UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended January 3, 1999
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 0-16852
KOMAG, INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 94-2914864
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1704 Automation Parkway, San Jose, California 95131
(Address of Principal Executive Offices, including Zip Code)
Registrant's telephone number, including area code: (408) 576-2000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- ------------------- --------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
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
--- ---
Indicate by check mark 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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this form 10-K or any
amendment of this Form 10-K. [X]
[Cover page 1 of 2 pages]
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The aggregate market value of voting stock held by non-affiliates of
the Registrant as of February 28, 1999 was approximately $313,892,180 based upon
the closing sale price for shares of the Registrant's Common Stock as reported
by the Nasdaq National Market for the last trading date prior to that date).
Shares of Common Stock held by each officer, director and holder of 5% or more
of the outstanding Common Stock have been excluded in that such persons may be
deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
On February 28, 1999, approximately 53,920,660 shares of the
Registrant's Common Stock, $0.01 par value, were outstanding.
Documents Incorporated by Reference
Designated portions of the following document are incorporated by
reference into this Report on Form 10-K where indicated:
Komag, Incorporated Proxy Statement for the Annual Meeting of
Stockholders to be held on May 25, 1999, Part III.
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KOMAG, INCORPORATED
TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10K
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Page
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Item 1. Business ................................................................ 4-19
Item 2. Properties ................................................................ 20
Item 3. Legal Proceedings ........................................................ 20
Item 4. Submission of Matters to Vote of Security Holders ...................... 21
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters ..... 24
Item 6. Selected Consolidated Financial Data ................................... 25
Item 7. Management's Discussion and Analysis of Financial Condition
Results of Operations .............................................. 26-34
Item 7A. Financial Market Risks .................................................. 35
Item 8. Consolidated Financial Statements .................................... 37-63
Item 9. Changes In and Disagreements with Accountants and Financial
Disclosure ............................................................. 64
Item 10. Directors and Executive Officers ......................................... 64
Item 11. Executive Compensation ................................................... 64
Item 12. Security Ownership of Certain Beneficial Owners and Management ............ 64
Item 13. Certain Relationships and Related Transactions ......................... 64
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K ......................................................... 65-70
</TABLE>
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PART I
ITEM 1. BUSINESS
Komag, Incorporated ("Komag" or the "Company") designs, manufactures and
markets thin-film media ("disks"), the primary storage medium for digital data
used in computer hard disk drives. Komag believes it is the world's largest
independent manufacturer of thin-film media and is well positioned as a
broad-based strategic supplier of choice for the industry's leading disk drive
manufacturers. The Company's business strategy relies on the combination of
advanced technology and high-volume manufacturing. Komag's products are made for
the high-end desktop and high-capacity/high-performance enterprise segments of
the disk drive market and are used in products such as personal computers, disk
arrays, network file servers and engineering workstations. The Company
manufactures leading-edge disk products primarily for 3 1/2-inch form factor
hard disk drives. The Company was organized in 1983 and is incorporated in the
State of Delaware.
The Company's business is subject to risks and uncertainties, a number of
which are discussed under "Risk Factors."
Increasing demand for digital storage and low-cost, high-performance hard
disk drives has resulted in strong unit demand for these products. International
Data Corporation ("IDC") forecasts that worldwide disk drive unit shipments in
1999 through 2002 will grow at a 15% compound annual growth rate. Greater
processing power, more sophisticated operating systems and application software,
high-resolution graphics, larger databases and the emergence of the Internet are
among the developments that have required ever higher performance from disk
drives. For example, the first 5 1/4-inch hard disk drive, introduced in 1980,
offered a capacity of five megabytes (one million bytes is a megabyte or "MB")
with an areal density of less than two megabits (one million bits is a megabit;
eight bits is one byte) per square inch. Current-generation 3 1/2-inch drives
typically have capacities of four to twenty gigabytes (one billion bytes is a
gigabyte or "GB") with areal densities of approximately three to four gigabits
(one billion bits is a gigabit) per square inch. Today's areal densities allow
for approximately 4 GB of storage per 3 1/2-inch disk platter. By the end of
1999, the Company expects that increases in areal densities will allow for
approximately 6 GB of storage per 3 1/2-inch disk. Advances in component
technology have been critical to improving the performance and storage capacity
of disk drives and lowering the cost per bit stored.
The Company has capitalized on its technological strength in thin-film
processes and its manufacturing capabilities to achieve and maintain its
position as the leading independent supplier to the thin-film media market. The
Company's technological strength stems from the depth of its understanding of
materials science and the interplay between disks, heads and other drive
components. Komag's manufacturing expertise in thin-film media is evidenced by
its history of delivering reliable products in high volume. Current
manufacturing operations are conducted by the Company in the U.S. and Malaysia
as well as through Asahi Komag Co., Ltd. ("AKCL"), a joint venture with Asahi
Glass Co., Ltd. ("Asahi Glass") and Vacuum Metallurgical Company, which
manufactures thin-film media in Japan and Thailand. The Company manufactures
disk substrates for internal use through its subsidiary, Komag Material
Technology, Inc. ("KMT") located in Santa Rosa, California. A 20% minority
interest in KMT is held by Kobe Steel USA Holdings Inc. ("Kobe USA"), together
with Kobe Steel, Ltd. ("Kobe") and other affiliated companies.
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Technology
Komag manufactures and sells thin-film magnetic media on rigid disk
platters for use in hard disk drives. These drives are used in computer systems
to record, store and retrieve digital information. Inside a disk drive, the
media or disk rotates at speeds of up to 10,000 rpm. The head scans across the
disk as it spins, magnetically recording or reading information. The domains
where each bit of magnetic code is stored are extremely small and precisely
placed. The tolerances of the disks and recording heads are extremely demanding
and the interaction between these components is one of the most critical design
aspects in an advanced disk drive.
The primary factors governing the density of storage achievable on a disk's
surface are (1) the minimum distance at which read/write heads can reliably pass
over the surface of the disk to detect a change in magnetic polarity when
reading from the disk, defined as glide height (measured in microinches or
millionths of an inch); (2) the strength of the magnetic field required to
change the polarity of a bit of data on the magnetic layer of a disk when
writing, defined as coercivity (measured in oersteds--"Oe"), and (3) the ability
of the head to discriminate a signal from background media noise
(signal-to-noise ratio). As glide height is reduced, smaller bits can be read.
The higher the coercivity of the media, the smaller the width of the bit that
can be stored. The signal-to-noise ratio is determined by the choice of magnetic
materials and the method for depositing those materials on the disk's surface.
The Company's plating, polishing and texturing processes produce a uniform disk
surface with relatively few defects, which permits the read/write heads to fly
over the disk surface at glide heights of 0.8 to 1.0 microinches. The magnetic
alloys deposited on the surfaces of Komag's disks have high coercivity, low
noise and other desirable magnetic characteristics. The combination of these
factors results in more data stored in a given area on the disk surface.
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. An MR disk is optimized for use with MR heads that use
separate read and write elements. The write element is made from conventional
inductive materials, but the read element is made of a material whose electrical
resistance changes when subjected to changes in a magnetic field. MR heads are
more sensitive to magnetic fields enabling them to read more densely-packed,
smaller-sized bits. The transition to MR disk drives has led to significant,
unprecedented increases in areal density. The Company believes that the number
of gigabits per square inch doubled in 1998. The Company began 1998
manufacturing both MR and inductive media. The Company had largely completed its
transition to MR products by the fourth quarter of 1998 at which time MR media,
including more advanced giant magnetoresistive ("GMR") disks, accounted for
approximately 97% of the Company's unit sales. GMR disks accounted for 12% of
unit sales in the fourth quarter of 1998. The Company believes that MR and GMR
disks will continue to be the predominant media for disk drives in 1999.
Products, Customers and Marketing
Komag sells primarily MR media for 3 1/2-inch disk drives. The Company has
also historically sold disks for 5 1/4-inch drives and other disk drive form
factors. Komag's products offer a range of coercivities, glide height
capabilities and other parameters to meet specific customer requirements. Unit
sales of 3 1/2-inch disks capable of storing at least 3.2 GB per platter
accounted for approximately 70% of the Company's unit sales in the fourth
quarter of 1998. The Company anticipates that over 60% of its unit sales in the
first quarter of 1999 will be 3 1/2-inch disks capable of storing at least 4.3
GB per platter and the Company is in the process of obtaining customer
qualification of 3 1/2-inch products capable of storing up to 6.8 GB per
platter.
Prior to 1997, market demand for advanced thin-film media typically
exceeded supply. In mid-1997, the rate of growth in demand for media slowed
abruptly due in large measure to the rapid advancement
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in increased storage capacity per disk achieved through the use of MR
technology. As a result, drive designs incorporated fewer disks and recording
heads to achieve the disk drive capacities demanded by the market. In addition,
based upon historical supply shortages and forecasts for continued strong demand
growth rates, the Company and its competitors (both independent and captive
suppliers) began adding significant media manufacturing capacity in 1996 which
for the most part became operational in 1997. The increased supply of media
generated by the expanded physical capacity, coupled with the tremendous
improvement in disk storage capacity, allowed the overall supply of thin-film
media to catch up to, and then exceed, market demand. Captive media suppliers
(owned by vertically integrated disk drive customers) utilized their capacity at
the expense of independent suppliers, such as Komag, during this period. As a
result, in 1997 and 1998, the market for disks produced by independent suppliers
decreased sharply and pricing pressures intensified. In both 1997 and 1998, the
Company idled certain equipment and facilities to more closely align its
production capacity to demand for its products. These restructuring activities
resulted in significant restructuring and impairment charges.
The Company believes that there remains excess media capacity within the
industry. Certain media manufacturers have idled capacity and restructured their
operations. StorMedia, Inc., an independent media supplier, declared bankruptcy
in late 1998. The Company believes that the longer-term success of the thin-film
media industry is dependent upon high growth in demand for storage capacity and
further consolidation within the media industry. Improvements in enabling
technologies, such as increased bandwidth capability that will speed data
transfers over the Internet and will promote use of other storage-intensive
applications such as multimedia, are expected to drive the demand for storage
capacity.
Komag primarily sells its media products to independent OEM disk drive
manufacturers for incorporation into hard disk drives that are marketed under
the manufacturers' own labels. The Company also currently sells its disks to
computer system manufacturers who make disk drives for their own use or for sale
in the open market. The Company works closely with customers as they design new
high-performance disk drives and generally customizes its products according to
customer specifications.
Three customers accounted for approximately 86% of the Company's net sales
in 1998. Net sales to major customers were as follows: Western Digital
Corporation ("Western Digital")--43%; Maxtor Corporation ("Maxtor")--25%; and
International Business Machines ("IBM")--18%. Sales are generally concentrated
in a small number of customers due to the high volume requirements of the
dominant disk drive manufacturers and their tendency to rely on a few suppliers
because of the close interrelationship between media and other disk drive
components. Given the relatively small number of high-performance disk drive
manufacturers, the Company expects that it will continue its dependence on a
limited number of customers.
Sales are made directly to disk drive manufacturers worldwide (except media
sales into Japan) from the Company's U.S. and Malaysian operations. Sales of
media for assembly into disk drives within Japan are made solely through AKCL.
On a selective basis, the Company has used AKCL to distribute the Company's
products to Japanese drive manufacturers for assembly outside of Japan. During
1998, the Company sold product to Matsushita-Kotobuki Electronics Industries,
Ltd. ("MKE") in Japan and to MKE's Singapore manufacturing facility through
AKCL. Media sales to the Far East from the Company's U.S. and Malaysian
operations represented 83%, 96% and 88% of Komag's net sales in 1998, 1997 and
1996, respectively. The Company's customers assemble a substantial portion of
their disk drives in the Far East and subsequently sell these products
throughout the world. Therefore, the Company's high concentration of Far East
sales does not accurately reflect the eventual point of consumption of the
assembled disk drives. All foreign sales are subject to certain risks common to
all export activities, such as government regulation and the risk of imposition
of tariffs or other trade barriers. Foreign sales must also be licensed by the
Office of Export Administration of the U.S. Department of Commerce.
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The Company's sales are generally made pursuant to purchase orders rather
than long-term contracts. At January 3, 1999, the Company's backlog of purchase
orders scheduled for delivery within 90 days totaled approximately $69.6 million
compared to $23.7 million at December 28, 1997. These purchase orders may be
changed or canceled by customers on short notice without significant penalty.
Accordingly, the backlog should not be relied upon as indicative of sales for
any future period.
Manufacturing
Komag's manufacturing expertise in thin-film media is evidenced by its
history of delivering reliable products in high volume. Through the utilization
of proprietary processes and techniques, the Company has the capability to
produce advanced disk products that generally exhibit uniform performance
characteristics. Such uniform performance characteristics enhance the
reliability of the drive products manufactured by the Company's customers. In
addition, these characteristics raise production yields on the customers'
manufacturing lines, which is an important cost consideration especially in
high-performance disk drives with large component counts. Manufacturing costs
are highly dependent upon the Company's ability to effectively utilize its
installed physical capacity to produce large volumes of products at acceptable
yields. To improve yields and capacity utilization, Komag has adopted formal
continuous improvement programs at all of its worldwide operations. The process
technologies employed by the Company require substantial capital investment. In
addition, long lead times to install new increments of physical capacity
complicate capacity planning.
The manufacture of the Company's thin-film sputtered disks is a complex,
multistep process that converts aluminum substrates into finished data storage
media ready for use in a hard disk drive. The process requires the deposition of
extremely thin, uniform layers of metallic film onto a disk substrate. To
achieve this, the Company uses a vacuum deposition, or sputtering, method
similar to that used to coat semiconductor wafers. The basic process consists of
many interrelated steps that can be grouped into five major categories:
1. Sizing and Grinding of the Substrate: A raw aluminum blank substrate is
sized by precisely cutting the inner and outer diameter of the blank. A
mechanical grinding process is then utilized to provide a relatively flat
surface on the substrate prior to nickel alloy plating.
2. Nickel Alloy Plating and Polishing of the Substrate: Through a series of
chemical baths aluminum substrates are plated with a uniform nickel phosphorus
layer in order to provide support for the magnetic layer. Next, this layer is
polished to achieve the required flatness.
3. Fine Polishing, Texturing and Cleaning: During these process steps,
disks are smoothed and cleaned to remove surface defects to allow the read/write
heads of the disk drives to fly at low and constant levels over the disks.
4. Sputtering and Lube: By a technically demanding vacuum deposition
process, magnetic layers are successively deposited on the disk and a hard
protective overcoat is applied. After sputtering, a microscopic layer of
lubrication is applied to the disk's surfaces to improve durability and reduce
surface friction.
5. Glide Test and Certification: In robotically controlled test cells,
disks are first tested for surface defects optically, then for a specified glide
height and finally certified for magnetic properties. Based on these test
results, disks are graded against customers' specific performance requirements.
Most of the critical process steps are conducted in Class 100 or better
environments. Throughout the process, disks are generally handled by
custom-designed and, in many cases, Company-built automated equipment to reduce
contamination and enhance process precision. Minute impurities in materials,
particulate contamination or other production problems can reduce production
yields and, in extreme cases, result in the prolonged suspension of production.
Although no contamination problems have
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required prolonged suspension of the Company's production to date, no assurance
can be given that the Company will not experience manufacturing problems from
contamination or other causes in the future.
As areal density increases, recording heads are required to read and write
smaller data bits packed more tightly together on the surface of the disk. To
accomplish this, the read/write head must fly closer to the disks' surfaces in
order to discriminate smaller, weaker magnetic signals. In 1998, the Company
completed a number of changes in its manufacturing processes designed to improve
disk characteristics. These new processes produce disk substrates that are
smoother and flatter, with fewer, smaller defects. Additionally, disks produced
with these modified processes facilitate increased density through more uniform
crystal growth and improved magnetic orientation on the disk surface. The
Company modified its sputtering process from the deposition of a magnetic layer
over an amorphous underlayer to epitaxial deposition of the active magnetic
layer upon a crystalline underlayer. Since epitaxial deposition requires higher
temperatures and dryer process chambers than the former processes, several
significant process changes were implemented in 1998. First, the processes
related to producing substrates, prior to sputtering, were changed by adding new
annealing steps to accommodate higher process temperatures. Next, to make
substrates smoother and reduce defects a new polish step was added.
Additionally, the Company upgraded a portion of its in-line sputtering lines to
increase process temperatures and provide higher vacuum capability.
Facilities and Production Capacity
Based on analysis of the Company's production capacity and its expectations
of media market demand, the Company implemented restructuring plans during the
third quarter of 1997 and the second quarter of 1998. Under the 1997
restructuring plan, the Company consolidated its U.S. manufacturing operations
onto its new campus in San Jose, California by closing two older factories in
Milpitas, California. The first of the two Milpitas facilities was closed at the
end of the third quarter of 1997 and the second facility was closed in January
1998. Under its 1998 restructuring plan, the Company ceased its back-end
operations in its oldest San Jose, California facility in the fourth quarter of
1998. The Company, however, continues to use this facility for its front-end
operations for both production and new process development. Additionally, the
Company may periodically utilize back-end operations in this facility based on
media demand. At January 3, 1999, the Company and its joint venture, AKCL, had
facilities in the U.S., Malaysia, Japan and Thailand.
