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 April 4, 1999
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 April 4, 1999, 53,920,523 shares of the Registrant's common stock, $0.01 par
value, were issued and outstanding.
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INDEX
KOMAG, INCORPORATED
Page No.
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated statements of operations--Three months
ended April 4, 1999 and March 29, 1998 ............................... 3
Consolidated balance sheets--April 4, 1999
and January 3, 1999 .................................................. 4
Consolidated statements of cash flows--Three months
ended April 4, 1999 and March 29, 1998 ............................... 5
Notes to consolidated financial statements--
April 4, 1999 ..................................................... 6-10
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations .................... 11-17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ................................................... 18
Item 2. Changes in Securities ............................................... 18
Item 3. Defaults Upon Senior Securities ..................................... 18
Item 4. Submission of Matters to a Vote of Security Holders ................. 18
Item 5. Other Information ................................................... 18
Item 6. Exhibits and Reports on Form 8-K .................................... 18
SIGNATURES .................................................................. 19
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PART I. FINANCIAL INFORMATION
<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, except per share data)
(Unaudited)
<CAPTION>
Three Months Ended
------------------------------
April 4 March 29
1999 1998
--------- ---------
<S> <C> <C>
Net sales $ 90,013 $ 76,057
Cost of sales 89,266 107,652
--------- ---------
GROSS PROFIT (LOSS) 747 (31,595)
Operating expenses:
Research, development and engineering 12,015 14,944
Selling, general and administrative 5,478 4,611
--------- ---------
17,493 19,555
--------- ---------
OPERATING LOSS (16,746) (51,150)
Other income (expense):
Interest income 1,616 2,552
Interest expense (5,004) (4,554)
Other, net 661 4,323
--------- ---------
(2,727) 2,321
Loss before income taxes, minority interest, --------- ---------
and equity in joint venture loss (19,473) (48,829)
Provision for income taxes 400 --
--------- ---------
Loss before minority interest and equity in
joint venture loss (19,873) (48,829)
Minority interest in net income (loss) of consolidated subsidiary 251 (95)
Equity in net loss of unconsolidated joint venture (1,402) (9,424)
--------- ---------
NET LOSS $ (21,526) $ (58,158)
--------- ---------
Basic loss per share $ (0.40) $ (1.10)
--------- ---------
Diluted loss per share $ (0.40) $ (1.10)
--------- ---------
Number of shares used in basic computation 53,915 52,875
--------- ---------
Number of shares used in diluted computation 53,915 52,875
--------- ---------
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
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<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In Thousands)
<CAPTION>
April 4 January 3
1999 1999
-------- --------
(unaudited) (note)
<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents 64,670 64,467
Short-term investments 61,000 63,350
Accounts receivable less allowances of
$2,807 in 1999 and $2,847 in 1998 45,016 42,922
Accounts receivable from related parties 147 512
Inventories:
Raw materials 7,853 8,434
Work-in-process 7,798 10,672
Finished goods 13,872 14,534
-------- --------
Total inventories 29,523 33,640
Prepaid expenses and deposits 3,466 4,348
Income taxes receivable 2,216 2,216
Deferred income taxes 7,883 7,883
-------- --------
Total current assets 213,921 219,338
Investment in Unconsolidated Joint Venture -- 1,399
Property, Plant and Equipment
Land 7,785 7,785
Building 128,385 128,359
Equipment 692,140 686,169
Furniture 10,919 10,911
Leasehold Improvements 86,794 86,565
-------- --------
926,023 919,789
Less allowances for depreciation and amortization (471,074) (449,772)
-------- --------
Net property, plant and equipment 454,949 470,017
Deposits and Other Assets 3,105 3,341
-------- --------
671,975 694,095
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt 260,000 260,000
Trade accounts payable 25,815 27,274
Accounts payable to related parties 1,800 1,848
Accrued compensation and benefits 15,290 15,544
Other liabilities 7,821 7,382
Income taxes payable 145 134
-------- --------
Total current liabilities 310,871 312,182
Deferred Income Taxes 52,564 52,564
Other Long-term Liabilities 1,551 1,403
Minority Interest in Consolidated Subsidiary 4,390 4,139
Stockholders' Equity
Preferred stock -- --
Common stock 539 539
Additional paid-in capital 407,867 407,549
Accumulated deficit (106,386) (84,860)
Accumulated other comprehensive income 579 579
-------- --------
Total stockholders' equity 302,599 323,807
-------- --------
671,975 694,095
======== ========
Note: The balance sheet at January 3, 1999 has been derived from the audited financial statements at that date.
