of 1997. Lower provisions for bonus and
profit sharing programs (decrease of $1.5 million) and lower provisions
for bad debt (decrease of $0.3 million) resulted in the majority of the
overall decrease in SG&A expenses between the quarters. Excluding
provisions for bonus and profit sharing programs and provisions for bad
debt, SG&A expenses decreased $0.9 million. The lower spending was
primarily due to the combination of decreased payroll and facility
costs. SG&A expenses decreased 46.2% ($8.2 million) in the first half of
1998 compared to the first half of 1997 primarily due to a $4.7 million
reduction in bonus and profit sharing provisions. Provisions for bad
debt decreased $2.2 million in the first half of 1998 compared to the
first half of 1997 due to a lower accounts receivable balance in the
current year period. Excluding provisions for bonus and profit sharing
programs and provisions for bad debt, SG&A expenses decreased $1.3
million due mainly to the lower payroll and facility costs.
In the second quarter of 1998 the Company recorded a
restructuring/impairment charge totaling $187.8 million. The cash
component of the total charge was $12.8 million. The Company will cease
operations at its oldest San Jose, California plant before the
expiration of the building lease in July 1999 and reduce its U.S. and
Malaysian workforce by approximately 10%. The restructuring charge
included $4.1 million for severance costs associated with approximately
170 terminated employees, primarily in the U.S. Additional employees
will be terminated in the last half of 1998 through the continuation of
a reduction in force program and attrition. The restructuring charge
included $5.8 million related to equipment order cancellations and other
equipment related costs, and $2.9 million for facility closure costs. The
asset impairment component of the charge was $175.0 million and effectively
reduced asset valuations to reflect the economic effect of recent industry
price erosion for disk media and the projected underutilization of the
Company's production equipment and facilities. Production equipment and
leasehold improvements at the Company's U.S. and Malaysian facilities
with a net book value of $562.8 million were written down to their fair
value as a result of the impairment. The fair value of these assets was
determined based upon the estimated future cash flows to be generated by
the assets, discounted at a market rate of interest. Non-cash items in
the restructuring/impairment charge totaled $175.0 million. At June 28,
1998, $10.5 million related to the 1998 restructuring activities
remained in current liabilities. The Company has made cash payments
totaling approximately $2.3 million primarily for severance and
equipment-related costs. The majority of the remaining 1998
restructuring liability, primarily related to equipment and facility
closure-related costs, is expected to be settled by the first half of
1999.
In the third quarter of 1997, the Company implemented a
restructuring plan involving the consolidation of its U.S. manufacturing
operations and recorded a restructuring charge of $52.2 million. The
restructuring charge included $3.9 million for severance costs
associated with approximately 330 terminated employees, $33.0 million
for the write down of the net book value of equipment and leasehold
improvements, $10.1 million related to equipment order cancellations and
other equipment-related costs, and $5.2 million for facility closure
costs. Non-cash items included in the restructuring charge totaled
approximately $33.0 million. At June 28, 1998, $8.5 million related to
the 1997 restructuring activities remained in current liabilities. The
Company has made cash payments totaling approximately $10.7 million
primarily for severance and equipment-related costs. The majority of
the remaining 1997 restructuring liability, primarily related to
equipment order cancellations and facility closure costs, is expected to
be settled by the end of 1998.
Interest and Other Income/Expense
Interest income increased $1.0 million in the second quarter of
1998 relative to the second quarter of 1997 and $2.3 million in the
first half of 1998 relative to the first half of 1997. The increases
were due to higher average cash and short-term investment balances in
the current year periods. Interest expense increased $2.3 million in
the second quarter of 1998 compared to the second quarter of 1997 and
$5.3 million in the first half of 1998 compared to the first half of
1997. The higher interest expense was due to higher outstanding debt
balances in the 1998 periods. The Company borrowed $190.0 million under
its credit facilities between March 1997 and January 1998. Other
expense increased $0.3 million in the second quarter of 1998 compared to
the second quarter of 1997. Other income increased $3.3 million in the
first half of 1998 relative to the first half of 1997. This was
primarily due to a $3.1 million gain on the sale of vacant land located
in Milpitas, California.