The Company occupies three production factories in the U.S. comprising
approximately 372,000 square feet of floorspace, an R&D facility of
approximately 188,000 square feet and warehouse and administrative facilities
with approximately 130,000 square feet. Two factories are located in San Jose,
California. The third factory, the Company's majority-owned subsidiary (KMT), is
located in Santa Rosa, California. The factories in San Jose primarily perform
the process steps from plate through test, whereas the KMT facility manufactures
aluminum substrates.
The Company owns three production facilities in Malaysia, two in Penang
totaling approximately 615,000 square feet and one in Sarawak of approximately
275,000 square feet. One of the Penang factories performs all of the Company's
process steps except aluminum substrate preparation and the other is equipped to
perform the fine polish through test steps. The Sarawak factory is primarily
dedicated to substrate, plating and polishing operations. The Company has
strategically located a large portion of its total worldwide front-end and
back-end manufacturing capacity in Malaysia. These facilities are closer to the
customers' disk drive assembly plants in Southeast Asia and enjoy certain cost
and tax advantages.
AKCL occupies approximately 495,000 square feet of building space. AKCL's
Japanese facilities are primarily dedicated to fine polish through test and its
Thailand facility is designed for plating and polishing.
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Recent Development
In February 1999, the Company and Western Digital announced the signing of
a letter of intent under which the Company will acquire Western Digital's disk
media business for approximately $80 million of the Company's Common Stock
(based on the market value of the Company's Common Stock at the time the letter
of intent was signed). In addition, the Company will assume certain liabilities,
mainly lease obligations related to production equipment and facilities. Terms
of the strategic relationship include a three-year volume purchase agreement
under which Western Digital will buy a substantial portion of its media from the
Company. The Company plans to combine Western Digital's media group with its
manufacturing operations over the next 18 months. Such action will relocate a
portion of Western Digital's production equipment to the Company's offshore
locations, thus more fully utilizing the Company's lower-cost Malaysian
operations. At the time of this filing the Company and Western Digital were
continuing to negotiate terms of the acquisition.
Research, Development and Engineering
Since its founding, Komag has focused on the development of advanced
thin-film disk designs as well as the process technologies necessary to produce
these designs. The Company's spending and capital investment for R&D are aimed
at the investigation, design, development and testing of new products and
processes as well as the development of more efficient and cost effective
processes that can be integrated into manufacturing in a commercially viable
manner. Historically, the Company has utilized a full-scale in-line sputtering
line for both development and pilot production. The Company's R&D facility is
equipped with two in-line sputtering lines and two static sputtering systems.
The Company believes this additional capacity will allow more rapid development
of new products as well as expanded prototype and pilot production capability.
The Company's expenditures (and percentage of sales) on research,
development and engineering activities, were $61.6 million (18.7%) in fiscal
1998, $51.4 million (8.1%) in fiscal 1997 and $29.4 million (5.1%) in fiscal
1996.
Strategic Alliances
The Company has established joint ventures with Asahi Glass and Kobe. Komag
believes these alliances have enhanced the Company's competitive position by
providing research, development, engineering and manufacturing expertise that
reduce costs and technical risks and shorten product development cycles.
Asahi Komag Co., Ltd. ("AKCL")
In 1987, the Company formed a partnership (Komag Technology Partners) with
the U.S. subsidiaries of two Japanese companies, Asahi Glass and Vacuum
Metallurgical Company. The partners simultaneously formed a wholly owned
subsidiary, AKCL, to manufacture and distribute thin-film disks in Yonezawa,
Japan. Under the joint venture agreement, the Company contributed technology
developed prior to January 1987 and licensed technology developed after January
1987, to the extent such technology relates to sputtered thin-film hard disk
media, for a 50% interest in the partnership. The Japanese partners contributed
equity capital aggregating 1.5 billion yen (equivalent to approximately $11
million at that time). AKCL began commercial production in 1988.
The terms of the joint venture agreement provide that AKCL may only sell
disks for incorporation into disk drives that are assembled in Japan, with no
limitation on the territory in which AKCL's customers can sell such assembled
disk drive products. During the term of the joint venture agreement and for five
years thereafter, the Japanese partners and their affiliates have agreed not to
develop, manufacture or sell sputtered media anywhere in the world other than
through the joint venture, and the Company and its affiliates have agreed not to
develop, manufacture or sell such media in Japan except
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through the joint venture. The Company has, however, periodically granted AKCL a
limited right to sell its disks outside of Japan and has received royalties on
such sales. Upon the occurrence of certain terminating events and the subsequent
acquisition of AKCL by one or more of the joint venture partners, the
restrictions related to activities of the acquiring joint venture partner(s)
within Japan may lapse.
Disk sales to AKCL represented 3% of the Company's net sales in 1998
compared to 14% in 1997 and less than 6% in 1996. The Company purchased 1% of
AKCL's unit output during 1998 compared to approximately 11% and 3% in 1997 and
1996, respectively. The Company anticipates that distribution sales of
AKCL-produced disks to U.S. customers in 1999 will remain a relatively small
percentage of the Company's net sales.
Substantially lower average selling prices, coupled with equipment
writedowns and lower manufacturing yields, adversely affected AKCL's financial
results for 1998. AKCL completed a transition to static sputter equipment in
early 1998. As a result, AKCL idled its remaining in-line sputtering equipment
and wrotedown the remaining book value of these permanently impaired assets
during 1998. AKCL believes that the products produced by a static sputtering
process are 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.
AKCL incurred substantial losses in 1998. In the first half of 1998 AKCL
incurred low yields and operated significantly under capacity. In the second
half of 1998 unit volume and manufacturing yields increased but the overall
average selling price for AKCL's products decreased sharply. AKCL's current
financing arrangements may not be sufficient if losses continue at AKCL. 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. The Company has no obligation to provide or
guarantee financing to AKCL. Further writedowns of the Company's investment in
AKCL are limited to the book value of the investment on the Company's
consolidated balance sheet ($1.4 million at January 3, 1999).
Komag Material Technology, Inc. ("KMT")
In 1988, Komag formed a wholly owned subsidiary, KMT, to secure an
additional stable supply of aluminum substrates of satisfactory quality for the
Company's products. In 1989, Kobe, a leading worldwide supplier of blank
aluminum substrates, purchased a 45% interest in KMT for $1.4 million. In
December 1995, the Company reacquired 25% of the outstanding Common Stock of KMT
by purchasing shares from Kobe for $6.75 million. The Company's purchase raised
its total ownership percentage of KMT to 80%. Kobe retains one seat on KMT's
Board of Directors.
Under agreements between Kobe and the Company, Kobe will continue to supply
substrate blanks to KMT while the Company will continue to purchase KMT's entire
output of finished substrates. In combination, KMT, Kobe, and the Company's
Sarawak facility supply substantially all of the Company's substrate
requirements.
Equity Positions Held by Asahi Glass and Kobe in Komag
Asahi Glass and Kobe each purchased two million shares of newly issued
Common Stock from the Company for $20 million in January 1989 and March 1990,
respectively. In 1992, Asahi Glass transferred ownership of its shares to a U.S.
subsidiary of Asahi Glass. Under their respective stock purchase agreements,
Asahi Glass and Kobe each have the right to purchase additional shares of the
Company's Common Stock on the open market to increase their respective equity
interests in the Company to 20%, to maintain their percentage interest in the
Company by purchasing their pro rata shares of any new equity issuance by the
Company and to require the Company to register their shares for resale, either
on a demand basis or concurrent with an offering by the Company. Each stock
purchase agreement further provides that the Company shall use its best efforts
to elect a representative of each
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investor to the Company's Board of Directors and to include such representatives
on the Nominating Committee of the Board. There were no purchases or sales of
the Company's stock by Asahi Glass or Kobe in 1998 and according to the
Company's stock records at February 28, 1999, Asahi America and Kobe held
2,000,000 and 2,000,002 shares of Common Stock, respectively. Sales of
significant amounts of the security holdings of Asahi Glass and/or Kobe in the
future could adversely affect the market price of the Company's Common Stock.
Any sales by either party, however, would relieve the Company of its obligation
to nominate that party's representative for election to the Board of Directors.
Competition
Current thin-film disk competitors fall into three groups: U.S. independent
manufacturers, U.S. captive manufacturers, and Japanese/Asian manufacturers.
Based upon research conducted by an independent market research firm, the
Company believes it is the leading independent supplier of thin-film disks. U.S.
independent thin-film disk competitors in 1998 included HMT Technology
Corporation and StorMedia Inc. ("StorMedia"). StorMedia ceased operations and
declared bankruptcy in the third quarter of 1998. Japan-based thin-film disk
competitors include Fuji Electric Company, Ltd.; Mitsubishi Kasei Corp.; Showa
Denko K.K.; and HOYA Corporation. The U.S. captive manufacturers include IBM and
OEM disk drive manufacturers, such as Seagate Technology, Inc. ("Seagate") and
Western Digital, which manufacture disks as a part of their vertical integration
programs. In addition, Maxtor received a portion of its disks requirements from
MaxMedia, a subsidiary of Hyundai Electronics America. Hyundai Electronics
America is a major shareholder of Maxtor. To date, IBM and other OEM disk drive
manufacturers have sold nominal quantities of disks in the open market.
Prior to 1997, the U.S. independent manufacturers, U.S. captive
manufacturers, and Japanese/Asian manufacturers each supplied approximately
one-third of the worldwide thin-film disk unit output. The Company believes that
the captive manufacturers increased their market share to approximately 40% and
50% in 1997 and 1998, respectively. The increased market share for the captive
suppliers heightened price competition among the independent media suppliers for
the remaining available market. This significant pricing pressure adversely
affected the financial results of independent suppliers, including those of
Komag. See "Risk Factors--Competition."
Environmental Regulation
The Company is subject to a variety of environmental and other regulations
in connection with its operations and believes that it has obtained all
necessary permits for its operations. The Company uses various industrial
hazardous materials, including metal plating solutions, in its manufacturing
processes. Wastes from the Company's manufacturing processes are either stored
in areas with secondary containment before removal to a disposal site or
processed on site and discharged to the industrial sewer system.
The Company has made investments in upgrading its waste-water treatment
facilities to improve the performance and consistency of its waste-water
processing. Nonetheless, industrial waste-water discharges from the Company may,
in the future, be subject to more stringent regulations. Failure to comply with
present or future regulations could result in the suspension or cessation of
part or all of the Company's operations. Such regulations could restrict the
Company's ability to expand at its present locations or could require the
Company to acquire costly equipment or incur other significant expenses.
Patents and Proprietary Information
Komag holds and has applied for U.S. and foreign patents and has entered
into cross-licenses with certain of its customers. While possession of patents
could present obstacles to the introduction of new products by competitors and
possibly result in royalty-bearing licenses from third parties, the Company
believes that its success does not depend on the ownership of intellectual
property rights but rather on its
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<PAGE>
innovative skills, technical competence and marketing abilities. Accordingly,
the patents held and applied for will not constitute any assurance of the
Company's future success.
The Company regards elements of its equipment designs and processes as
proprietary and confidential and relies upon employee and vendor nondisclosure
agreements and a system of internal safeguards for protection. Despite these
steps for protecting proprietary and confidential information, there is a risk
that competitors may obtain and use such information. Furthermore, the laws of
certain foreign countries in which the Company does business may provide a
lesser degree of protection to the Company's proprietary and confidential
information than provided by the laws of the U.S. In addition, the Company from
time to time receives proprietary and confidential information from vendors,
customers and partners, the use and disclosure of which are governed by
nondisclosure agreements. Through internal communication and the monitoring of
use and disclosure of such information, the Company complies with its
obligations regarding use and nondisclosure. However, despite these efforts,
there is a risk that such information may be used or disclosed in violation of
the Company's obligations of nondisclosure.
The Company has occasionally received, and may receive in the future,
communications from third parties asserting violation of intellectual rights
alleged to cover certain of the Company's products or manufacturing processes or
equipment. In such cases, the Company evaluates whether it would be necessary to
defend against the claims or to seek licenses to the rights referred to in such
communications. No assurance can be given that the Company will be able to
negotiate necessary licenses on terms that would not have a material adverse
effect on the Company or that any litigation resulting from such claims would
not have a material adverse effect on the Company's business and financial
results.
Employees
As of January 3, 1999, the Company and its consolidated subsidiaries had
4,086 employees (4,012 of which are regular employees and 74 of which were
employed on a temporary basis), including 3,665 in manufacturing, 269 in
research, development and engineering and 152 in sales, administrative and
management positions. Of the total, 2,611 are employed at offshore facilities.
The Company believes that its future success will depend in large part upon
its ability to continue to attract, retain and motivate highly skilled and
dedicated employees. None of the Company's employees is represented by a labor
union and the Company has never experienced a work stoppage.
Risk Factors
The following discussion of risks and uncertainties facing Komag is
presented in accordance with the SEC's Plain English requirements.
Our business is subject to a number of risks and uncertainties. While this
discussion represents our current judgment on the risks facing us and the future
direction of our business, such risks and uncertainties could cause actual
results to differ materially from any future performance suggested herein. The
discussion contained in Item 1--"Business" and Item 7--"Management's Discussion
and Analysis of Financial Condition and Results of Operations" contains
predictions, estimates and other forward-looking statements that involve a
number of risks and uncertainties. Among the factors that could cause actual
results to differ are the following. We sell a single product into a market
characterized by rapid technological change and sudden shifts in the balance
between supply and demand. Further, we are dependent on a limited number of
customers, some of whom also manufacture some or most of their own disks
internally. Competition in the market, defined by both technology offerings and
pricing, can be fierce, especially during times of excess available capacity.
Such conditions were prevalent in 1998. We have a high fixed-cost structure that
can cause operating results to vary dramatically with changes in product yields
and utilization of our equipment and factories. In addition, our business
requires
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<PAGE>
substantial investments for research and development activities and for physical
assets such as equipment and facilities that are dependent on our access to
financial resources. These and other risks are discussed more fully below. We
undertake no obligation to publicly release the result of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
Our Business Depends on the Success of the Hard Disk Drive Industry
The demand for our high-performance thin-film disks depends on the demand
for hard disk drives and our ability to provide high quality, technically
superior products at competitive prices. The hard disk drive market is
characterized by short product life cycles and rapid technological change. The
market is also characterized by changes in the balance between supply and
demand. During periods of excess supply, prices can drop rapidly, causing abrupt
changes in our financial performance.
Demand for disk drives grew rapidly for years, including a 22% increase in
1996 unit shipments over 1995, and industry forecasts were for continued strong
growth. Komag and a majority of our 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 to approximately 8%. 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, resulted in excess media production
capacity in the last half of 1997 and continuing through 1998. This excess media
production capacity caused sharp declines in average selling prices for disk
products as independent suppliers struggled to utilize their capacity. Pricing
pressure on component suppliers was further compounded by high consumer demand
for sub-$1,000 personal computers.
Recently, the disk drive industry has migrated from qualifying specific
vendors to qualifying specific vendor plant sites for given product programs.
This practice reduces the disk drive manufacturer's cost to qualify a given
product and, in some cases, is a requirement imposed upon the disk drive
manufacturer by computer systems manufacturers. Qualification by plant site
limits our ability to more quickly balance production levels at our various
plants and, in periods of excess capacity, may require us to staff and operate
multiple plants inefficiently. Furthermore, our failure to qualify new products
and/or successfully achieve volume production of such products could adversely
affect our results of operations.
In general, our customers have been moving towards fewer, larger-volume
disk drive programs, characterized by shorter product life cycles. Additionally,
media must be more customized to each disk drive program and supply chain
management, including just-in-time delivery, is rapidly becoming a standard
industry practice. Timely development of new products and technologies that
assist customers in reducing their time-to-market performance and operational
excellence that supports high-volume manufacturing ramps and tight inventory
management throughout the supply chain will be keys to both the maintenance of
constructive customer relationships and our profitability. We cannot assure you
that we will be able to respond to this rapidly changing environment in a manner
that will maximize utilization of our production facilities and minimize our
inventory losses.
We are in Default under Financial Covenants Contained in Our Bank Credit
Facilities
The size of our second quarter 1998 net loss resulted in a default
under certain financial covenants contained in our bank credit facilities. We
are not in payment default under these credit facilities as we have continued to
pay all interest charges and fees associated with these facilities on their
scheduled due dates. At the time of the covenant default we had $260 million of
debt outstanding against a total borrowing capacity of $345 million under our
various senior unsecured credit facilities. As a result of the covenant default,
our lenders withdrew the $85 million in unused borrowing capacity.
13
<PAGE>
To date, our lenders have not accelerated any principal payments under our
credit facilities. As a result of the technical default and reclassification of
our bank debt to current liabilities, our auditors have included a going concern
paragraph in their audit opinion to highlight our need to amend or restructure
our debt obligations.
We are currently negotiating with our lenders for amendments to our 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. We cannot assure you that we will be able to obtain such
amendments to our credit facilities on commercially reasonable terms. If we do
not successfully amend these credit facilities, we would remain in technical
default of our 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, we would continue to operate in default for
the near term. However, we will likely need to raise additional funds to
restructure our debt obligations and to operate our business for the long term.