</TABLE>
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<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
<CAPTION>
Three Months Ended
----------------------------
April 4 March 29
1999 1998
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (21,526) $ (58,158)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 23,761 34,635
Provision for losses on accounts receivable 33 (838)
Equity in net loss of unconsolidated joint venture 1,402 9,424
(Gain) Loss on disposal of property, plant and equipment 222 (2,728)
Deferred rent 148 110
Minority interest in net income (loss) of consolidated subsidiary 251 (95)
Changes in operating assets and liabilities:
Accounts receivable (2,127) 30,738
Accounts receivable from related parties 365 2,020
Inventories 4,117 6,216
Prepaid expenses and deposits 879 (93)
Trade accounts payable (1,459) (13,991)
Accounts payable to related parties (48) (4,100)
Accrued compensation and benefits (254) 3,264
Other liabilities 439 316
Income taxes receivable/payable 11 21,055
--------- ---------
Net cash provided by operating activities 6,214 27,775
INVESTING ACTIVITIES
Acquisition of property, plant and equipment (8,915) (41,378)
Purchases of short-term investments -- (44,400)
Proceeds from short-term investments at maturity 2,350 --
Proceeds from disposal of property, plant and equipment -- 4,930
Deposits and other assets 236 291
--------- ---------
Net cash used in investing activities (6,329) (80,557)
FINANCING ACTIVITIES
Increase in long-term obligations -- 15,000
Sale of Common Stock, net of issuance costs 318 836
--------- ---------
Net cash provided by financing activities 318 15,836
Increase (decrease) in cash and cash equivalents 203 (36,946)
Cash and cash equivalents at beginning of year 64,467 133,897
--------- ---------
Cash and cash equivalents at end of period $ 64,670 $ 96,951
========= =========
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
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KOMAG, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
APRIL 4, 1999
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) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended April 4, 1999
are not necessarily indicative of the results that may be expected for the year
ending January 2, 2000.
The financial statements have been prepared on a going concern basis.
The Report of Independent Auditors on the Company's financial statements for the
year ended January 3, 1999 included in Form 10-K contained an explanatory
paragraph which indicated substantial doubt about the Company's ability to
continue as a going concern because of recent operating losses and lack of
compliance with certain covenants of its various bank agreements. Such
non-compliance constitutes and event of default under the agreements. The
Company has not been in payment default under these credit facilities and has
continued to pay all interest charges and other fees associated with these
facilities on their scheduled due dates. Amounts outstanding under these
unsecured credit agreements at April 4, 1999 amounted to $260 million. To date,
the Company's lenders have not accelerated any principal payments under these
facilities. The Company is currently negotiating with its lenders for amendments
to its existing credit facilities. There can be no assurance that the Company
will be able to obtain such amendments to its credit facilities on commercially
reasonable terms. In the event that the Company does not successfully amend its
credit facilities or restructure its debt obligations, the Company could be
required to significantly reduce or possibly suspend its operations, and/or sell
additional securities on terms that would be highly dilutive to current
stockholders of the Company. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of assets and
liabilities that may result from the outcome of this uncertainty.
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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 January 3, 1999.
The Company uses a 52-53 week fiscal year ending on the Sunday closest
to December 31. The three-month reporting periods for the comparable years
included in this report are each comprised of thirteen weeks.