Income Taxes
The Company's income tax provision of $0.7 million for the first
half of 1998 represents income taxes on certain transactions exempt from
the various tax holidays in effect at the Company's Malaysian
operations. No additional income tax provision or benefit has been
recorded in the first half of 1998 due to a projected 1998 pre-tax loss
at the Company's U.S. operations and the effect of the tax holidays and
investment allowances at the Malaysian operations. In the first half of
1997, the Company recorded a 17% estimated tax rate. The estimated tax
rate at the end of the first half of 1997 anticipated taxable income in
fiscal year 1997 for the Company's U.S. operations and the effect of tax
holidays at the Company's Malaysian operations. In the third quarter of
1997, the Company revised its tax rate estimate in anticipation of a
loss for fiscal year 1997 and recorded a tax benefit representing the
utilization of available loss carrybacks associated with its U.S.
operations. No additional utilization of loss carrybacks is available
for the U.S. operations.
The Company's wholly-owned thin-film media operation, Komag USA
(Malaysia) Sdn. ("KMS"), has operated under an initial five-year tax
holiday for its first plant site. This five-year tax holiday expired in
July 1998 and is currently under application for extension for an
additional five-year period by the Malaysian government. KMS has also
been granted a ten-year tax holiday for its second and third plant sites
in Malaysia. The commencement date for this new tax holiday has not
been determined as of July 20, 1998.
Minority Interest in KMT/Equity in Net Income (Loss) of AKCL
The minority interest in the net income (loss) of consolidated
subsidiary represented Kobe Steel USA Holdings Inc.'s ("Kobe USA's") 20%
share of Komag Material Technology, Inc.'s ("KMT's") net income (loss).
KMT recorded net income of $3.0 million in the second quarter of 1998
and net income of $0.9 million in the second quarter of 1997. KMT
recorded net income of $2.5 million in the first half of 1998 compared
to $1.8 million in the first half of 1997.
The Company owns a 50% interest in AKCL and records its share of
AKCL's net income (loss) as equity in net income (loss) of
unconsolidated joint venture. The Company recorded $11.4 million as its
equity in AKCL's net loss for the second quarter of 1998 compared to the
equity in AKCL's net loss of $1.1 million recorded in the second quarter
of 1997. The combination of a significant decrease in the overall
average selling price for AKCL's disk products, manufacturing yield and
equipment utilization issues, and substantial equipment writedowns
adversely affected AKCL's financial results for the second quarter of
1998. The Company's equity in AKCL's net loss for the second quarter of
1998 included the writedown of AKCL's remaining in-line sputtering
equipment. AKCL believes that the products produced by a static
sputtering process will be technically similar to those produced by
other Japanese media suppliers, thus improving AKCL's ability to meet
specific requirements of certain Japanese customers on a timely basis.
The Company recorded a loss of $20.8 million as its equity in
AKCL's net loss for the first half of 1998 compared to income of $2.3
million as its equity in AKCL's net income in the first half of 1997.
AKCL's results for the first half of 1997 included a $5.3 million net of
tax gain on AKCL's March 1997 sale of its investment in Headway
Technologies, Inc. The Company's equity in this gain was $2.6 million.
Excluding the gain, the Company reported a loss of $0.3 million as its
equity in AKCL's net loss in the first half of 1997. Equipment
writedowns coupled with substantially lower average selling prices and
manufacturing yield, equipment utilization, and customer qualification
issues adversely affected AKCL's financial results for the first half of
1998. The Company anticipates that AKCL will record losses through at
least the third quarter of 1998, but at a lower level than recorded in
the first and second quarters of 1998.
AKCL's current financing arrangements may not be sufficient in
light of AKCL's expected continuing losses. There can be no assurance
that additional financing will be available to AKCL. Failure to secure
additional financing could have a material adverse affect on AKCL's
business and financial results. Further writedowns of the Company's
investment in AKCL are limited to the book value of the investment on
the accompanying consolidated balance sheet ($6.8 million at June 28,
1998).
Liquidity and Capital Resources:
Cash and short-term investments of $149.8 million at the end of
the second quarter of 1998 decreased $16.4 million from the end of the
prior fiscal year. Consolidated operating activities generated $33.6
million in cash during the first six months of 1998. The $320.0 million
operating loss for the first half of 1998, net of non-cash depreciation
charges of $68.5 million, the non-cash asset impairment charge of $175.0
million and the non-cash equity loss from AKCL of $20.8 million,
consumed $55.7 million. The net change in certain working capital
accounts provided $91.1 million. Reductions in accounts receivable
($50.2 million) related to the lower sales volume in the first half of
1998 offset a decrease in accounts payable ($11.1 million) related to
the lower production volume. Additionally, the Company received $22.1
million in U.S. and California income tax refunds during the first half
of 1998. The Company borrowed $15.0 million under its credit facilities
and spent $74.3 million on capital requirements during the first six
months of 1998. Proceeds from sales of property, plant and equipment
(primarily the sale of vacant land in Milpitas, California) generated
$5.3 million. Sales of Common Stock under the Company's stock option
programs generated $3.6 million.