Over the next several years we will need financial resources for
capital expenditures, working capital and research and development. During 1997
and 1998, we spent approximately $199 million and $89 million, respectively, on
property, plant and equipment. In 1999, we plan to spend approximately $40
million on property, plant and equipment, primarily for projects designed to
improve yield and productivity. We believe that in order to achieve our
long-term growth objectives and maintain and enhance our competitive position,
such additional financial resources will be required. We cannot assure you that
we will be able to secure such financial resources on commercially reasonable
terms. If we are unable to obtain adequate financing, we could be required to
significantly reduce or possibly suspend our operations, and/or sell additional
securities on terms that would be highly dilutive to our current stockholders.
We are Dependent on a Small Number of Customers for Most of our Business
Our sales are concentrated in a small number of customers. This
concentration is due to the high-volume requirements of the dominant disk drive
manufacturers and their tendency to rely on a few suppliers because of the close
interrelationship between media performance and disk drive performance and the
complexity of integrating components from a variety of suppliers. Our net sales
to major customers in 1998 were as follows:
o Western Digital Corporation ("Western Digital")--43%;
o Maxtor Corporation, ("Maxtor")--25%; and
o International Business Machines ("IBM")--18%.
Given the relatively small number of disk drive manufacturers, we expect that we
will continue to depend on a very limited number of customers.
Our sales are generally made pursuant to purchase orders that are subject
to cancellation, modification or rescheduling without significant penalties. We
cannot assure you that our current customers will continue to place orders with
us, that orders by existing customers will recover to the levels of earlier
periods or that we will be able to obtain orders from new customers.
In addition, given our dependence on a few customers and a limited number
of product programs for each customer, we must make significant inventory
commitments to support our customers' programs. We have limited remedies in the
event of program cancellations. If a customer cancels or materially reduces one
or more product programs, or experiences financial difficulties, we may be
required to take significant inventory charges, which, in turn, could materially
and adversely affect our results of
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<PAGE>
operations. While we have taken certain charges including inventory write-downs
to address known issues, we cannot assure you that we will not be required to
take additional inventory writedowns due to our inability to obtain necessary
product qualifications or due to further order cancellations by customers.
The Hard Disk Drive Industry is Very Competitive
Our thin-film disk products primarily serve the 3 1/2-inch hard disk drive
market, where product performance, consistent quality and availability are of
great competitive importance. To succeed in an industry characterized by rapid
technological developments, we must continuously advance our thin-film
technology at a pace consistent with or faster than our competitors. If we are
unable to keep pace with rapid advances, we may lose market share and face
increased price competition from other manufacturers. Such competition could
materially adversely affect our results of operations.
In response to higher historical and projected growth rates for the disk
drive market, Komag and a majority of our competitors (both independent disk
manufacturers and captive disk manufacturers owned by vertically integrated disk
drive customers) substantially increased disk manufacturing capacity in 1997 to
satisfy the anticipated demand for disk products. These significant investments
in capable new disk production capacity, combined with the slowdown in demand,
have resulted in excess disk media capacity in the merchant market as drive
manufacturers sourced a higher portion of their disk requirements from their
captive media operations. This excess supply over demand condition has increased
competition for the remaining merchant market and has led to
higher-than-historical price erosion and lower factory utilization among
independent media suppliers. These market conditions adversely affected our
results of operations beginning in the last half of 1997 and continued
throughout 1998. Our operating results for the last half of 1998 improved
relative to results for the first half of 1998 due to the lower cost structure
associated with our restructuring activities, variable cost reductions, improved
manufacturing yields, and higher factory utilization. We believe that our
manufacturing operations in Penang and Sarawak, Malaysia can provide a
competitive cost advantage relative to most other thin-film disk manufacturers
that operate exclusively or primarily in the U.S. and Japan.
We also compete against media operations owned directly by or affiliated
with many of our customers for the supply of the thin-film disks. Of our
customers, IBM, Seagate and Western Digital produce significant portions of
their media demand through their directly-owned media operations. During 1998
IBM and Seagate produced more than 80% of their media demand internally, and
Western Digital produced more than 60% of its media requirement internally.
During 1998, MaxMedia supplied approximately 40% of Maxtor's requirement for
media. Hyundai Electronics America owns MaxMedia and is also a major shareholder
in Maxtor. To date, MaxMedia and the captive media operations of IBM, Seagate,
and Western Digital have sold nominal quantities of disks in the merchant
market.
Our Operating results are Subject to Quarterly Fluctuations
We believe that our future operating results will continue to be subject to
quarterly variations based upon a wide variety of factors, including:
o the cyclical nature of the hard disk drive industry;
o our ability to develop and implement new manufacturing process
technologies;
o increases in our production and engineering costs associated with
initial design and production of new product programs;
o the extensibility of our process equipment to meet more stringent
future product requirements;
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o our ability to introduce new products that achieve cost-effective,
high-volume production in a timely manner;
o changes in our product mix and average selling prices;
o the availability and the extent of utilization of our production
capacity;
o changes in our manufacturing efficiencies, in particular product yields
and input costs for direct materials, operating supplies and other
running costs;
o prolonged disruptions of operations at any of our facilities for any
reason;
o changes in the cost of or limitations on availability of labor; and
o structural changes within the disk media industry, including
combinations, failures, and joint venture arrangements.
Because thin-film disk manufacturing requires a high level of fixed costs,
our gross margins are also extremely sensitive to changes in volume. At constant
average selling prices, reductions in our manufacturing efficiency cause
declines in our gross margins. Additionally, decreasing market demand for our
products generally results in reduced average selling prices and/or low capacity
utilization that, in turn, adversely affect gross margins and operating results.
We incurred substantial negative gross margins of 41.5% and 45.2% during the
first and second quarters of 1998, respectively, as a result of the combination
of the lower overall average selling price and higher unit production costs
related to underutilized capacity. Our gross margin improved in the third and
fourth quarters of 1998 to negative 3.4% and positive 7.9%, respectively,
primarily due to:
o increased unit volume;
o higher manufacturing yields;
o reduced material input costs; and
o the lower fixed cost structure of our business resulting from our
implementation of restructuring plans.
Industry consolidation, including mergers, alliances or failures, within
the hard disk drive industry can cause sudden market changes making capacity
planning difficult and causing dramatic fluctuations in operating results. In
1998, disk drive makers JTS Corporation and Micropolis (USA) Inc. ceased
operations. StorMedia Inc., one of our thin-film media competitors, also ceased
operations in 1998. While we believe that further consolidation within hard disk
drive manufacturers and media manufacturers will likely be beneficial to the
industry for the long-term, we cannot assure you that such consolidation would
not have an adverse affect on our results of operations.
The Thin-film Disk Industry has been Characterized by Rapid Technology
Developments, Increasingly Shorter Product Life Cycles and Price Erosion
We believe that our future success depends, in large measure, on our
ability to develop and implement new process technologies in a timely manner and
to continually improve these technologies. New process technologies must support
cost-effective, high-volume production of thin-film disks that meet the
ever-advancing customer requirements for enhanced magnetic recording
performance.
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<PAGE>
In this regard, in 1998, we modified our plating and polishing process for
aluminum substrates and our sputtering process for applications of magnetic
layers to the surface of a disk. Both changes required substantial process and
equipment modifications. In the fourth quarter of 1998, more than three-quarters
of our unit sales were manufactured using these new processes.
Advances in hard disk drive technology demands continually lower glide
heights and higher areal densities requiring substantial on-going process and
technology development. Additionally, the development of alternatives to
aluminum-based substrates, such as glass-based substrates, may require
substantial investments in new process technologies and capital expenditures. We
expect that manufacturers will migrate their programs to glass as the cost of
glass-based media technologies decreases and/or demands for increasingly
higher-density products require the technological advantages offered by glass.
We have devoted a portion of our research and development efforts to glass-based
technologies. However, we cannot assure you that we will be able to develop
cost-efficient processes to compete in the glass-based thin-film media market.
Although we have a significant, ongoing research and development effort to
advance our process technologies and the resulting products, we cannot assure
you that we will be able to develop and implement such technologies in a timely
manner in order to compete effectively against competitors' products and/or
entirely new data storage technologies. Our results of operations would be
materially adversely affected if our efforts to advance our process technologies
are not successful or if the technologies that we have chosen not to develop
proved to be viable competitive alternatives.
Our Foreign Operations and Joint Ventures Entail Risks to Our Business and
Operations
In 1998, our sales to customers in the Far East, including the foreign
subsidiaries of domestic disk drive companies, accounted for approximately 83%
of our net sales from our U.S. and Malaysian facilities. Our customers assemble
a substantial portion of their disk drives in the Far East and subsequently sell
these products throughout the world. Therefore, our high concentration of Far
East sales does not accurately reflect the eventual point of consumption of the
assembled disk drives. We anticipate that international sales will continue to
represent the majority of our net sales. All of our sales are currently priced
in U.S. dollars worldwide. Certain costs at our foreign manufacturing and
marketing operations are incurred in the local currency. We also purchase
certain operating supplies and production equipment from Japanese suppliers in
yen-denominated transactions. Accordingly, our operating results are subject to
the risks inherent with international operations, including, but not limited to:
o compliance with or changes in the law and regulatory requirements of
foreign jurisdictions;
o fluctuations in exchange rates, tariffs or other barriers;
o difficulties in staffing and managing foreign operations;
o exposure to taxes in multiple jurisdictions; and
o transportation delays and interruptions.
Our Malaysian operations accounted for a significant portion of our 1998
consolidated net sales. Prolonged disruption of operations in Malaysia for any
reason would cause delays in shipments of our products, thus materially
adversely affecting our results of operations. Changes in relative currency
values can be swift and unpredictable. In 1998, economic difficulties and
political unrest throughout Southeast Asia created substantial currency
devaluations in the region. In mid-1998, the Malaysian government devalued the
Malaysian ringgit ("MR") to a fixed exchange rate of 3.8 MR to $1 U.S. While the
effect of a devaluation in the MR reduces the U.S. dollar equivalent of MR-based
operating
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<PAGE>
expenses, future fluctuations could also have the opposite effect. While the
political and economic issues in Southeast Asia have not had a material adverse
affect on our Malaysian operations, we cannot assure you that future events
would not cause a disruption in our operations. Extended disruptions would have
a material adverse affect on our results of operations.
Fluctuations in the financial results of AKCL, our unconsolidated Japanese
disk manufacturing joint venture, also impact our financial performance. Our
equity in the net loss of AKCL increased our 1998 consolidated net loss by $27.0
million. Equipment writedowns for permanent impairment on AKCL's in-line
sputtering equipment, coupled with low sales volumes in the first half of 1998
and substantially lower average selling prices and manufacturing yields,
adversely affected AKCL's financial results for 1998. Further writedowns of our
investment in AKCL are limited to the book value of the investment on our
consolidated balance sheet ($1.4 million at January 3, 1999) assuming the
Japanese yen to U.S. dollar exchange rate remains stable. Our investment in AKCL
is adjusted for changes in the prevailing rate of exchange between the yen and
dollar. A strengthening yen increases the dollar-based investment balance. AKCL
is subject to many of the same risks that we face, including dependence on a
limited customer base. Additionally, AKCL is subject to risks associated with
fluctuations in the relative strength of the Japanese Yen to the U.S. dollar.
AKCL, which bases the pricing for a large portion of its products in U.S.
dollars, incurs most of its costs in Japanese Yen.
The Market Price of Our Common Stock has been Volatile
The market price of our common stock has been volatile in response to
actual and anticipated quarterly variations in:
o our operating results;
o perceptions of the disk drive industry's relative strength or weakness;
o developments in our relationships with our customers and/or suppliers;
o announcements of alliances, mergers or other relationships by or
between our competitors and/or customers;
o announcements of technological innovations or new products by us or our
competitors;
o the success or failure of new product qualifications;
o developments related to patents or other intellectual property rights;
and
o other events or factors.
We expect this volatility to continue in the future. In addition, any
shortfall or changes in our revenue, gross margins, earnings or other financial
results from analysts' expectations could cause the price of our Common Stock to
fluctuate significantly. In recent years, the stock market in general has
experienced extreme price and volume fluctuations which have particularly
affected the market price of many technology companies and which have often been
unrelated to the operating performance of those companies. These broad market
fluctuations may adversely affect the market price of our Common Stock.
Volatility in the price of stocks of companies in the hard disk drive industry
has been particularly high, especially during 1997 and 1998. During this period
the price of our stock fell to a low of $2 5/8 during the third quarter of 1998
from a high of $35 1/8 during the second quarter of 1997. See "Price Range of
Common Stock."
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Our Business Depends on Our Ability to Protect Our Patents and Proprietary
Information Rights
Protection of technology through patents and other forms of intellectual
property rights in technically sophisticated fields is commonplace. In the disk
drive industry, it is not uncommon for companies and individuals to initiate
actions against others in the industry to enforce intellectual property rights.
We cannot assure you that others have not or will not perfect intellectual
property rights and either enforce those rights to prevent us from using certain
technologies or demand royalty payments from us in return for using those
technologies, either of which may have a material adverse affect on our results
of operations. As a measure of protection, we have entered into cross-license
agreements with certain customers. In addition, we review, on a routine basis,
patent issuances in the U.S. and patent applications that are published in
Japan. Through these reviews, we occasionally become aware of a patent, or an
application that may mature into a patent, which could give rise to a claim of
infringement. When such patents are identified, we investigate the validity and
possibility of actual infringement. We are presently involved in such an
investigation of several recently issued patents. However, we cannot assure you
that we will anticipate claims that we infringe the technology of others or
successfully defend ourselves against such claims. Similarly, we cannot assure
you that we will discover significant infringements of our technology or
successfully enforce our rights to our technology if we discover infringing
uses.
We Rely on a Limited Number of Suppliers for Materials and Equipment Used in Our
Manufacturing Processes
We rely on a limited number of suppliers, and in some cases a sole
supplier, for some of the materials and equipment used in our manufacturing
processes including aluminum substrates, nickel plating solutions, polishing and
texturing supplies, and sputtering target materials. As a result, our production
capacity would be limited if one or more of these materials were to become
unavailable or available in reduced quantities. If such materials were
unavailable for a significant period of time, our results of operations would be
adversely affected.
Earthquakes or Other Natural or Man-made Disasters Could Disrupt Our Operations
Our California manufacturing facilities, our Japanese joint venture (AKCL),
our Japanese supplier of aluminum blanks for substrate production, other
Japanese suppliers of key manufacturing supplies and our Japanese supplier of
sputtering machines are each located in areas with seismic activity. Our
Malaysian operations have been subject to temporary production interruptions due
to localized flooding, disruptions in the delivery of electrical power, and, on
one occasion in 1997, by smoke generated by large, widespread fires in
Indonesia. These events have in the past disrupted production and prevented a
portion of our workforce from reaching the facility. We cannot assure you that
natural or man-made disasters will not result in a prolonged disruption of
production in the future. If any natural or man-made disasters do occur, they
could have a material adverse effect on our results of operations.
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ITEM 2. PROPERTIES
Worldwide (excluding AKCL), the Company currently occupies facilities
totaling approximately 1.6 million square feet. The Company owns three
manufacturing facilities in Malaysia, two in Penang and one in Sarawak. The
square footage of each of these facilities and acreage of the related land
parcels are 340,000 square feet and 13 acres, 275,000 square feet and 18 acres,
and 275,000 square feet and 89 acres. The Company leases four manufacturing
facilities in San Jose and Santa Rosa, California. These facilities are leased
for the following terms:
Facility Size Current Lease
(square feet) Term Expires Extension Options
------------- ------------- -----------------
225,000 September 2006 20 years
188,000 January 2007 20 years
103,000 July 1999 10 years
97,000(1) February 2001 10 years
82,000 February 2007 20 years
48,000 December 1999 --
44,000 April 1999 10 years
In addition to the facilities listed above, the Company leases other
smaller facilities in California and Singapore. The Company owned approximately
6 acres of undeveloped land adjacent to its Milpitas manufacturing complex which
was sold in March 1998.
(1) This facility was vacated in the third quarter of 1997 as part of the
Company's restructuring plan and subleased in December 1997.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings to which either the Company or its
subsidiaries is a party or to which any of its property is subject.
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ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to the stockholders of the Company during the
Company's fourth quarter of 1998.
Executive Officers of the Registrant
<TABLE>
As of February 23, 1999, the executive officers of the Company are as
follows:
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Tu Chen.............................63 Chairman of the Board of Directors
Stephen C. Johnson..................56 President, Chief Executive Officer and Director
Christopher H. Bajorek..............55 Senior Vice President--Chief Technical Officer
Ray Martin..........................55 Senior Vice President--Customer Sales and Service
William L. Potts, Jr................52 Senior Vice President, Chief Financial Officer
and Secretary
Thian Hoo Tan.......................50 Senior Vice President--Operations
Ronald Allen........................50 Vice President--Manufacturing Technologies
Richard Austin......................43 Vice President--Worldwide Substrate
Manufacturing and Support Services
Tim Gallagher.......................46 Vice President--Product Development
Elizabeth A. Lamb...................47 Vice President--Human Resources
Thiam Seng Tan......................42 Vice President--Penang Operations
Eric Tu.............................45 Vice President--U.S. Media Operations
Tsutomu T. Yamashita................44 Vice President--Research and Process
Development
</TABLE>
Dr. Chen is a founder of the Company and has served as Chairman of the
Board from its inception in June 1983. From 1971 to June 1983, he was a Member,
Research Staff, and Principal Scientist at Xerox Corporation's Palo Alto
Research Center. From 1968 to 1971, Dr. Chen was employed as a research
scientist for Northrop Corp. Dr. Chen received his Ph.D. and M.S. degrees in
Metallurgical Engineering from the University of Minnesota and holds a B.S.
degree in Metallurgical Engineering from Cheng Kung University in Taiwan. Dr.