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:
Apr 4 Jan 3
(in thousands) 1999 1999
-------- --------
Municipal auction rate preferred stock $ 61,000 $ 63,350
Corporate debt securities 31,186 33,765
Mortgage-backed securities 27,482 34,060
-------- --------
$119,668 $131,175
======== ========
Amounts included in cash and cash equivalents $ 58,668 $ 67,825
Amounts included in short-term investments 61,000 63,350
-------- --------
$119,668 $131,175
======== ========
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 approximately $0.4 million for
the first quarter of 1999 primarily represents foreign withholding taxes. The
Company's wholly-owned thin-film media operation, Komag USA (Malaysia) Sdn.
("KMS") received an extension of its initial five-year tax holiday for an
additional five years commencing July 1998. 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 May 13, 1999.
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NOTE 4 - COMPREHENSIVE LOSS
The following are the components of comprehensive loss:
Three Months Ended
-----------------------
Apr 4 Mar 29
1999 1998
-------- --------
(in thousands)
Net loss $(21,526) $(58,158)
Foreign currency translation adjustments -- (1,927)
-------- --------
Comprehensive loss $(21,526) $(60,085)
-------- --------
Accumulated foreign currency translation adjustments on the
accompanying Consolidated Balance Sheets account for all of the Company's
accumulated other comprehensive loss at April 4, 1999 and March 29, 1998.
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NOTE 5 - LOSS PER SHARE
The net loss per share was computed using only the weighted-average
number of shares of common stock outstanding during the period. The following
table sets forth the computation of net loss per share.
Three Months Ended
-------------------------
Apr 4 Mar 29
1999 1998
-------- --------
(in thousands, except per share amounts)
Numerator: Net loss $(21,526) $(58,158)
-------- --------
Denominator for basic
loss per share -
weighted-average shares 53,915 52,875
-------- --------
Effect of dilutive securities:
Employee stock options -- --
Denominator for diluted
-------- --------
loss per share 53,915 52,875
-------- --------
Basic loss per share $ (0.40) $ (1.10)
-------- --------
Diluted loss per share $ (0.40) $ (1.10)
-------- --------
Incremental common shares attributable to the exercise of outstanding options
(assuming proceeds would be used to purchase treasury stock) of 2,077,738 and
882,687 for the three months ended April 4, 1999 and March 29, 1998,
respectively, were not included in the net loss per share computation because
the effect would be antidilutive.
NOTE 6 - 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.
NOTE 7 - SUBSEQUENT EVENT
In April 1999, the Company purchased the assets of Western Digital
Corporation's media operations through the issuance of approximately 10.8
million shares of the Company's Common Stock, a note in the principal amount of
$30.1 million,
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and cash consideration of $1.6 million. The shares issued in the transaction,
which represent 16.7% of the Company's outstanding shares on a post-issuance
basis, are unregistered and subject to trading restrictions. Western Digital may
resell these shares in specified increments over a three and one-half year
period under registration rights granted by the Company or under SEC rules after
expiration of the required holding periods. Principal and interest accrued on
the note are due in three years and the note is subordinated to the Company's
senior credit facilities. In the event Western Digital realizes a return on its
Komag equity holdings in excess of a targeted amount within three years, the
excess amount will reduce the balance due under the note. The Company also
assumed certain liabilities, mainly equipment and building leases, as part of
the transaction. Additionally, the Company and Western Digital signed a volume
purchase agreement under which the Company will supply a substantial portion of
Western Digital's media needs over the next three years.
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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.
These statements may be identified by the use of words such as "expects,"
"anticipates," "intends," "plans," and similar expressions. 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. Due to a recently
completed volume purchase agreement with Western Digital Corporation ("WDC"),
the Company's results are more dependent on the relative success of WDC in the
data storage market. Other factors that could cause actual results to differ
include the following: disk consumption per drive based on the relative growth
rates of areal density and overall storage usage; pricing levels determined by
the continuing imbalance between supply and demand for disk products; growth
rate of the merchant disk market as influenced by the level of captive disk
production; structural changes within the disk media industry created by
combinations, failures, and joint venture arrangements; unit volumes derived
from new product qualifications; costs related to consolidation of the media
operations of Komag and WDC; changes in manufacturing efficiencies, in
particular product yields and material input costs; factory utilization levels,
including absorption of the additional fixed manufacturing costs associated with
the recently acquired WDC facilities; and capital expenditure levels required to
maintain or acquire process equipment with capabilities to meet more stringent
future product requirements. Moreover, the Company will need sufficient cash
resources to operate efficiently. The Company's ability to raise additional
funding will be affected by the status of the Company's credit facilities and
the audit opinion for the Company's 1998 financial statements. Other risk
factors that may affect the Company's financial performance are listed in the
Company's various SEC filings, including its Form 10-K for the fiscal year ended
January 3, 1999 which was filed on April 2, 1999. 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.