Total capital expenditures for 1998 are currently planned at
approximately $100 million. Capital expenditures for 1998 are primarily
targeted for process improvements, including costs to modify the
Company's in-line equipment for the epitaxial sputtering process and
costs to implement advances in the Company's substrate process
technologies. Current noncancellable capital commitments total
approximately $33 million.
The size of the Company's second quarter net loss has resulted in
a default under certain financial covenants contained in the Company's
various bank credit facilities. The Company currently has $260 million
of unsecured bank borrowings outstanding. The remaining $85 million of
unutilized credit under the Company's $345 million credit facilities is
currently unavailable due to the financial covenant default. The
Company is not in payment default under any of its credit facilities.
The Company's borrowing capacity is subject to the successful re-
negotiation of the terms of these agreements and/or the negotiation of
new financing arrangements. The Company is currently in discussions
with existing and potential new lenders about these matters. In a
recent proxy statement for a special meeting of stockholders to be held
on July 22, 1998 the Company requested stockholder approval of two
proposals that would provide additional financing flexibility for the
Company. There can be no assurance, however, that the Company will be
able to successfully re-negotiate the terms of its existing credit
agreements, negotiate new financing arrangements and/or obtain the
stockholder approval of the proposals required to provide financing
flexibility. If the Company is unable to obtain adequate financing, the
Company will be required to further reduce its operations and capital
spending which could have a material adverse effect on the Company's
results of operations.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings-Not Applicable.
ITEM 2. Changes in Securities-Not Applicable.
ITEM 3. Defaults Upon Senior Securities.
The Company's credit facilities total $345 million and are
comprised of five agreements: a five-year term loan that expires
in 2002, two separate revolving line of credit agreements that
expire in 2002 and two separate four-year revolving line of credit
agreements that expire in 1999 and 2000. None of these credit
facilities is secured by any of the assets of the Company. The
size of the Company's net loss for the second quarter of 1998 has
resulted in defaults under certain financial covenants contained
in these bank credit facilities. The Company currently has $260
million of bank borrowings outstanding. The remaining $85 million
of unutilized credit under the credit facilities is currently
unavailable due to the technical default.
ITEM 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Stockholders was held on May 27, 1998.
(b) The meeting included the election of the Board of Directors,
submitted as Item No. 1, whose names are as follows:
Tu Chen
Stephen C. Johnson
Craig R. Barrett
Chris A. Eyre
Irwin Federman
George A. Neil
Max Palevsky
Anthony Sun
Masayoshi Takebayashi
(c) Other matters voted upon at the stockholders meeting were:
Item No. 2, Amendment to the Company's 1988 Employee Stock Purchase
Plan to increase the number of shares issuable by 1,300,000; and
Item No. 3, Ratification of the Appointment of Ernst & Young LLP
as the Company's Independent Auditors for the year ended
January 3, 1999.
Shares of Common Stock voted were as follows:
Item No.1
(Election of Board of Directors)
Total Vote for Total Vote Withheld
Each Director From Each Director
-------------- -------------------
Tu Chen 44,154,559 338,691
Stephen C. Johnson 44,157,380 335,870
Craig R. Barrett 44,154,845 338,405
Chris A. Eyre 44,152,620 340,630
Irwin Federman 44,144,935 348,315
George A. Neil 44,155,405 337,845
Max Palevsky 44,138,044 355,206
Anthony Sun 44,149,505 343,745
Masayoshi Takebayashi 44,141,485 351,765
For Against Abstain Non-vote
----------- ----------- ----------- ----------
Item No.2
(Amendment to 1988
Employee Stock Purchase
Plan) 42,281,962 1,980,606 230,682 8,402,820
Item No.3
(Selection of
Independent Auditors) 44,348,661 86,236 57,453 8,403,720
(d) Not Applicable
ITEM 5. Other Information-Not Applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27-Financial Data Schedule
(b) On June 8, 1998 the Company filed Form 8-K containing the
contents of its press release dated June 2, 1998 entitled
"Komag Updates Second Quarter Outlook and Announces
Actions to Address Weak Market Conditions"
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KOMAG, INCORPORATED
(Registrant)
DATE: July 20, 1998 BY: /s/ William L. Potts, Jr.
----------------- --------------------------------------
William L. Potts, Jr.
Senior Vice President and
Chief Financial Officer
DATE: July 20, 1998 BY: /s/ Stephen C. Johnson
----------------- --------------------------------------
Stephen C. Johnson
President and
Chief Executive Officer
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<PERIOD-START> MAR-30-1998
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