Chen is a director of Headway Technologies, Inc.
Mr. Johnson has served as President and Chief Executive Officer of the
Company since September 1983. From 1977 to 1983, Mr. Johnson was an officer of
Boschert Incorporated, a manufacturer of switching power supplies, initially as
Vice President, Marketing and subsequently as President and Chief Executive
Officer. Mr. Johnson holds a B.S. degree in Engineering from Princeton
University, a M.S. degree in Electrical Engineering from the University of New
Mexico and an M.B.A. degree from the Harvard Graduate School of Business. Mr.
Johnson is a director of Exabyte Corporation and Uniphase Corporation.
Dr. Bajorek joined the Company and was elected to the newly created
position of Senior Vice President-Chief Technical Officer in June 1996. Prior to
joining Komag, Dr. Bajorek was Vice President, Technology Development and
Manufacturing, for the Storage Systems Division of IBM in San Jose, California.
During his 25-year career with IBM, Dr. Bajorek held various positions in
research and management related to magnetic recording, magnetic bubble and
optical storage applications. He holds a Ph.D. degree in Electrical Engineering
and Business Economics from the California Institute of Technology. Dr. Bajorek
is a director of the International Disk Drive Equipment and Materials
Association (IDEMA), an industry trade association.
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Mr. Martin joined the Company in October 1997 and served as Vice
President--Product Assurance and Product Test until his promotion to Senior Vice
President--Customer Sales and Service in June 1998. From 1990 to 1997, he headed
product engineering and head/media development as Director of Process and
Technology at Quantum Corporation. Prior to working at Quantum, Mr. Martin held
a number of management and engineering positions at several leading disk drive
manufacturers, including Western Digital, Seagate, and IBM. Mr. Martin holds a
B.S. degree in Mechanical Engineering from Kansas State University.
Mr. Potts joined the Company in 1987 and served as Vice President and Chief
Financial Officer from January 1991 until his promotion to Senior Vice President
and Chief Financial Officer in January 1996. In addition, Mr. Potts serves as
Secretary. Prior to joining Komag, Mr. Potts held financial management positions
at several high-technology manufacturing concerns. He has also served on the
consulting staff of Arthur Andersen & Co. Mr. Potts holds a B.S. degree in
Industrial Engineering from Lehigh University and an M.B.A. degree from the
Stanford Graduate School of Business.
Mr. Thian Hoo Tan was appointed Vice President of Manufacturing in
September 1993 and was promoted to Senior Vice President--Operations in February
1998. He previously served as Vice President--Manufacturing--Asia Operations in
charge of the Company's operations in Penang and Sarawak, Malaysia. Mr. Tan
joined Komag in 1989 and was in charge of operations at the Company's first San
Jose, California manufacturing facility. Before joining Komag in 1989, Mr. Tan
was Vice President of Operations at HMT Technology. Mr. Tan holds a M.S. degree
in Physics from the University of Malaya at Kuala Lumpur.
Mr. Allen was promoted to Vice President--Manufacturing Technologies in
January 1997. Mr. Allen joined the Company in October 1983 to establish the
Company's automation manufacturing program that he has since directed. Prior to
joining Komag, Mr. Allen was employed with Xerox's Palo Alto Research Center as
a member of the research staff. Mr. Allen also worked at General Electric, in
the Schenectady Research Center. Mr. Allen holds a B.S. degree in Physics and a
minor in Chemistry from Dillard University.
Mr. Austin joined the Company in October 1988 as Facilities and Equipment
Maintenance Manager. Prior to his appointment as Vice President--Worldwide
Substrate Manufacturing and Support Services in June 1998, Mr. Austin served
Komag as Vice President--U.S. Manufacturing. Prior to joining Komag, Mr. Austin
was an Equipment Maintenance and Facilities Manager at VLSI Technology Inc. Mr.
Austin also worked at National Semiconductor and Rockwell International between
1975 and 1983.
Dr. Gallagher joined the Company in May 1996 as Director of Advanced
Product Integration and served in that capacity until his promotion to Vice
President--Product Development in July 1998. Prior to joining Komag, Dr.
Gallagher held positions as Director of New Products at Seagate and Senior
Technical Staff Member at IBM, working primarily on advanced disk and recording
head development. He holds a PhD degree in Applied Physics from the California
Institute of Technology.
Ms. Lamb joined the Company as Vice President--Human Resources in October
1996. From 1995 to 1996 she was Director of Worldwide Staffing and Employee
Relations at Adaptec. Prior to that, Ms. Lamb was Director of Compensation,
Benefits and Executive programs at Tandem. Ms. Lamb holds a B.A. degree in
Communications from San Jose State University.
Mr. Thiam Seng Tan joined the Company in December 1993 as Director of
Quality Assurance. He was appointed Vice President--Penang Operations in October
1998. Prior to joining the Company, Mr. Tan held positions in manufacturing,
engineering, customer service and materials management at Hewlett Packard Sdn.
Bhd. from 1979 to 1993. Mr. Tan holds a B.Sc. degree in Mechanical Engineering
from the University of London.
22
<PAGE>
Mr. Tu rejoined the Company as Vice President--U.S. Media Operations in
July 1998. He previously worked for Komag from 1988 to 1993. Prior to rejoining
the Company, Mr. Tu held senior manufacturing positions with Kobe Precision,
Inc., a manufacturer of aluminum substrates and Fuji Electric (Malaysia) Sdn.
Bhd., a computer hard disk maker in Malaysia. Mr. Tu holds a MS degree in
Mechanical Engineering from University of Missouri.
Mr. Yamashita joined the Company in 1984 and was Senior Director of
Research prior to his promotion to Vice President--Research and Development in
January 1995. Mr. Yamashita currently serves as Vice President--Research and
Process Development. Prior to joining the Company, Mr. Yamashita was a graduate
research assistant in the Department of Material Science and Engineering at
Stanford University. Mr. Yamashita holds a B.S. degree in Chemistry and an M.S.
degree in Materials Science from Stanford University.
23
<PAGE>
PART II
ITEMS 5, 6, 7 and 8.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol KMAG. The following table sets forth the range of high and low
closing sales prices, as reported on the Nasdaq National Market. At March 1,
1999 the Company had approximately 476 holders of record of its Common Stock and
53,923,044 shares outstanding.
Price Range of
Common Stock
------------
High Low
---- ---
1997
First Quarter 32 7/8 25 13/32
Second Quarter 35 1/8 16 7/16
Third Quarter 22 7/16 16 1/8
Fourth Quarter 21 3/8 14 1/2
1998
First Quarter 15 5/8 12 1/16
Second Quarter 15 1/2 5 5/8
Third Quarter 6 1/8 2 5/8
Fourth Quarter 11 2 1/8
1999
First Quarter (through March 30, 1999) 15 1/4 4 13/16
DIVIDEND POLICY
The Company has never paid cash dividends on its Common Stock. The
Company presently intends to retain all cash for use in the operation and
expansion of the Company's business and does not anticipate paying any cash
dividends in the near future. Komag's debt agreements prohibit the payment of
dividends without the lenders' consent.
24
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
The following table sets forth selected consolidated financial data and
other operating information of Komag, Incorporated. The financial data and
operating information is derived from the consolidated financial statements of
Komag, Incorporated and should be read in conjunction with the consolidated
financial statements, related notes and other financial information included
herein.
<CAPTION>
Fiscal Year Ended
-------------------------------------------------------------------------------
1998 (1) 1997 (2) 1996 1995 1994
---------------- ----------------- -------------- -------------- --------------
(in thousands, except per share amounts and number of employees)
<S> <C> <C> <C> <C> <C>
Consolidated Statements of
Operations Data:
Net Sales $ 328,883 $ 631,082 $577,791 $512,248 $392,391
Gross Profit (Loss) (62,752) 93,546 175,567 197,486 125,386
Restructuring Charge 187,768 52,157 - - -
Income (Loss) Before
Minority Interest and Equity
in Joint Venture Income (Loss) (338,789) (16,838) 100,553 101,410 54,156
Minority Interest in Net Income
of Consolidated Subsidiary 544 400 695 1,957 1,091
Equity in Net Income (Loss) of
Unconsolidated Joint Venture (27,003) (4,865) 10,116 7,362 5,457
Net Income (Loss) $(366,336) $ (22,103) $109,974 $106,815 $ 58,522
Basic Net Income (Loss) Per Share $(6.89) $(0.42) $2.15 $2.24 $1.31
Diluted Net Income (Loss) Per Share $(6.89) $(0.42) $2.07 $2.14 $1.27
Consolidated Balance Sheet Data:
Working Capital $ (92,844) $ 296,099 $142,142 $252,218 $118,230
Net Property, Plant & Equipment 470,017 678,596 643,706 329,174 228,883
Long-term Debt (less current portion) - 245,000 70,000 - 16,250
Stockholders' Equity 323,807 686,184 697,940 574,564 331,215
Total Assets $ 694,095 $1,084,664 $938,357 $686,315 $424,095
Number of Employees at Year-end 4,086 4,738 4,101 2,915 2,635
<FN>
(1) Results of operations for 1998 included a $187.8 million restructuring
charge that primarily related to an asset impairment charge of $175
million. The asset impairment charge effectively reduced asset valuations
to reflect the economic effect of industry price erosion for disk media and
projected underutilization of the Company's production equipment and
facilities. Based on analysis of the Company's production capacity and its
expectations of the media market over the remaining life of the Company's
fixed assets, the Company concluded that it would not be able to recover
the book value of those assets.
(2) Results of operations for 1997 included a $52.2 million restructuring
charge related to the consolidation of the Company's U.S. manufacturing
operations.
(3) The Company paid no cash dividends during the five-year period.
</FN>
</TABLE>
25
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
Overview
The Company's business is both capital intensive and volume sensitive,
making capacity planning and efficient capacity use imperative. Physical
capacity, utilization of this physical capacity, yields and average unit sales
price constitute the key determinants of the Company's profitability. Of these
key determinants, price and utilization are the most sensitive to changes in
product demand. If capacity and product price are fixed at a given level and
demand is sufficient to support a higher level of output, then increased output
attained through improved utilization rates and higher manufacturing yields will
translate directly into increased sales and improved gross margins.
Alternatively, if demand for the Company's products decreases, falling average
selling prices and lower capacity utilization will adversely affect the results
of the Company's operations.
Risk Factors
The following discussion contains predictions, estimates and other
forward-looking statements that involve a number of risks and uncertainties.
While this discussion 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 qualification of next-generation products; utilization of
manufacturing facilities; changes in manufacturing efficiencies, in particular
product yields and material input costs; extensibility of process equipment to
meet more stringent future product requirements; structural changes within the
disk media industry such as combinations, failures, and joint venture
arrangements; vertical integration and consolidation within the Company's
customer base; dependence of the Company's sales on a limited number of
customers; increased competition; timely and successful deployment of new
process technologies into manufacturing; and the availability of certain
sole-sourced raw material supplies. See "Business--Risk Factors" for more
detailed discussions of risks and uncertainties facing the Company.
1998 vs. 1997
Operating results for 1998 were significantly lower than 1997. Adverse
market conditions, which began late in the second quarter of 1997, intensified
during 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 by 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 Company's
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
26
<PAGE>
segment. Weakened demand for desktop media products, combined with the
continuing slow recovery of the enterprise-class market segment, lowered overall
media demand. The market share available to independent media suppliers shrank
as captive media operations supplied a larger share of the industry's overall
media requirements. The resulting excess supply of media in the merchant market
heightened price competition among independent media suppliers, including the
Company. The Company's 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 continued
weak merchant market demand for disk media. The Company's 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 would extend into
1999, the Company adjusted its expectations for the utilization of its installed
production capacity. Based on this analysis of the Company's production capacity
and its expectations of the media market over the remaining life of the
Company's fixed assets, the Company concluded that it would not be able to
recover the book value of those assets. As a result, the Company implemented a
restructuring plan in June 1998 and recorded a charge of $187.8 million. This
charge included an asset impairment charge and provisions for facility closure
expenses and severance-related costs. The asset impairment component of the
charge was $175.0 million and effectively reduced asset valuations to reflect
the economic effect of the industry price erosion for disk media and the
projected underutilization of the Company's production equipment and facilities.
Net sales for the third quarter of 1998 increased slightly on a
sequential basis to $81.3 million as the net result of an 8% increase in unit
sales and a 4% decrease in the overall average selling price. The gross margin
percentage improved sequentially to a negative 3.4%. The asset impairment charge
recorded in the second quarter of 1998 lowered depreciation and amortization
charges beginning in June 1998. The impairment charge resulted in a reduction in
depreciation and amortization of approximately $10.2 million in the third
quarter of 1998 compared to the second quarter of 1998. Lower payroll costs, and
improved unit demand, coupled with a favorable impact of certain non-recurring
inventory adjustments, also contributed to the improved gross margin percentage
in the third quarter of 1998.
Net sales for the fourth quarter of 1998 increased to $92.7 million as
the net result of an 18% increase in unit sales and a 4% decrease in the overall
average selling price. The gross margin percentage improved sequentially to a
positive 7.9%. The higher unit volume, higher manufacturing yields, and reduced
material input costs generated the substantial sequential quarterly improvement.
Net Sales
Net sales for 1998 decreased to $328.9 million, down 47.9% from $631.1
million in 1997. The decrease was due to a combination of a 36% decrease in unit
sales volume and a 19% decrease in the overall average selling price. Price
reductions are common on individual product offerings in the thin-film media
industry. The Company has traditionally prevented significant reductions in its
overall
27
<PAGE>
average selling price through transitions to higher-priced, more technologically
advanced product offerings. The effect of price reductions in response to
significant pricing pressures generated by the imbalance in supply and demand
for thin-film media during 1998 more than offset the effect of transitions to
more advanced product offerings.
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 $2.5 million in 1998 compared to $10.5 million in
1997. The Company expects that distribution sales of AKCL product will remain a
relatively small percentage of the Company's net sales.
During 1998, three customers accounted for approximately 86% of
consolidated net sales: Western Digital Corporation ("Western Digital")--43%,
Maxtor Corporation, a subsidiary of Hyundai Electronics America,
("Maxtor")--25%, and International Business Machines ("IBM")--18%. 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 19.1% in
1998 compared to a positive gross margin percentage of 14.8% in 1997. Unit
production decreased 37% in 1998 relative to 1997. The Company operated well
below capacity in 1998 in order to match unit production to the sharply lower
demand for its products. The combination of the lower overall average selling
price, higher unit production costs related to underutilized capacity, and lower
manufacturing yields resulted in the negative gross margin percentage in 1998.
Operating Expenses
Research and development ("R&D") expenses increased 19.9% ($10.2
million) in 1998 relative to 1997. The additional R&D effort was directed toward
the introduction of new product generations, process changes to manufacture such
products, process improvements to increase yields and reduce material input
costs of products in volume production, and increased development efforts to
qualify new products with customers. In 1999, the Company plans to spend
approximately $45-$50 million for R&D. Selling, general and administrative
("SG&A") expenses decreased $7.8 million in 1998 compared to 1997. Lower
provisions for bonus and profit sharing programs (decrease of $3.8 million) and
lower provisions for bad debt (decrease of $2.4 million) resulted in the
majority of the overall decrease in SG&A between the years. Excluding provisions
for bonus and profit sharing programs and provisions for bad debt in 1998, SG&A
expenses decreased $1.6 million. The lower spending was primarily due to lower
payroll and other employee-related costs as a direct result of restructuring
activities completed in the fourth quarter of 1997 and second quarter of 1998.
In the second quarter of 1998, the Company implemented a restructuring
plan which included a reduction in the Company's U.S. and Malaysian workforce
and the cessation of operations at its oldest San Jose, California plant. The
Company recorded a restructuring charge of $187.8 million which included $4.1
million for severance costs (approximately 170 employees, primarily in the
U.S.), $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. The cash component of the total
charge was $12.8 million. Non-cash items in the restructuring/impairment charge
totaled $175.0 million.
During the third quarter of 1997, the Company implemented a
restructuring plan involving the consolidation of its U.S. manufacturing
operations. The Company recorded a $52.2 million restructuring charge which
included $3.9 million for severance costs associated with approximately 330
terminated
28
<PAGE>
employees, $33.0 million for the write-down of the net book value of excess
equipment and disposed of 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.
<TABLE>
The Company incurred lower facility closure costs than anticipated in
the restructuring charges. The oldest Milpitas plant was sublet sooner than
anticipated and the Company reached a lease termination agreement with its
landlord on the second Milpitas plant in the third quarter of 1998. The Company
thereby avoided expected future rent payments and the cost of renovating the
facility to its original lease condition. Additionally, the Company determined
that it would not close its oldest San Jose, California facility at the
expiration of its lease. As a result the Company will not incur costs to restore
the facility to its original lease condition as contemplated in the
restructuring charge. Higher than expected costs for equipment order
cancellations offset the lower facility closure costs. A total of 515 employees
were terminated in the restructuring activities. The following table summarizes
these restructuring activities.