Recent Development:
In April 1999, the Company acquired the thin-film media operations of
Western Digital Corporation (WDC). As part of the acquisition the Company and
WDC also entered into a volume purchase agreement under which the Company will
supply a substantial portion of WDC's thin-film media requirements. The Company
expects that second quarter of 1999 unit sales from the combined operations will
grow sequentially in the range of 20-35% compared to the Company's first quarter
of 1999 results. The
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Company expects that its fixed costs, including goodwill amortization, will
increase by approximately $10-12 million per quarter. In addition, as part of
the consolidation effort the Company extended job offers to approximately 50% of
the WDC media employees and reduced its existing U.S. operations by
approximately 8%. These actions resulted in a net increase of approximately 400
employees. These additional payroll and fixed costs, coupled with the projected
volume growth, will widen the net loss for the second quarter of 1999 compared
the net loss reported for the first quarter of 1999.
Overview:
Adverse market conditions, which began in mid-1997, continued to impact
the thin-film media market throughout 1998 and the first quarter of 1999. Demand
for disk drives grew rapidly during the mid-1990s and industry forecasts were
for continued strong growth. The Company and a majority of its competitors (both
independent disk manufacturers and captive disk manufacturers owned by
vertically integrated disk drive customers) committed to expansion programs in
1996 and substantially increased their media manufacturing capacity in 1997. In
1997 the rate of growth in demand for disk drives fell sharply. Disk drive
manufacturers abruptly reduced orders for media from independent suppliers and
relied more heavily on internal capacity to supply a larger proportion of their
media requirements. The media industry's capacity expansion, coupled with the
decrease in the rate of demand growth, has resulted in excess media production
capacity. This excess media production capacity caused sharp declines in average
selling prices for disk products as independent suppliers struggled to utilize
their capacity.
In addition to adversities caused by the excess supply of media, 1998
was a year of tremendous transition for the Company and the disk drive industry.
Disk drive programs utilizing newer, more advanced, magnetoresistive ("MR")
media and recording heads replaced older generation programs utilizing inductive
media and heads. By the end of 1998 most disk drives were manufactured with MR
components. The transition to MR disk drives has led to significant,
unprecedented increases in areal density and, therefore, the amount of data that
can be stored on a single disk platter. In the first quarter of 1999 the
majority of the Company's 3 1/2-inch disks were capable of storing at least 4.3
gigabytes (GB) per platter. This product mix represents a 34% jump in disk
capacity relative to a product mix of predominately 3.2 GB platters in the
fourth quarter of 1998. Such increased storage capacity allows drive
manufacturers to offer lower-priced disk drives at given capacity points,
especially in the price-sensitive desktop segment, through the incorporation of
fewer components into their disk drives. The rapid advancement in the storage
capacity per disk platter has further slowed disk demand throughout the
industry. According to industry market analysts, this resulting reduction in the
average number of disks per drive will likely slow the growth rate of disk
shipments below the growth rate of disk drives during 1999. The significant
amount of captive capacity employed by certain disk drive manufacturers also
continues to reduce the market opportunities for independent disk suppliers such
as the Company.