<CAPTION>
Restructuring Incurred
(in millions) Charges Through 1/3/99
---------------- ---------------
<S> <C> <C>
Asset impairment charge $175.0 $175.0
Writedown net book value of equipment
and leasehold improvements 33.0 33.0
Equipment order cancellations and other
equipment related costs 16.0 17.5
Facility closure costs 8.0 2.2
Severance costs 7.9 8.1
</TABLE>
At January 3, 1999, $4.1 million related to the restructuring
activities remained in current liabilities. The Company has made cash payments
totaling approximately $27.8 million primarily for severance, equipment order
cancellations and facility closure costs. The majority of the remaining
liability, primarily for equipment order cancellations, is expected to be
settled through the use of cash by the end of 1999.
Interest Income/Expense and Other Income
Interest income increased $4.1 million (85.2%) in 1998 relative to 1997
primarily due to a higher average investment balance in 1998. Interest expense
increased $10.1 million (110.8%) in 1998 compared to 1997. The higher interest
expense was due to a higher outstanding debt balance in 1998 compared to 1997.
Income Taxes
The Company's income tax provision of approximately $1.3 million for
1998 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 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 March 15, 1999. The tax provision
benefit of 55% for 1997 primarily represents tax loss carrybacks associated with
the Company's U.S. operations. As a result of profitable operations at
29
<PAGE>
KMS in 1997, the tax holiday reduced the Company's 1997 consolidated net loss by
approximately $16.6 million ($0.32 per share under both the basic and diluted
methods).
Minority Interest in Consolidated Subsidiary/Equity in Unconsolidated Joint
Venture
The minority interest in the net income of consolidated subsidiary
during 1998 represented Kobe Steel USA Holdings Inc.'s ("Kobe USA") share of
Komag Material Technology, Inc.'s ("KMT") net income. KMT recorded net income of
$2.7 million and $2.0 million in 1998 and 1997, respectively.
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 $27.0 million as its equity in AKCL's
net loss for 1998 compared to a net loss of $4.9 million recorded for 1997.
AKCL's results for 1997 included a $5.3 million (net of tax) gain on the sale of
its investment in Headway Technologies, Inc. ("Headway"). The Company's equity
in this gain was $2.6 million. Excluding the gain, the Company reported a loss
of $7.5 million as its equity in AKCL's net loss for 1997. The combination of a
significant decrease in the overall average selling price for AKCL's disk
products, lower manufacturing yields, reduced equipment utilization, customer
qualification issues and substantial equipment writedowns adversely affected
AKCL's financial results for 1998. During 1998, AKCL wrote-off its remaining
in-line sputtering equipment as it ramped products on its static sputtering
equipment. AKCL believes that the products produced by a static sputtering
process are 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. During 1997, AKCL operated
substantially under capacity for the majority of the year due to product
transition issues related to AKCL's customer qualification and its production of
MR products.
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 ($1.4
million at January 3, 1999).
Impact of Year 2000
Many computer systems were not designed to handle any 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 is currently in the process of assessing its systems, equipment and
processes to determine its 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.
Additionally, the Company had its Year 2000 assessment plan reviewed by an
outside consulting firm to evaluate the effectiveness. The Company will perform
remediation procedures concurrent with its assessment planning. The Company
plans to complete the assessment of its Year 2000 readiness by the end of the
first quarter of 1999.
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
30
<PAGE>
parties with whom the Company has critical business relationships. The Company
has completed its inventory of internal IT and non-IT systems. 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
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 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 February 28, 1999 the Company has
incurred remediation costs of approximately $0.1 million. 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 sale 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 materials 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.
1997 vs. 1996
Operating results for 1997 were dramatically lower than 1996. An
imbalance between media supply and demand as well as product transitions were
significant factors in 1997. In the last half of 1996, the Company began a rapid
transition to MR and proximity-inductive thin-film media products. Quarterly
sales in excess of $150 million and gross margins exceeding 40% during the first
half of 1996 decreased to $131.5 million and 24%, respectively, in the third
quarter of 1996 and $141.2 million and 11.7%, respectively, in the fourth
quarter of 1996. During the first and second quarters of 1997, net sales
increased sequentially to $167.2 million and $175.1 million, respectively,
primarily due to manufacturing capacity additions. The gross margin percentages
for the first and second quarters of 1997 were 23.5% and 20.4%, respectively.
Demand for thin-film media products fell sharply at the end
31
<PAGE>
of the second quarter of 1997 as an excess supply of enterprise-class disk
drives caused drive manufacturers to reduce their build plans for this class of
drives. The resulting imbalance between media supply and demand caused a loss of
sales and prevented the Company from fully utilizing its expanded capacity
during the last half of 1997. Net sales and the gross margin percentage fell
sharply to $129.7 million and 0.2%, respectively, in the third quarter of 1997
and to $159.0 million and 11.6%, respectively, in the fourth quarter of 1997.
Additionally, the Company recorded a restructuring charge to consolidate its
U.S. manufacturing operations during the third quarter of 1997.
Net Sales
Net sales for 1997 increased to $631.1 million, up 9% from $577.8
million in 1996. The increase was primarily due to an increase in unit sales
volume. The overall average selling price increased less than 1% in 1997
relative to 1996. The effect of the sales mix shift to higher-priced MR and
proximity-inductive media more than offset the effect of price reductions on
maturing inductive disk products and resulted in the flat overall average
selling price. Distribution sales of product manufactured by AKCL increased to
$10.5 million in 1997 from $5.7 million in 1996.
Unit production increased 6% in 1997 relative to 1996. The Company
increased capacity 25% in 1997 relative to 1996. Equipment utilization rates,
therefore, decreased significantly as the Company operated below capacity in the
last half of 1997 due to weak market demand for enterprise-class disk products.
In addition, overall manufacturing yields declined as the Company experienced
continuing yield losses on MR products. During the first half of 1996, the
overall manufacturing yield was substantially higher prior to the transition to
proximity-inductive and MR media.
Gross Margin
The gross margin percentage for 1997 decreased to 14.8% from 30.4% for
1996 primarily due to a combination of lower manufacturing yields, reduced
equipment utilization rates and inherently higher material and processing costs
for MR and advanced proximity disks. Additionally, the Company incurred
inventory write-downs in 1997, which accounted for approximately one-fourth of
the decrease in the gross margin percentage.
Operating Expenses
Research and development ("R&D") expenses increased 75% ($22.0 million)
in 1997 relative to 1996. The increase was primarily due to higher facility
costs associated with a newly constructed 188,000-square-foot R&D facility and
increased R&D staffing. Selling, general and administrative ("SG&A") expenses
decreased $6.1 million in 1997 compared to 1996. The decrease was mainly due to
a decrease of $10.2 million in provisions for bonus and profit sharing programs
offset by increased provisions for bad debt of $2.4 million. Excluding
provisions for bonus/profit sharing programs and provisions for bad debt, SG&A
expenses increased $1.7 million due primarily to higher payroll and
facility-related costs connected with the Company's newly constructed
administration facility in 1997.
In 1997, the Company implemented a restructuring plan involving the
consolidation of its U.S. manufacturing operations. The restructuring charge
primarily related to disposing of assets, equipment order cancellations,
provisions for facility closure expenses and severance-related costs. The
Company recorded a $52.2 million restructuring charge which 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 excess
equipment and disposed of 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.
32
<PAGE>
Interest Income/Expense and Other Income
Interest income decreased $1.7 million (26%) in 1997 relative to 1996
primarily due to a lower average investment balance in 1997. Interest expense
increased $8.5 million in 1997 compared to 1996. The Company was debt free from
late 1995 until November 1996. Between November 1996 and the end of 1997, the
Company borrowed $245 million under its credit facilities. Other income
increased $1.3 million in 1997 relative to 1996 mainly due to foreign currency
gains generated by the weakening of the Malaysian ringgit.
Income Taxes
The tax provision benefit of 55% for 1997 represents tax loss
carrybacks associated with the Company's U.S. operations. The effective income
tax rate for 1996 of 17% was lower than the 1996 combined federal and state
statutory rate of 41% primarily as a result of an initial five-year tax holiday
granted to the Company's wholly owned thin-film media operation, Komag USA
(Malaysia) Sdn. ("KMS"), which commenced in July 1993. The impact of this tax
holiday was to reduce the Company's 1997 net loss by approximately $16.6 million
($0.32 per share under both the basic and diluted methods) and increase 1996 net
income by approximately $21.8 million ($0.43 basic income per share and $0.41
diluted income per share).
Minority Interest in Consolidated Subsidiary/Equity in Unconsolidated Joint
Venture
The minority interest in the net income of consolidated subsidiary
during 1997 represented Kobe Steel USA Holdings Inc.'s ("Kobe USA") share of
Komag Material Technology, Inc.'s ("KMT") net income. KMT recorded net income of
$2.0 million and $3.5 million in 1997 and 1996, respectively.
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. As its share of AKCL's net income (loss), the Company recorded a loss
of $4.9 million in 1997 compared to income of $10.1 million in 1996. Product
transition issues related to AKCL's qualification and production of new MR
products resulted in AKCL's underutilization of its capacity and adversely
affected 1997 results.
Liquidity and Capital Resources
Cash and short-term investments of $127.8 million at the end of 1998
decreased from $166.2 million at the end of 1997. Consolidated operating
activities generated $23.6 million in cash during 1998. The $366.3 million loss
for 1998, net of non-cash depreciation charges of $116.7 million, the non-cash
asset impairment charge of $175.0 million and the non-cash equity loss from AKCL
of $27.0 million, consumed $47.6 million. Changes in operating assets and
liabilities provided $71.0 million. The Company borrowed $15.0 million under its
credit facilities and spent $89.0 million on capital requirements during 1998.
Proceeds from sales of property, plant and equipment (primarily the sale of
vacant land in Milpitas, California) generated $5.5 million. Sales of Common
Stock under the Company's stock option programs generated $5.7 million.
Working capital decreased by $388.9 million in 1998 primarily due to
the reclassification of $260.0 million of the Company's long-term debt to
current liabilities as a result of a technical default under the Company's
credit facilities (see further discussion in the following paragraph).
Additionally, capital expenditures of $89.0 million further reduced working
capital in 1998. Accounts receivable and inventory decreased $39.6 million and
$33.1 million, respectively, in line with reductions in sales.
Current noncancellable capital commitments total approximately $17
million. Total capital expenditures for 1999 are currently planned at
approximately $40 million. The 1999 capital spending
33
<PAGE>
plan primarily includes costs for projects designed to improve yield and
productivity. The size of the Company's second quarter 1998 net loss resulted in
a default under certain financial covenants contained in the Company's bank
credit facilities. The Company is not in payment default under these credit
facilities as all interest charges and fees associated with these facilities
have been paid on their scheduled due dates. At the time of the covenant default
the Company had $260 million of debt outstanding against a total borrowing
capacity of $345.0 million under the various senior unsecured credit facilities.
As a result of the covenant default, the Company's lenders withdrew the $85
million in unused borrowing capacity. To date, the lenders have not accelerated
any principal payments under the credit facilities. As a result of the technical
default and reclassification of the bank debt to current liabilities, the
Company's auditors have included a going concern paragraph in their audit
opinion to highlight the Company's need to amend or restructure its debt
obligations.
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. During
1997 and 1998, the Company spent approximately $199 million and $89 million,
respectively, on property, plant and equipment. In 1999, the Company plans to
spend approximately $40 million on property, plant and equipment, primarily for
projects designed to improve yield and productivity. 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.
In July 1998, at a Special Meeting of Stockholders, the Company
received authorization to sell and issue up to $350,000,000 of Common Stock in
equity or equity-linked private transactions from time to time through July 22,
1999 at a price below book value but at or above the then current market value
of the Company's Common Stock. Additionally, the Company's stockholders approved
a proposal to increase the amount of Common Stock the Company is authorized to
issue from 85,000,000 to 150,000,000 shares.
Other
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. It requires
that derivatives be recognized in the balance sheet at fair value and specifies
the accounting for changes in fair value. This statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 1999, and will be
adopted by the Company for its fiscal year 2000. The Company is currently
assessing the impact of adoption of this pronouncement on its financial
statements.
34
<PAGE>
ITEM 7A. FINANCIAL MARKET RISKS
The Company is exposed to financial market risks, including changes in
interest rates and foreign currency exchange rates. To mitigate these risks, the
Company utilizes derivative financial instruments. The Company does not use
derivative financial instruments for speculative or trading purposes.
The primary objective of the Company's investment activities is to
preserve principal while at the same time maximizing yields without
significantly increasing risk. The Company invests primarily in high-quality,
short-term debt instruments. A hypothetical 60 basis point increase in interest
rates would result in an approximate $2.2 million decrease (approximately 0.3%)
in the fair value of the Company's available-for-sale securities.
The Company has long-term debt with a notional value of $260 million
which includes both term debt and lines of credit. Term debt totaling $75
million bears interest at a fixed rate of 7.4% per annum. The lines of credit
totaling $185 million bear interest at the lenders' base rate (currently 7.75%).
The Company has not hedged its exposure to fluctuations in the base interest
rate. A hypothetical 60 basis point increase in interest rates would result in
approximately $1.1 million of additional interest expense per year.
The Company enters into foreign currency forward exchange contracts to
reduce the impact of currency fluctuations on firm purchase order commitments
for equipment and construction-in-process. Gains and losses on these foreign
currency investments would generally be offset by corresponding losses and gains
on the related hedging instruments, resulting in negligible net exposure to the
Company.
A substantial majority of the Company's revenue, expense and capital
purchasing activities are transacted in U.S. dollars. However, the Company does
enter into these transactions in other currencies, primarily, the Malaysian
ringgit. The Company cannot eliminate the impact of foreign currency exchange
rate movements on the expenses it incurs in ringgits. An adverse change in
exchange rates (defined as 20% in the Malaysian ringgit to U.S. dollar rate)
would result in a decline in income before taxes of approximately $17 million.
35
<PAGE>
[This Page Intentionally Left Blank]
36
<PAGE>
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
KOMAG, INCORPORATED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Ernst & Young LLP, Independent Auditors 37
Consolidated Statements of Operations,
1998, 1997 and 1996 38
Consolidated Balance Sheets, 1998 and 1997 39-40
Consolidated Statements of Cash Flows,
1998, 1997 and 1996 41-42
Consolidated Statements of Stockholders' Equity,
1998, 1997 and 1996 43
Notes to Consolidated Financial Statements 44-64
37
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Stockholders
Komag, Incorporated
We have audited the accompanying consolidated balance sheets of Komag,
Incorporated as of January 3, 1999 and December 28, 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended January 3, 1999. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits. We did not audit the financial
statements of Asahi Komag Co., Ltd. (a corporation in which the Company has a
50% interest) as of January 3, 1999 and December 28, 1997, and for each of the
three years in the period ended January 3, 1999. Those financial statements were
audited by other auditors whose reports have been furnished to us, and our
opinion, insofar as it relates to data included for Asahi Komag Co., Ltd. as of
January 3, 1999 and December 28, 1997, and for each of the three years in the
period ended January 3, 1999, is based solely on the report of the other
auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Komag, Incorporated at January 3, 1999
and December 28, 1997, and the consolidated results of its operations and its
cash flows for each of the three years in the period ended January 3, 1999, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
The accompanying financial statements have been prepared assuming that
Komag, Incorporated will continue as a going concern. As more fully described in
Note 1, the Company has incurred recent operating losses and is out of
compliance with certain covenants of loan agreements with its lenders. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1. 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 liabilities that may result from the
outcome of this uncertainty.
ERNST & YOUNG LLP
San Jose, California
January 22, 1999
38
<PAGE>
<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<CAPTION>
Fiscal Year Ended
-----------------------------------------------------
1998 1997 1996
---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Net sales (see Note 13) $ 328,883 $631,082 $577,791
Cost of sales (see Notes 12 and 13) 391,635 537,536 402,224
---------------- ---------------- ---------------
Gross profit (loss) (62,752) 93,546 175,567
Operating expenses:
Research, development and engineering 61,637 51,427 29,409
Selling, general and administrative 19,762 27,523 33,665
Restructuring charge 187,768 52,157 -
---------------- ---------------- ---------------
269,167 131,107 63,074
---------------- ---------------- ---------------
Operating income (loss) (331,919) (37,561) 112,493
Other income (expense):
Interest income 8,804 4,753 6,437
Interest expense (19,212) (9,116) (625)
Other, net 4,853 4,104 2,843
---------------- ---------------- ---------------
(5,555) (259) 8,655
---------------- ---------------- ---------------
Income (loss) before income taxes, minority
interest and equity in joint venture income (loss) (337,474) (37,820) 121,148
Provision (benefit) for income taxes 1,315 (20,982) 20,595
---------------- ---------------- ---------------
Income (loss) before minority interest and equity
in joint venture income (loss) (338,789) (16,838) 100,553
Minority interest in net income of
consolidated subsidiary 544 400 695
Equity in net income (loss) of unconsolidated joint venture (27,003) (4,865) 10,116
---------------- ---------------- ---------------
Net income (loss) $(366,336) $(22,103) $109,974
================ ================ ===============
Basic income (loss) per share $ (6.89) $ (0.42) $ 2.15
================ ================ ===============
Diluted income (loss) per share $ (6.89) $ (0.42) $ 2.07
================ ================ ===============
Number of shares used in basic computation 53,169 52,217 51,179
================ ================ ===============
Number of shares used in diluted computation 53,169 52,217 53,132
================ ================ ===============
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
39
<PAGE>
<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
<CAPTION>
Fiscal Year End
-------------------------------------
1998 1997
----------------- ---------------
Assets
<S> <C> <C>
Current Assets
Cash and cash equivalents $64,467 $ 133,897
Short-term investments 63,350 32,300
Accounts receivable, less allowances of $2,847 in 1998
and $4,424 in 1997 42,922 77,792
Accounts receivable from related parties 512 4,106
Inventories:
Raw materials 8,434 33,730
Work-in-process 10,672 17,490
Finished goods 14,534 15,558
----------------- ---------------
Total inventories 33,640 66,778
Prepaid expenses and deposits 4,348 3,697
Refundable income taxes 2,216 24,524
Deferred income taxes 7,883 28,595
----------------- ---------------
Total current assets 219,338 371,689
Investment in Unconsolidated Joint Venture 1,399 30,126
Property, Plant and Equipment
Land 7,785 9,526
Building 128,359 126,405
Leasehold improvements 86,565 141,111
Furniture 10,911 11,791
Equipment 686,169 793,561
----------------- ---------------
919,789 1,082,394
Less allowances for depreciation and amortization (449,772) (403,798)
----------------- ---------------
Net property, plant and equipment 470,017 678,596
Deposits and Other Assets 3,341 4,253
----------------- ---------------
$694,095 $1,084,664
================= ===============
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year End
---------------------------------------
1998 1997
------------------ ----------------
Liabilities and Stockholders' Equity
<S> <C> <C>
Current Liabilities
Current portion of long-term debt $260,000 $ -
Trade accounts payable 27,274 40,043
Accounts payable to related parties 1,848 7,093
Accrued compensation and benefits 15,544 13,596
Other liabilities 3,254 3,596
Income taxes payable 134 9
Restructuring liability 4,128 11,253
------------------ ----------------
Total current liabilities 312,182 75,590
Long-term Debt, Less Current Portion - 245,000
Deferred Income Taxes 52,564 73,335
Other Long-term Liabilities 1,403 960
Minority Interest in Consolidated Subsidiary 4,139 3,595
Commitments
Stockholders' Equity
Preferred Stock, $0.01 par value per share:
Authorized-1,000 shares
No shares issued and outstanding - -
Common Stock, $0.01 par value per share:
Authorized-150,000 shares in 1998
and 85,000 shares in 1997
Issued and outstanding 53,887 shares
in 1998 and 52,794 shares in 1997 539 528
Additional paid-in capital 407,549 401,869
Retained earnings/(accumulated deficit) (84,860) 281,476
Accumulated other comprehensive income 579 2,311
------------------ ----------------
Total stockholders' equity 323,807 686,184
------------------ ----------------
$694,095 $1,084,664
================== ================
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
41
<PAGE>
<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
Fiscal Year Ended
--------------------------------------------------
1998 1997 1996
--------------- -------------- ---------------
<S> <C> <C> <C>
Operating Activities
Net cash provided by operating activities-
see detail on following page $23,601 $ 84,396 $200,892
Investing Activities
Acquisition of property, plant and equipment (89,033) (199,112) (403,062)
Purchases of short-term investments (31,050) (37,585) (163)
Proceeds from short-term investments at maturity - 7,785 196,462
Proceeds from disposal of property, plant and equipment 5,449 550 1,883
Deposits and other assets 912 (1,190) (649)
Dividend distribution from unconsolidated joint venture - 1,535 -
--------------- -------------- ---------------
Net cash used in investing activities (113,722) (228,017) (205,529)
Financing Activities
Proceeds from long-term obligations 15,000 175,000 70,000
Sale of Common Stock, net of issuance costs 5,691 11,777 10,778
Distribution to minority interest holder - - (279)
--------------- -------------- ---------------
Net cash provided by financing activities 20,691 186,777 80,499
--------------- -------------- ---------------
Increase (decrease) in cash and cash equivalents (69,430) 43,156 75,862
Cash and cash equivalents at beginning of year 133,897 90,741 14,879
--------------- -------------- ---------------
Cash and cash equivalents at end of year $64,467 $133,897 $ 90,741
=============== ============== ===============
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Ended
---------------------------------------------------
1998 1997 1996
----------------- -------------- --------------
<S> <C> <C> <C>
Net income (loss) $(366,336) $(22,103) $109,974
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 116,682 128,542 86,928
Provision for losses on accounts receivable (1,125) 1,315 (1,011)
Equity in net (income) loss of unconsolidated
joint venture 27,003 4,865 (10,117)
Loss on disposal of equipment 481 2,854 445
Impairment charge related to property, plant and
equipment 175,000 - -
Non-cash portion of restructuring charge
related to write-off of property, plant and equipment - 33,013 -
Deferred income taxes (59) 2,513 13,153
Deferred rent 443 463 23
Minority interest in net income of
consolidated subsidiary 544 400 695
Changes in operating assets and liabilities:
Accounts receivable 35,995 (23,431) 6,995
Accounts receivable from related parties 3,594 4,343 (3,415)
Inventories 33,138 (4,818) (32,939)
Prepaid expenses and deposits (659) (831) 974
Trade accounts payable (12,769) (40,046) 51,372
Accounts payable to related parties (5,245) 3,799 (4,467)
Accrued compensation and benefits 1,948 (8,239) (10,131)
Other liabilities (342) 1,683 (183)
Income taxes (payable) refundable 22,433 (11,179) (7,404)
Restructuring liability (7,125) 11,253 -
----------------- -------------- --------------
Net cash provided by operating activities $ 23,601 $ 84,396 $200,892
================= ============== ==============
Supplemental disclosure of cash flow information
Cash paid for interest $ 19,683 $ 8,148 $ 340
Cash paid (refunded) for income taxes (21,017) (12,305) 15,280
Income tax benefit from stock
options exercised - 1,834 3,138
<FN>
See notes to consolidated financial statements.
</FN>
</TABLE>
43
<PAGE>
<TABLE>
KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<CAPTION>
Retained Accumulated
Common Stock Additional Earnings/ Other
----------------------- Paid-in (Accumulated Comprehensive
Shares Amount Capital Deficit) Income Total
----------- ---------- ------------- --------------- ----------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 50,714 $507 $374,399 $193,605 $6,053 $574,564
Net Income 109,974 109,974
(514) (514)
Accumulated translation adjustment -------------
Total Comprehensive Income 109,460
-------------
Common Stock issued under stock
option and purchase plans, including
related tax benefits 982 10 13,906 13,916
----------- ---------- ------------- --------------- ----------------- -------------
Balance at December 29, 1996 51,696 517 388,305 303,579 5,539 697,940
Net Loss (22,103) (22,103)
(3,228) (3,228)
Accumulated translation adjustment -------------
Total Comprehensive Income (25,331)
-------------
Common Stock issued under stock
option and purchase plans, including
related tax benefits 1,098 11 13,564 13,575
----------- ---------- ------------- --------------- ----------------- -------------
Balance at December 28, 1997 52,794 528 401,869 281,476 2,311 686,184
Net Loss (366,336) (366,336)
Accumulated translation adjustment (1,732) (1,732)
-------------
Total Comprehensive Loss (368,068)
Common Stock issued under stock -------------
option and purchase plans 1,093 11 5,680 5,691
----------- ---------- ------------- --------------- ----------------- -------------
Balance at January 3, 1999 53,887 $539 $407,549 ($84,860) $ 579 $323,807
=========== ========== ============= =============== ================= =============
</TABLE>
44
<PAGE>
KOMAG, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation: The consolidated financial statements include the
accounts of the Company, its wholly owned and majority-owned subsidiaries (see
Note 12) and equity in its unconsolidated joint venture (see Note 13). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
The financial statements have been prepared on a going concern basis. The
Company has incurred recent operating losses and is not in compliance with
certain financial covenants of its various bank agreements. Such non-compliance
constitutes an 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 January 3, 1999 amounted to $260,000,000. 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.
Foreign Currency Translation: The functional currency of the Company's
unconsolidated joint venture is the Japanese yen. Translation adjustments
relating to the translation of these statements are included as a separate
component of stockholders' equity and not included in net income. The functional
currency for the Company's Malaysian operation is the U.S. dollar. Remeasurement
gains and losses, resulting from the process of remeasuring these foreign
currency financial statements into U.S. dollars, are included in operations.
Foreign Exchange Gains and Losses: The Company enters into foreign currency
forward exchange contracts to reduce the impact of currency fluctuations on firm
purchase order commitments for equipment and construction-in-process. Gains and
losses related to these contracts are included in the cost of the assets
acquired. The Company had approximately $767,000 of Japanese yen and $129,000 of
Singapore dollar based firm purchase commitments at January 3, 1999. There were
no foreign exchange contracts outstanding at January 3, 1999. The Company had
approximately $14,095,000 in foreign exchange forward purchase contracts
outstanding at December 28, 1997. These forward exchange contracts were
comprised of Japanese yen and Malaysian ringgit foreign currencies and
approximated fair market value at December 28, 1997.
Cash Equivalents: The Company considers as a cash equivalent any highly liquid
investment that matures within three months of its purchase date.
Short-Term Investments: The Company invests its excess cash in high-quality,
short-term debt instruments. None of the Company's debt security investments
have maturities greater than one year. At January 3, 1999, all short-term
investments are designated as available for sale. Interest and dividends on the
investments are included in interest income.
45
<PAGE>
The following is a summary of the Company's investments by major security type
at amortized cost, which approximates fair value:
Fiscal Year Ended
-------------------------------
1998 1997
--------------- ---------------
(in thousands)
Municipal auction rate preferred stock $63,350 $32,300
Corporate debt securities 33,765 56,837
Mortgage-backed securities 34,060 79,419
--------------- ---------------
$131,175 $168,556
=============== ===============
Amounts included in cash and cash equivalents $67,825 $136,256
Amounts included in short-term investments 63,350 32,300
--------------- ---------------
$131,175 $168,556
=============== ===============
There were no realized gains or losses on the Company's investments during 1998
as all investments were held to maturity during the year. The Company utilizes
zero-balance accounts and other cash management tools to invest all available
funds, including bank balances in excess of book balances.
Inventories: Inventories are stated at the lower of cost (first-in, first-out
method) or market.
Property, Plant and Equipment: Property, plant and equipment are stated at cost
less accumulated depreciation and amortization. Depreciation is computed by the
straight-line method over the estimated useful lives of the assets. The
estimated useful life of the Company's buildings is 30 years. Furniture and
equipment are generally depreciated over 3 to 5 years and leasehold improvements
are amortized over the shorter of the lease term or the useful life.
Revenue Recognition: The Company records sales upon shipment and provides an
allowance for estimated returns of defective products.
Research and Development: Research and development costs are expensed as
incurred.
Stock Compensation: The Company has adopted Statement of Financial Accounting
Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). In
accordance with the provisions of FAS 123, the Company applies APB Opinion 25
and related Interpretations in accounting for its stock-based compensation
plans. Note 5 to the Consolidated Financial Statements contains a summary of the
pro forma effects to reported net income (loss) and basic and diluted income
(loss) per share for 1998, 1997 and 1996 as if the Company had elected to
recognize compensation cost based on the fair value of the options granted at
grant date as prescribed by FAS 123.
Income Taxes: The provision (benefit) for income taxes is based on pretax
financial accounting income (loss). Deferred tax assets and liabilities are
recognized for the expected tax consequences of temporary differences between
the tax and book basis of assets and liabilities.
46
<PAGE>
<TABLE>
Income (Loss) Per Share: The Company determines earnings per share in accordance
with Financial Accounting Standards Board Statement No. 128, "Earnings per
Share" ("FAS 128").
<CAPTION>
Fiscal Year Ended
------------------------------------------------------------
1998 1997 1996
------------------- ------------------- -------------------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Numerator: Net income (loss) ($366,336) ($22,103) $109,974
------------------- ------------------- -------------------
Denominator for basic
income (loss) per share -
weighted-average shares 53,169 52,217 51,179
------------------- ------------------- -------------------
Effect of dilutive securities:
Employee stock options - - 1,953
Denominator for diluted
------------------- ------------------- -------------------
income (loss) per share 53,169 52,217 53,132
------------------- ------------------- -------------------
Basic income (loss) per share ($6.89) ($0.42) $2.15
=================== =================== ===================
Diluted income (loss) per share ($6.89) ($0.42) $2.07
=================== =================== ===================
</TABLE>
No stock options were included in the computation of diluted loss per share for
1998 and 1997 as their effect would have been antidilutive.
Comprehensive Income (Loss): In June 1997, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" ("SFAS 130"). SFAS 130 requires that all items that are
required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. This statement is effective
for the Company's 1998 fiscal year. Prior year financial statements have been
reclassified to conform to the requirements of Statement 130. Adoption of this
pronouncement did not have a material impact on the Company's financial
statements. Accumulated other comprehensive income is primarily comprised of
accumulated translation adjustments.
Segment Information: In June 1997, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131
replaces Statement of Financial Accounting Standards No. 14 and changes the way
public companies report segment information. This statement is effective for the
Company's 1998 fiscal year. Adoption of this pronouncement did not have a
material impact on the Company's financial statements
Fiscal Year: The Company uses a 52-53 week fiscal year ending on the Sunday
closest to December 31. The year ended January 3, 1999 was comprised of 53
weeks. The years ended December 28, 1997 and December 29, 1996 were each
comprised of 52 weeks.
Derivative Instruments and Hedging Activities: In June 1998, the FASB issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities"
47
<PAGE>
("SFAS 133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments and for hedging activities. It requires that derivatives
be recognized in the balance sheet at fair value and specifies the accounting
for changes in fair value. This statement is effective for all fiscal quarters
of fiscal years beginning after June 15, 1999, and will be adopted by the
Company for its fiscal year 2000. The Company is currently assessing the impact
of adoption of this pronouncement on its financial statements.
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 2. SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in one business segment, which is the development,
production and marketing of high-performance thin-film media for use in hard
disk drives. The Company sells to original equipment manufacturers in the rigid
disk drive market and computer system manufacturers that produce their own disk
drives.
The Company adopted Statement of Financial Accounting Standards No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("SFAS
131") at January 3, 1999. SFAS 131 establishes annual and interim reporting
standards for an enterprise's operating segments and related disclosures about
its products, services, geographic areas and major customers. Under SFAS 131,
the Company's operations are treated as one operating segment as it only reports
profit and loss information on an aggregate basis to chief operating decision
makers of the Company.
48
<PAGE>
<TABLE>
Summary information for the Company's operations by geographic location is as
follows:
<CAPTION>
1998 1997 1996
----------------- ------------------ ---------------
(in thousands)
<S> <C> <C> <C>
Net sales
To customers from U.S. operations $ 157,408 $ 290,986 $ 316,658
To customers from Far East operations 171,475 340,096 261,133
Intercompany from Far East operations 88,890 121,945 75,608
Intercompany from U.S. operations 33,360 38,310 22,232
----------------- ------------------ ---------------
451,133 791,337 675,631
Eliminations (122,250) (160,255) (97,840)
----------------- ------------------ ---------------
Total net sales $ 328,883 $ 631,082 $ 577,791
================= ================== ===============
Operating income (loss)
U.S. operations $(205,852) $ (112,022) $9,108
Far East operations (127,837) 70,821 107,774
----------------- ------------------ ---------------
(333,689) (41,201) 116,882
Eliminations 1,770 3,640 (4,389)
----------------- ------------------ ---------------
Total operating income (loss) $(331,919) $ (37,561) $ 112,493
================= ================== ===============
Identifiable assets
U.S. operations $ 538,989 $ 768,395 $ 708,436
Far East operations 263,153 467,990 381,015
----------------- ------------------ ---------------
802,142 1,236,385 1,089,451
Eliminations (108,047) (151,721) (151,094)
----------------- ------------------ ---------------
Total identifiable assets $ 694,095 $1,084,664 $ 938,357
================= ================== ===============
Export sales by domestic operations included the following:
Fiscal Year Ended
----------------------------------------------------
1998 1997 1996
----------------- ------------------ ---------------
(in thousands)
Far East (see Note 13) $109,842 $268,117 $249,130
Europe 23,973 11,896 -
</TABLE>
49
<PAGE>
NOTE 3. CONCENTRATION OF CUSTOMER AND SUPPLIER RISK
The Company performs ongoing credit evaluations of its customers' financial
conditions and generally requires no collateral. Significant customers accounted
for the following percentages of net sales in 1998, 1997 and 1996:
Fiscal Year Ended
------------------------------------------
1998 1997 1996
------------- -------------- -------------
Western Digital Corporation 43% 38% 22%
Maxtor Corporation 25% 19% Less than 10%
International Business Machines 18% 10% Less than 10%
Quantum Corporation/MKE Less than 10% 15% 18%
Seagate Technology, Inc. Less than 10% 14% 52%
In early 1996, Seagate merged with Conner Peripherals, Inc. In addition, Quantum
ceased disk drive production in Milpitas, California and Penang, Malaysia and
contracted with its Japanese manufacturing partner, Matsushita-Kotobuki
Electronics Industries, Ltd. ("MKE"), to manufacture all of its disk drives.