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Revenue:
Net sales increased to $90.0 million in the first quarter of 1999, up
18% compared to $76.1 million in the first quarter of 1998. The year-over-year
increase was due to the net effect of a 39% increase in unit sales volume and a
17% decrease in the overall average selling price. Net sales in first quarters
of 1999 and 1998 included $4.0 million and $1.3 million of substrate sales,
respectively. The Company periodically sells substrate products but does not
currently anticipate that such sales will become a significant portion of its
revenue. First quarter 1999 unit sales (excluding sales of substrate products)
increased to 10.1 million disks from 7.2 million disks in the first quarter of
1998. Unit sales for the first quarter 1998 were unusually low due to weakened
demand for desktop media products as several disk drive manufacturers sharply
reduced their desktop product production during early 1998 in response to
supply/demand imbalances within the industry. The severe pricing pressures
generated by the continuing imbalance in supply and demand for thin-film media
in the first quarter of 1999 resulted in the significant year-over-year decrease
in the overall average selling price.
In addition to sales of internally produced disk products, the Company
has historically resold products manufactured by its 50%-owned Japanese joint
venture, Asahi Komag Co., Ltd. (AKCL). Distribution sales of thin-film media
manufactured by AKCL were negligible in the first quarter of 1999 and accounted
for $2.4 million in the first quarter of 1998. The Company expects that
distribution sales of AKCL product will be negligible for the remainder of 1999.
During the first quarter of 1999 three customers accounted for
approximately 90% of consolidated net sales: Western Digital Corporation (58%),
Maxtor Corporation (22%) and International Business Machines (10%). 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 customers. Additionally, as a result of the
April 1999 acquisition of WDC's media operation and related volume purchase
agreement, the Company's dependence on WDC will increase in the near term.
Gross Margin:
The Company recorded a positive gross margin percentage of 0.8% in the
first quarter of 1999 compared to a negative gross margin of 41.5% in the first
quarter of 1998. The substantial improvement in the gross margin percentage
resulted from the combination of improvements in manufacturing efficiencies,
higher unit production volumes, and reductions in fixed manufacturing costs.
These favorable manufacturing cost reductions more than offset the 17% decline
in the overall average selling price. Manufacturing efficiency improvements
included both improvements in production yields and reductions in product input
costs. The Company produced 10.1 million units in the first quarter of
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1999 compared to 6.5 million units in the first quarter of 1998. The higher unit
production volume reduces the Company's unit cost as fixed costs are spread over
more units. Additionally, fixed manufacturing costs were lower in the first
quarter of 1999 as a result of a $175.0 million asset impairment charge recorded
in June 1998. The asset impairment charge effectively reduced asset valuations
to reflect the economic effect of industry price erosion for disk media and the
projected underutilization of the Company's production equipment and facilities.
Due to the reduced asset valuations depreciation expenses were approximately 30%
lower in the first quarter of 1999 compared to the first quarter of 1998.
Operating Expenses:
Research and development ("R&D") expenses decreased 19.6% ($2.9
million) to $12.0 million in the first quarter of 1999 relative to the
comparable period of 1998. Decreased R&D staffing and lower facility and
equipment costs (primarily due to the 1998 impairment charge) accounted for most
of the decrease. Selling, general and administrative ("SG&A") expenses increased
to $5.5 million in the first quarter of 1999 from $4.6 million in the first
quarter of 1998. The increase was primarily due to higher bad debt provisions in
the first quarter of 1999 relative to the first quarter of 1998. Excluding
provisions for bad debt, SG&A expenses increased less than $0.1 million (0.3%).
Interest and Other Income/Expense:
Interest income decreased $0.9 million in the first quarter of 1999
relative to the first quarter of 1998 due to a lower average cash and short-term
investment balance in the current year period. Interest expense increased $0.5
million primarily due to a higher average interest rate in the first quarter of
1999 compared to the first quarter of 1998. Other income decreased $3.7 million
in the first quarter of 1999 compared to the first quarter of 1998. Other income
in first quarter 1998 included a $3.1 million gain on the sale of vacant land
located in Milpitas, California.
Income Taxes:
The Company's income tax provision of approximately $0.4 million for
the first quarter of 1999 primarily represents foreign withholding taxes. No tax
provision was recorded in the first quarter of 1998. The Company's wholly-owned
thin-film media operation, Komag USA (Malaysia) Sdn. ("KMS"), received an
extension of its initial five-year tax holiday for an additional five years
commencing in July 1998. 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 May 13, 1999.