Percentages for 1998, 1997 and 1996 represent the combined sales to
Seagate/Conner and Quantum/MKE.
Kobe Steel, Ltd. ("Kobe") supplies aluminum substrate blanks to Komag Material
Technology, Inc. ("KMT"), and the Company in turn purchases KMT's entire output
of finished substrates. The Company also relies on a limited number of other
suppliers, in some cases a sole supplier, for certain other materials used in
its manufacturing processes. These materials include nickel plating solutions,
certain polishing and texturing supplies and sputtering target materials. These
suppliers work closely with the Company to optimize the Company's production
processes. Although this reliance on a limited number of suppliers, or a sole
supplier, entails some risk that the Company's production capacity would be
limited if one or more of such materials were to become unavailable or available
in reduced quantities, the Company believes that the advantages of working
closely with these suppliers outweigh such risks. If such materials should be
unavailable for a significant period of time, the Company's results of
operations could be adversely affected.
NOTE 4. STOCKHOLDER'S EQUITY
In July 1998, the Company's stockholders approved at a Special Meeting of
Stockholders a proposal to increase the amount of Common Stock the Company is
authorized to issue from 85,000,000 to 150,000,000 shares.
In July 1998, at a Special Meeting of Stockholders, the Company received
authorization to sell and issue up to $350,000,000 of Common Stock in equity or
equity-linked private transactions from time to time through July 22, 1999 at a
price below book value but at or above the then current market value of the
Company's Common Stock.
50
<PAGE>
NOTE 5. STOCK OPTION PLANS AND STOCK PURCHASE PLAN
<TABLE>
At January 3, 1999, the Company has stock-based compensation plans, which are
described below. The Company has elected to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
Interpretations in accounting for its plans. Accordingly, no compensation cost
has been recorded in the financial statements for its stock option and stock
purchase plans. Had compensation cost for the stock-based compensation plans
been determined consistent with Statement of Financial Accounting Standard No.
123, "Accounting for Stock-Based Compensation," the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below:
<CAPTION>
Fiscal Year Ended
-----------------------------------------------------
1998 1997 1996
----------------- ---------------- --------------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Net income (loss): As reported ($366,336) ($22,103) $109,974
Pro forma (396,390) (36,833) 102,355
Basic EPS: As reported ($6.89) ($0.42) $2.15
Pro forma (7.46) (0.71) 2.00
Diluted EPS: As reported ($6.89) ($0.42) $2.07
Pro forma (7.46) (0.71) 1.93
</TABLE>
Since FAS 123 is applicable only to options granted subsequent to December 31,
1994, its pro forma effect will not be fully reflected until 1999.
In September 1997, the Company's Board of Directors approved the 1997
Supplemental Stock Option Plan ("Supplemental Plan"). Under the Supplemental
Plan, the Company may grant nonqualified stock options to purchase up to
3,600,000 shares of Common Stock. In January 1998 and in June 1998, the
Company's Board of Directors approved increases of 1,000,000 and 1,500,000
shares, respectively, in the total number of shares that may be issued under the
Supplemental Plan.
Under the Company's stock option plans ("Plans"), including the Supplemental
Plan, the Company may grant options to purchase up to 24,360,000 shares of
Common Stock. Options may be granted to employees, directors, independent
contractors and consultants. Options under the Supplemental Plan may not,
however, be granted to the Company's executive officers or nonemployee members
of the Company's Board of Directors. The Plans provide for issuing both
incentive stock options and nonqualified stock options, both of which must be
granted at fair market value at the date of grant. Outstanding options generally
vest over four years and expire no later than ten years from the date of grant.
Options may be exercised in exchange for cash or outstanding shares of the
Company's Common Stock. Approximately 16,000 and 5,000 shares of the Company's
Common Stock were received in exchange for option exercises in 1997 and 1996,
respectively. No options were exercised in exchange for outstanding shares of
the Company's Common Stock in 1998.
In October 1997, the Company's Board of Directors approved an option exchange
program, subject to election by the option holders, whereby options to purchase
1,806,000 shares of the Company's Common Stock at prices ranging from $19.75 to
$36.00 per share were canceled and reissued at $19.44 per share, which was the
fair market value of the Company's Common Stock at that time. The average
exercise price of the canceled options was approximately $26.62 per share. The
new options generally vest over two to four years. The option exchange program
was not available to the Company's executive officers or nonemployee members of
the Company's Board of Directors.
51
<PAGE>
In June 1998, the Company's Board of Directors approved an option exchange
program, subject to election by the option holders, whereby options to purchase
7,551,000 shares of the Company's Common Stock at prices ranging from $6.19 to
$31.06 per share were canceled and reissued at $5.35 per share, which was the
fair market value of the Company's Common Stock at that time. The average
exercise price of the canceled options was approximately $15.65 per share.
Vesting under the new options remained unchanged, however, the options were
subject to a one year prohibition on exercisability. The option exchange program
was available to executive officers but was not available to the Company's
nonemployee members of the Company's Board of Directors.
At January 3, 1999, approximately 6,882,000 shares of Common Stock were reserved
for future option grants and 8,816,000 shares of Common Stock were reserved for
the exercise of outstanding options. Approximately 950,000, 2,297,000 and
1,917,000 of the outstanding options were exercisable at January 3, 1999,
December 28, 1997 and December 29, 1996, respectively.
For purposes of the pro forma disclosure, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions used for grants in 1998, 1997 and 1996, respectively:
risk-free interest rates of 5.5%, 6.3% and 6.1%; volatility factors of the
expected market price of the Company's Common Stock of 63.4%, 61.9% and 60.0%;
and a weighted-average expected life of the options of 4.7, 6.5 and 5.9 years.
There was no dividend yield included in the calculation as the Company does not
pay dividends. The weighted-average fair value of options granted during 1998,
1997 and 1996 was $4.29, $11.06 and $12.88, respectively.
52
<PAGE>
A summary of stock option transactions is as follows:
Weighted-
average
Shares Exercise Price Total
------------- ----------------- -------------
(in thousands, except
per share amounts)
Outstanding at December 31, 1995 5,028 $11.13 $55,954
Granted 1,651 25.65 42,351
Exercised (635) 9.00 (5,714)
Cancelled (299) 16.43 (4,913)
------------- ----------------- -------------
Outstanding at December 29, 1996 5,745 15.26 87,678
Granted 4,141 22.38 92,685
Exercised (678) 9.66 (6,549)
Cancelled (2,314) 25.42 (58,817)
------------- ----------------- -------------
Outstanding at December 28, 1997 6,894 16.68 114,997
Granted 11,290 7.43 83,842
Exercised (168) 8.55 (1,432)
Cancelled (9,200) 15.23 (140,122)
------------- ----------------- -------------
Outstanding at January 3, 1999 8,816 $ 6.50 $57,285
============= ================= =============
53
<PAGE>
<TABLE>
The following table summarizes information concerning currently outstanding and
exercisable options (option shares in thousands):
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------------------------------------
Remaining
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (yrs)* Price* Exercisable Price*
- ----------------------- ---------------- ---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$2.19 - $5.25 145 9.6 $ 3.00 - $ -
5.26 - 5.35 7,398 7.9 5.35 - -
5.36 - 12.56 893 5.4 9.04 665 8.52
12.57 - 20.75 154 6.5 16.28 132 16.07
20.76 - 34.13 226 7.6 29.56 153 31.62
---------------- ----------------
8,816 950
================ ================
*Weighted-average
</TABLE>
Under the terms of the Employee Stock Purchase Plan ("ESPP Plan"), employees may
elect to contribute up to 10% of their compensation toward the purchase of
shares of the Company's Common Stock. The purchase price per share will be the
lesser of 85% of the fair market value of the stock on the first day or the last
day of each semi-annual offering period.
In May 1998, the Company's shareholders approved a 1,300,000-share increase in
the total number of shares that may be issued under the ESPP Plan. The total
number of shares of stock that may be issued under the Plan cannot exceed
4,850,000 shares. Shares issued under the ESPP Plan approximated 925,000,
436,000 and 352,000 in 1998, 1997 and 1996, respectively. At January 3, 1999,
approximately 735,000 shares of Common Stock were reserved for future issuance
under the ESPP Plan.
For purposes of the pro forma disclosure, the fair value of the employees'
purchase rights has been estimated using the Black-Scholes model assuming
risk-free interest rates of 5.5%, 6.5% and 5.6% in 1998, 1997 and 1996,
respectively. Volatility factors of the expected market price were 63.5%, 60%
and 60% for 1998, 1997 and 1996, respectively. The weighted-average expected
life of the purchase rights was six months for 1998, 1997 and 1996. The
weighted-average fair value of those purchase rights granted in 1998, 1997 and
1996 was $3.09, $6.37 and $5.09, respectively.
NOTE 6. BONUS AND PROFIT SHARING PLANS
Under the terms of the Company's cash profit sharing plan, a percentage of
consolidated semi-annual operating profit, as defined in the plan, is allocated
among all employees who meet certain criteria. Under the terms of the Company's
bonus plans, a percentage of consolidated annual operating profit, as defined in
the respective bonus plans, is paid to eligible employees. No bonus and cash
profit sharing provision was recorded during 1998. The Company expensed
$1,966,000 and $9,078,000 under these bonus and cash profit sharing plans in
1997 and 1996, respectively.
The Company and its subsidiaries maintain savings and deferred profit sharing
plans. Employees who meet certain criteria are eligible to participate. In
addition to voluntary employee contributions to these plans, the Company
contributes four percent of semi-annual consolidated operating profit, as
defined in the plans. These contributions are allocated to all eligible
employees. Furthermore, the Company matches a portion of each employee's
contributions to the plans up to a maximum amount. The
54
<PAGE>
Company contributed $695,000, $2,534,000 and $5,573,000 to the plans in 1998,
1997 and 1996, respectively.
Expenses for the Company's bonus and profit sharing plans are included in
selling, general and administrative expenses.
NOTE 7. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Fiscal Year Ended
-----------------------------------------------
1998 1997 1996
----------------- -------------- --------------
(in thousands)
Federal:
Current $ 59 $(24,036) $ 3,988
Deferred (59) 2,192 10,265
----------------- -------------- --------------
- (21,844) 14,253
State:
Current 2 (490) 496
Deferred - 321 2,888
----------------- -------------- --------------
2 (169) 3,384
Foreign:
Current 1,313 1,031 2,958
----------------- -------------- --------------
$1,315 $(20,982) $20,595
================= ============== ==============
The foreign provision above consists of withholding taxes on royalty and
interest payments and foreign taxes of subsidiaries.
55
<PAGE>
Deferred tax assets (liabilities) are comprised of the following:
Fiscal Year End
--------------------------------
1998 1997
----------------- --------------
(in thousands)
Depreciation $ - $(22,118)
State income taxes (10,649) (10,299)
Deferred income (34,023) (34,023)
Other (7,892) (6,895)
----------------- --------------
Gross deferred tax liabilities (52,564) (73,335)
----------------- --------------
Depreciation 319 -
Inventory valuation adjustments 2,283 8,971
Accrued compensation and benefits 2,442 3,175
State income taxes 2,484 2,484
Other 355 13,965
Tax benefit of net operating losses 97,846 43,046
Tax benefit of credit carryforwards 33,085 24,000
----------------- --------------
Gross deferred tax assets 138,814 95,641
----------------- --------------
Deferred tax asset valuation allowance (130,931) (67,046)
----------------- --------------
$(44,681) $(44,740)
================= ==============
As of January 3, 1999, the Company has federal and state tax net operating loss
carryforwards of approximately $165,100,000 and $90,200,000, respectively. The
Company also has federal and state tax credit carryforwards of approximately
$15,500,000 and $17,500,000, respectively. The Company's federal net operating
losses expire beginning in 2013 through 2019 and the state net operating losses
expire beginning in 2003 through 2004. The Company's federal tax credit
carryovers expire beginning in 2000 through 2019 and the state tax credit
carryforwards expire beginning in 2003 through 2006. Due to the uncertainty of
the timing and amount of future income, the Company has fully reserved for the
potential future tax benefit of all net operating loss and credit carryforwards
in the deferred tax asset valuation allowance.
Dastek Holding Company, a 60%-owned subsidiary of the Company, has a federal tax
net operating loss carryforward of approximately $100,000,000. The Company has
fully reserved for the potential future federal tax benefit of this net
operating loss in the deferred tax asset valuation allowance due to the fact
that its utilization is limited to the subsidiary's separately computed future
taxable income and that the subsidiary has no history of operating profits. The
net operating losses expire beginning in 2009 through 2011.
The deferred tax asset valuation allowance increased $63,885,000 in 1998 and
$32,000,000 in 1997.
56
<PAGE>
<TABLE>
A reconciliation of the income tax provision at the 35% federal statutory rate
to the income tax provision at the effective tax rate is as follows:
<CAPTION>
Fiscal Year Ended
-----------------------------------------------
1998 1997 1996
----------------- -------------- --------------
(in thousands)
<S> <C> <C> <C>
Income taxes computed at federal statutory rate $(118,116) $(13,237) $42,402
State and foreign income taxes, net of federal
benefit 1,315 907 5,021
Permanently reinvested foreign (earnings) losses 46,446 (25,597) (26,050)
Losses for which no current year benefit available 70,995 16,561 -
Other 675 384 (778)
----------------- -------------- --------------
$ 1,315 $(20,982) $20,595
================= ============== ==============
</TABLE>
Foreign pretax income (loss) was ($131,400,000), $74,400,000 and $104,300,000 in
1998, 1997 and 1996, respectively.
Komag USA (Malaysia) Sdn. ("KMS"), the Company's wholly owned thin-film media
operation in Malaysia, was granted an extension of its initial five-year tax
holiday by the Malaysian government for an additional five years commencing in
July 1998. The tax holiday had no impact on the Company's 1998 net loss, but in
1997 the tax holiday reduced the Company's net loss by approximately $16,596,000
($0.32 per share under both the basic and diluted methods). Losses incurred
prior to the commencement of the initial tax holiday, approximately $6,237,000,
are available for carryforward to years following the expiration of the tax
holiday. KMS has also been granted an additional ten-year tax holiday for its
second and third plant sites in Malaysia. This new tax holiday had not yet
commenced at January 3, 1999.
The Company has generated $59,059,000 of cumulative earnings for which no U.S.
tax has been provided as of January 3, 1999. These earnings are considered to be
permanently invested outside the United States.
NOTE 8. TERM DEBT AND LINES OF CREDIT
The Company has borrowed $260,000,000 and $245,000,000 under its term debt and
line of credit facilities at January 3, 1999 and December 28, 1997,
respectively. At January 3, 1999, these borrowings incurred interest at 7.4% to
7.75%, with interest-only payments due quarterly.
The size of the Company's second quarter 1998 net loss resulted in a default
under certain financial covenants contained in the Company's bank credit
facilities. The Company is not in payment default under these credit facilities
as all interest charges and fees associated with these facilities have been paid
on their scheduled due dates. At the time of the covenant default the Company
had $260,000,000 of debt outstanding against a total borrowing capacity of
$345,000,000 under the various senior unsecured credit facilities. As a result
of the covenant default, the Company's lenders withdrew the $85,000,000 in
unused borrowing capacity. To date, the lenders have not accelerated any
principal payments under the credit facilities. The Company is currently
negotiating with its lenders for amendments to the existing credit facilities.
57
<PAGE>
NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying values of cash and short-term investments, accounts receivable and
certain other liabilities on the Consolidated Balance Sheets approximate fair
value at January 3, 1999 and December 28, 1997 due to the relatively short
period to maturity of the instruments. The carrying value of the Company's debt
borrowings on the Consolidated Balance Sheets approximated fair value as of
December 28, 1997. As of January 3, 1999, the Company was in default of its debt
covenants and the fair value of the Company's debt borrowings was approximately
$251,000,000. The fair value of the bank borrowings was based on quoted market
prices or pricing models using current market rates. See Note 1 for fair value
of foreign currency hedge contracts.
NOTE 10. LEASES AND COMMITMENTS
The Company leases certain production, research and administrative facilities
under operating leases that expire at various dates between 1999 and 2007.
Certain of these leases include renewal options varying from ten to twenty
years.
At January 3, 1999, the future minimum commitments for all noncancellable
operating leases are as follows (in thousands):
1999 $5,769
2000 4,778
2001 4,820
2002 4,815
2003 4,815
Thereafter 14,313
-------------
Total minimum lease payments $39,310
=============
Rental expense for all operating leases amounted to $6,573,000, $8,047,000 and
$4,838,000 in 1998, 1997 and 1996, respectively.
The Company has current noncancellable capital commitments of approximately
$17,000,000.
NOTE 11. RESTRUCTURING CHARGES
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.