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
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Technology, Inc.'s ("KMT's") net income (loss). KMT recorded net income of $1.3
million in the first quarter of 1999 compared to a $0.5 million net loss in the
first quarter of 1998.
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 a loss of $1.4 million as its equity in AKCL's net
loss for the first quarter of 1999 compared to its equity in AKCL's net loss of
$9.4 million recorded in the first quarter of 1998. The Company's share of
AKCL's loss for the first quarter of 1999 was limited to the Company's remaining
investment balance in AKCL of $1.4 million. The Company will not record its
share of any continuing losses at AKCL as no investment balance remains.
Assuming AKCL begins to report a net income in future periods, the Company will
record its share of such income only to the extent by which the income exceeds
the losses incurred subsequent to the date on which the investment balance
became zero. AKCL's net loss for the first quarter of 1999 was $4.0 million
compared to a net loss of $18.8 million in the first quarter of 1998. Higher
production and sales volumes in the first quarter of 1999 accounted for the
improved results.
Year 2000 Issue:
Many computer systems were not designed to properly handle dates beyond
the year 1999. Such systems were designed using two digits rather than four to
define the applicable year. Any computer programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations. Disruptions may also occur if key suppliers or
customers experience disruptions in their ability to transact with the Company
due to Year 2000 issues. The Company's global operations rely heavily on the
infrastructures of the countries in which it conducts business. The Year 2000
readiness within infrastructure suppliers (utilities, government agencies such
as customs, shipping organizations) will be critical to the Company's ability to
avoid disruption of its operations. The Company is working with industry trade
associations to evaluate the Year 2000 readiness of infrastructure suppliers.
The Company has assessed its systems, equipment and processes and is currently
testing these systems to determine the Company's Year 2000 readiness. The
Company has committed personnel and resources to resolve potential Year 2000
issues and is working with key suppliers and customers to ensure their Year 2000
readiness.
The Company's Year 2000 efforts are focused on three primary areas of
potential impact: internal information technology ("IT") systems, internal
non-IT systems, and the readiness of third parties with whom the Company has
critical business relationships. Testing and remediation of internal IT and
non-IT systems is approximately 60% complete. The Company expects to complete
the testing and remediation for these systems by July 31, 1999. The Company has
developed a process for identifying and assessing Year 2000 readiness of its
critical suppliers. This process generally involves
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the following steps: initial supplier survey, follow-up supplier review, and
contingency planning. The Company is following up with critical suppliers that
either did not respond initially or whose responses were unsatisfactory. To
date, the Company has received responses from a majority of its critical
suppliers, most of whom have responded that they expect to address all of their
significant Year 2000 issues on a timely basis.
The Company currently believes that the remediation costs of the Year
2000 issue will not be material to the Company's results of operations or
financial position. Cumulatively through May 10, 1999 the Company has incurred
remediation costs of approximately $0.1 million. The Company does not separately
track the internal costs incurred for the Year 2000 project (primarily the
payroll cost for its information systems group). While the Company currently
expects that the Year 2000 issue will not pose significant operational problems,
delays in the implementation of new information systems, or a failure to fully
identify all Year 2000 dependencies in the Company's systems and in the systems
of its suppliers, customers and financial institutions could have material
adverse consequences, including delays in the delivery or sales of products.
Therefore, the Company is developing contingency plans for continuing operations
in the event such problems arise. The Company intends to complete the
contingency planning phase of its Year 2000 readiness by July 31, 1999.
The Company is working to identify and analyze the most reasonably
likely worst-case scenarios where it may be affected by Year 2000 related
interruptions. These scenarios could include possible infrastructure collapse,
the failure of power and water supplies, major transportation disruptions,
unforeseen product shortages due to hoarding of material and supplies, and
failures of communications and financial systems. Any one of these scenarios
could have a major and material effect on the Company's ability to produce and
deliver products to its customers. While the Company is developing contingency
plans to address issues under its control, an infrastructure problem outside of
its control or some combination of several of these problems could result in a
delay in product shipments depending on the nature and severity of the problems.
The Company would expect that most utilities and service providers would be able
to restore service within days although more pervasive system problems involving
multiple providers could last several weeks or longer depending on the
complexity of the systems and the effectiveness of their contingency plans.
The Company's products are not date sensitive and the Company expects
that it will have limited exposure to product liability litigation resulting
from Year 2000 related failures. Disk drive manufacturers have generally stated
that disk drives as a stand-alone product are not date sensitive. However, disk
drives using the Company's thin-film media products have been incorporated into
computer systems which could experience Year 2000 related failures. The Company
anticipates that litigation may be brought against suppliers of all component
products of systems that are unable to properly handle Year 2000 issues.
-16-
<PAGE>
Liquidity and Capital Resources:
Cash and short-term investments of $125.7 million at the end of the
first quarter of 1999 decreased $2.1 million from the end of the prior fiscal
year. Working Capital decreased $4.1 million from the end of the prior fiscal
year. Consolidated operating activities generated $6.2 million in cash during
the first quarter of 1999. The $21.5 million operating loss for the first
quarter of 1999, net of non-cash depreciation charges of $23.8 million, and the
non-cash equity loss from AKCL of $1.4 million, provided $3.7 million. Changes
in operating assets and liabilities provided $1.9 million. Improvements in
operating cash flow were provided by reductions in inventory of $4.1 million and
in prepaid expenses and deposits of $0.9 million. Increases in accounts
receivable and reductions in accounts payable used $1.8 million and $1.5
million, respectively. The Company spent $8.9 million on capital requirements
during the first quarter of 1999. Sales of Common Stock under the Company's
stock programs generated $0.3 million.
Total capital expenditures for 1999 are currently planned at
approximately $60 million. Current noncancellable capital commitments total
approximately $12 million. The size of the Company's second quarter of 1998 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. No additional borrowing
capacity is available as a result of the technical default. The Company is not
in payment default under any of its credit facilities. The Company is currently
negotiating with its lenders for amendments to the existing credit facilities.
If we successfully amend or restructure our credit facilities we will seek to
have our auditors reissue their opinion without the going concern paragraph.
There can be no assurance that the Company will be able to obtain such
amendments to its credit facilities on commercially reasonable terms. If the
Company does not successfully amend these credit facilities, it would remain in
technical default of its bank loans and the lenders would retain their rights
and remedies under the existing credit agreements. As long as the lenders choose
not to accelerate any principal payments, the Company would continue to operate
in default for the near term. However, the Company will likely need to raise
additional funds to restructure its debt obligations and to operate its business
for the long term.
Over the next several years the Company will need financial resources
for capital expenditures, working capital and research and development. The
Company believes that in order to achieve its long-term growth objectives and
maintain and enhance its competitive position, such additional financial
resources will be required. There can be no assurance that the Company will be
able to secure such financial resources on commercially reasonable terms. If the
Company is unable to obtain adequate financing, it could be required to
significantly reduce or possibly suspend its operations, and/or to sell
additional securities on terms that would be highly dilutive to current
stockholders.
-17-
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings-Not Applicable.
ITEM 2. Changes in Securities-Not Applicable.
ITEM 3. Defaults Upon Senior Securities-
The size of the Company's second quarter of 1998 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. No additional
borrowing capacity is available as a result of the technical default.
The Company is not in payment default under any of its credit
facilities. The Company is currently negotiating with its lenders for
amendments to the existing credit facilities.
ITEM 4. Submission of Matters to a Vote of Security Holders-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 April 16, 1999 the Company filed Form 8-K containing
the contents of its press release dated April 9, 1999
entitled "Komag and Western Digital Complete Strategic
Transaction for Disk Media Manufacturing".
-18-
<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: May 14, 1999 BY: /s/ William L. Potts, Jr.
---------------- ---------------------------
William L. Potts, Jr.
Senior Vice President and
Chief Financial Officer
DATE: May 14, 1999 BY: /s/ Stephen C. Johnson
---------------- ---------------------------
Stephen C. Johnson
President and
Chief Executive Officer
-19-
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