58
<PAGE>
In 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 would extend into 1999, the
Company adjusted its expectations for the utilization of its installed
production capacity. Based on this analysis of the Company's production capacity
and its expectations of the media market over the remaining life of the
Company's fixed assets, the Company concluded that it would not be able to
recover the book value of those assets. As a result, the Company implemented a
restructuring plan in June 1998 and recorded a charge of $187.8 million. This
charge included an asset impairment charge and provisions for facility closure
expenses and severance-related 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.
Non-cash items in the restructuring/impairment charge totaled $175.0 million.
The cash component of the total charge was $12.8 million.
The restructuring plan included reducing the Company's U.S. and Malaysian
workforce and ceasing operations at its oldest San Jose, California plant. The
restructuring charge included $4.1 million for severance costs (approximately
170 employees, primarily in the U.S.), $5.8 million related to equipment order
cancellations and other equipment related costs, and $2.9 million for facility
closure costs. 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 (15.8%).
The Company incurred lower facility closure costs than anticipated in its 1997
and 1998 restructuring charges. The oldest Milpitas plant was sublet sooner than
anticipated and the Company reached a lease termination agreement with its
landlord on the second Milpitas plant in the third quarter of 1998. The Company
thereby avoided expected future rent payments and the cost of renovating the
facility to its original lease condition. Additionally, the Company determined
that it would not close its oldest San Jose, California facility at the
expiration of its lease. The Company plans to devote the front-end operations in
this facility for glass media development. Back-end operations in this facility
ceased in the fourth quarter of 1998. As a result the Company will not incur
costs to restore the facility to its original lease condition as contemplated in
the restructuring charge. Higher costs for equipment order cancellations offset
the lower facility closure costs. A total of 515 employees were in the
restructuring activities. The following table summarizes these restructuring
activities.
Restructuring Incurred
(in millions) Charges Through 1/3/99
---------------- ----------------
Asset impairment charge $175.0 $175.0
Writedown net book value of equipment
and leasehold improvements 33.0 33.0
Equipment order cancellations and other
equipment related costs 16.0 17.5
Facility closure costs 8.0 2.2
Severance costs 7.9 8.1
At January 3, 1999, $4,128,000 related to the restructuring activities remained
in current liabilities. The Company has made cash payments totaling
approximately $27,784,000 primarily for severance, equipment order cancellations
and facility closure costs. The majority of the remaining liability,
59
<PAGE>
primarily for equipment order cancellations is expected to be settled through
the use of cash by the end of 1999.
NOTE 12. KOMAG MATERIAL TECHNOLOGY, INC.
The Company's financial statements include the consolidation of the financial
results of Komag Material Technology, Inc. ("KMT"), which manufactures and sells
aluminum disk substrate products for high-performance magnetic storage media.
KMT is owned 80% by the Company and 20% by Kobe Steel USA Holdings Inc. ("Kobe
USA"), a U.S. subsidiary of Kobe Steel, Ltd. ("Kobe").
<TABLE>
Other transactions between Kobe or its distributors and the Company were as
follows:
<CAPTION>
Fiscal Year Ended
-------------------------------------------
1998 1997 1996
------------- ------------- -------------
(in thousands)
<S> <C> <C> <C>
Accounts payable to Kobe or its distributors:
Beginning of year $4,830 $2,430 $3,302
Purchases 23,758 52,308 53,554
Payments (26,789) (49,908) (54,426)
------------- ------------- -------------
End of year $1,799 $4,830 $2,430
============= ============= =============
</TABLE>
NOTE 13. UNCONSOLIDATED JOINT VENTURE
In 1987, the Company formed a partnership, Komag Technology Partners
("Partnership"), with the U.S. subsidiaries of two Japanese companies and
simultaneously formed a subsidiary, Asahi Komag Co., Ltd. ("AKCL"). The Company
contributed technology in exchange for a 50% interest in the Partnership. The
Partnership and its subsidiary (joint venture) established a facility in Japan
to manufacture and sell the Company's thin-film media products in Japan. AKCL
also sells its products to the Company for resale outside of Japan. In 1996, the
Company granted AKCL various licenses to sell its products to specified
customers outside of Japan in exchange for a 5% royalty on these sales. The
Company recorded approximately $1,989,000 and $1,388,000 of royalty in other
income in 1998 and 1997, respectively.
The Company's share of the joint venture's net income (loss) was ($27,003,000),
($4,865,000) and $10,116,000 in 1998, 1997 and 1996, respectively.
60
<PAGE>
<TABLE>
Other transactions between the joint venture and the Company were as follows:
<CAPTION>
Fiscal Year Ended
-------------------------------------------
1998 1997 1996
------------- ------------- -------------
(in thousands)
<S> <C> <C> <C>
Accounts receivable from joint venture:
Beginning of year $4,053 $8,316 $4,906
Sales 15,799 95,302 69,311
Cash receipts (19,393) (99,565) (65,901)
------------- ------------- -------------
End of year $ 459 $4,053 $8,316
============= ============= =============
Accounts payable to joint venture:
Beginning of year $2,256 $ 549 $ 355
Purchases 4,153 14,686 12,145
Payments (6,390) (12,979) (11,951)
------------- ------------- -------------
End of year $ 19 $2,256 $ 549
============= ============= =============
</TABLE>
Equipment purchases by the Company from its joint venture partners were
$14,458,000, $17,836,000 and $20,655,000 in 1998, 1997 and 1996, respectively.
<TABLE>
Summary combined financial information for the Partnership and AKCL for the
years ended December 31, 1998, 1997 and 1996, and as of December 31, 1998 and
1997 is as follows. The subsidiary's total assets, liabilities, revenues, costs
and expenses approximate 100% of the combined totals.
<CAPTION>
Fiscal Year Ended
-------------------------------------------------
1998 1997 1996
-------------- ---------------- ---------------
(in thousands)
<S> <C> <C> <C>
Summarized Statements of Operations:
Net sales $138,330 $186,474 $230,904
Costs and expenses 192,311 200,305 188,707
Income tax provision (benefit) 25 (4,101) 21,965
-------------- ---------------- ---------------
Net Income (loss) $(54,006) $ (9,730) $ 20,232
============== ================ ===============
</TABLE>
61
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year End
---------------------------------
1998 1997
---------------- ---------------
(in thousands)
<S> <C> <C>
Summarized Balance Sheets:
Current assets $ 69,773 $ 63,512
Noncurrent assets 163,035 151,540
---------------- ---------------
Total Assets $232,808 $215,052
================ ===============
Current liabilities $139,043 $115,106
Long-term obligations 88,892 41,975
Partners' capital 4,873 57,971
---------------- ---------------
Total Liabilities and Partners' Capital $232,808 $215,052
================ ===============
</TABLE>
NOTE 14. PARTICIPATION IN HEADWAY TECHNOLOGIES, INC.
Headway Technologies, Inc. ("Headway") was formed in 1994 to research, develop
and manufacture advanced magnetoresistive ("MR") heads for the data storage
industry. Hewlett-Packard Company ("HP") and AKCL (see Note 13) provided the
initial cash funding to Headway in exchange for equity interests. The Company
and Asahi America licensed to Headway MR technology developed through a prior
joint venture and contributed certain research and production equipment in
exchange for equity. As a result of these transactions, the Company held a
direct voting interest in Headway of less than 20% and had no cost basis in its
investment in Headway. In 1997, the Company sold its interest in Headway.
AKCL invested in Headway in 1994 and recorded partial write-downs of its
investment through 1995 based upon net losses incurred at Headway. During the
third quarter of 1996, Headway's major customer, HP, announced the closure of
its disk drive manufacturing operations. Based upon anticipated future operating
losses at Headway arising from the loss of HP's business, AKCL wrote off its
remaining Headway investment at the end of the third quarter of 1996. In 1997,
AKCL sold its entire interest in Headway for $10,800,000 to a group of new
investors as part of a recapitalization and AKCL recorded the proceeds from this
sale as a gain ($5,300,000, net of tax).
62
<PAGE>
<TABLE>
NOTE 15. QUARTERLY SUMMARIES
(in thousands, except per share amounts, unaudited)
<CAPTION>
1998
--------------------------------------------------------------------------------------
1st Quarter 2nd Quarter(1) 3rd Quarter 4th Quarter
--------------------- -------------------- --------------------- ---------------------
<S> <C> <C> <C> <C>
Net sales $ 76,057 $ 78,808 $ 81,314 $ 92,704
Gross profit (loss) (31,595) (35,637) (2,803) 7,283
Net loss (58,158) (261,884) (27,449) (18,845)
Basic loss per share ($1.10) ($4.95) ($0.51) ($0.35)
Diluted loss per share ($1.10) ($4.95) ($0.51) ($0.35)
1997
--------------------------------------------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter(2) 4th Quarter
--------------------- -------------------- --------------------- ---------------------
Net sales $167,242 $175,121 $129,694 $159,025
Gross profit 39,315 35,661 202 18,368
Net income (loss) 17,799 11,677 (52,748) 1,169
Basic income (loss) per share $ 0.34 $ 0.22 ($1.01) $ 0.02
Diluted income (loss) per share $ 0.33 $ 0.22 ($1.01) $ 0.02
<FN>
(1) Results for the second quarter of 1998 included a $187,768,000
restructuring charge which primarily related to an asset impairment charge
of $175,000,000. The asset impairment charge effectively reduced asset
valuations to reflect the economic effect of industry price erosion for
disk media and projected underutilization of the Company's production
equipment and facilities. Based on analysis of the Company's production
capacity and its expectations of the media market over the remaining life
of the Company's fixed assets, the Company concluded that it would not be
able to recover the book value of those assets.
(2) Results for the third quarter of 1997 included a $52,157,000 restructuring
charge to consolidate the Company's U.S. manufacturing operations.
</FN>
</TABLE>
NOTE 16. SUBSEQUENT EVENT (UNAUDITED)
In February 1999, the Company and Western Digital announced the signing of
a letter of intent under which the Company will acquire Western Digital's disk
media business for approximately $80 million of the Company's Common Stock
(based on the market value of the Company's Common Stock at the time the letter
of intent was signed). In addition, the Company will assume certain liabilities,
mainly lease obligations related to production equipment and facilities. Terms
of the strategic relationship include a three-year volume purchase agreement
under which Western Digital will buy a substantial portion of its media from the
Company. The Company plans to combine Western Digital's media group with its
manufacturing operations over the next 18 months. Such action will relocate a
portion of Western Digital's production equipment to the Company's offshore
locations, thus more fully utilizing the Company's lower-cost Malaysian
operations. At the time of this filing the Company and Western Digital were
continuing to negotiate terms of the acquisition.
63
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEMS 10, 11, 12 and 13.
<TABLE>
Items 10 through 13 of Part III will be contained in the Komag,
Incorporated Proxy Statement for the Annual Meeting of Stockholders to be held
May 25, 1999 (the "1999 Proxy Statement"), which will be filed with the
Securities and Exchange Commission no later than May 5, 1999. The cross-
reference table below sets forth the captions under which the responses to these
items are found:
<CAPTION>
10-K Item Description Caption in 1999 Proxy Statement
- --------- ----------- -------------------------------
<S> <C> <C>
10 Directors and Executive Officers "Item No. 1--Election of Directors:
Nominees; Business
Experience of Directors and
Nominees" and "Additional
Information: Certain
Relationships and Related
Transactions; Other Matters"
11 Executive Compensation "Additional Information: Executive
Compensation and Related
Information"
12 Security Ownership of Certain Beneficial "Additional Information: Principal
Owners and Management Stockholders"
13 Certain Relationships and Related "Additional Information: Certain
Transactions Relationships and Related
Transactions"
</TABLE>
The information set forth under the captions listed above, contained in
the 1999 Proxy Statement, are hereby incorporated herein by reference in
response to Items 10 through 13 of this Report on Form 10-K.
64
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) List of Documents filed as part of this Report.
1. Financial Statements.
The following consolidated financial statements of Komag, Incorporated
are filed in Part II, Item 8 of this Report on Form 10-K:
Consolidated Statements of Operations--Fiscal Years 1998, 1997 and 1996
Consolidated Balance Sheets--January 3, 1999 and December 28, 1997 Consolidated
Statements of Cash Flows--Fiscal Years 1998, 1997 and 1996 Consolidated
Statements of Stockholders' Equity--Fiscal Years 1998, 1997 and 1996 Notes to
Consolidated Financial Statements
2. Financial Statement Schedules.
The following financial statement schedule of Komag, Incorporated is
filed in Part IV, Item 14(d) of this report on Form 10-K:
Schedule II--Valuation and Qualifying Accounts
Report of Other Auditor
--Report of Chuo Audit Corporation on Asahi Komag Co., Ltd.
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable and therefore have been
omitted.
65
<PAGE>
3. Exhibits.
3.1 Amended and Restated Certificate of Incorporation (incorporated by
reference from a similarly numbered exhibit filed with the Company's
report on Form 10-Q for the quarter ended September 27, 1998).
3.2 Bylaws (incorporated by reference from Exhibit 3.3 filed with the
Company's report on Form 10-K for the year ended December 30, 1990).
4.2 Specimen Stock Certificate (incorporated by reference from a similarly
numbered exhibit filed with Amendment No. 1 to the Registration
Statement).
10.1.1 Lease Agreement dated May 24, 1991 between Milpitas-Hillview and
Komag, Incorporated (incorporated by reference from Exhibit 10.1.2
filed with the Company's report on Form 10-K for the year ended
December 29, 1991).
10.1.3 Lease Agreement dated July 29, 1988 by and between Brokaw Interests
and Komag, Incorporated (incorporated by reference from Exhibit 10.1.6
filed with the Company's report on Form 10-K for the year ended
January 1, 1989).
10.1.4 Lease Agreement dated May 2, 1989 by and between Stony Point
Associates I and Komag Material Technology, Inc. (incorporated by
reference from Exhibit 10.1.6 filed with the Company's report on Form
10-K for the year ended December 31, 1989).
10.1.6 Second Amendment to Lease dated December 28, 1990 by and between
Milpitas- Hillview and Komag, Incorporated (incorporated by reference
from Exhibit 10.1.12 filed with the Company's report on Form 10-K for
the year ended December 30, 1990).
10.1.7 First Amendment to Lease dated November 1, 1993 by and between Wells
Fargo Bank et al and Komag Material Technology, Inc. (incorporated by
reference from Exhibit 10.1.14 filed with the Company's report on Form
10-K for the year ended January 2, 1994).
10.1.9 Lease Agreement dated August 4, 1995 by and between Great Oaks
Interests and Komag, Incorporated (incorporated by reference from
Exhibit 10.1.12 filed with the Company's report on Form 10-Q for the
quarter ended October 1, 1995).
10.1.10 First Amendment to Lease dated November 3, 1995 by and between Great
Oaks Interests and Komag, Incorporated (incorporated by reference from
Exhibit 10.1.10 filed with the Company's report on Form 10-K for the
year ended December 29, 1996).
10.1.11 Lease Agreement (B10) dated May 24, 1996 between Sobrato Development
Companies #871 and Komag, Incorporated (incorporated by reference from
Exhibit 10.1.11 filed with the Company's report on Form 10-K for the
year ended December 29, 1996).
10.1.12 Lease Agreement (B11) dated May 24, 1996 between Sobrato Development
Companies #871 and Komag, Incorporated (incorporated by reference from
Exhibit 10.1.12 filed with the Company's report on Form 10-K for the
year ended December 29, 1996).
10.2 Form of Directors' Indemnification Agreement (incorporated by
reference from Exhibit 10.9 filed with the Company's report on Form
10-K for the year ended December 30, 1990).
66
<PAGE>
10.3.1 Joint Venture Agreement by and among Komag, Inc.; Asahi Glass Co.,
Ltd.; and Vacuum Metallurgical Company dated November 9, 1986, as
amended January 7, 1987 and January 27, 1987 (incorporated by
reference from Exhibit 10.10.1 filed with the Registration Statement
on Form S-1--File No. 33-13663) (confidential treatment obtained as to
certain portions).
10.3.2 General Partnership Agreement for Komag Technology Partners dated
January 7, 1987 (incorporated by reference from Exhibit 10.10.2 filed
with the Registration Statement on Form S-1--File No. 33-13663).
10.3.3 Technology Contribution Agreement dated January 7, 1987 by and between
Komag, Incorporated and Komag Technology Partners (incorporated by
reference from Exhibit 10.10.3 filed with the Registration Statement
on Form S-1--File No. 33-13663) (confidential treatment obtained as to
certain portions).
10.3.4 Technical Cooperation Agreement dated January 7, 1986 by and between
Asahi Glass Company, Ltd. and Komag, Incorporated (incorporated by
reference from Exhibit 10.10.4 filed with the Registration Statement
on Form S-1--File No. 33-13663).
10.3.5 Third Amendment to Joint Venture Agreement by and among Komag, Inc.;
Asahi Glass Co., Ltd.; Vacuum Metallurgical Company; et al dated March
21, 1990 (incorporated by reference from Exhibit 10.10.5 filed with
the Company's report on Form 10-K for the year ended December 31,
1989).
10.3.6 Fourth Amendment to Joint Venture Agreement by and among Komag, Inc.;
Asahi Glass Co., Ltd.; Vacuum Metallurgical Company; et al dated May
24, 1990 (incorporated by reference from Exhibit 10.10.11 filed with
the Company's report on Form 10-K for the year ended January 1, 1995).
10.3.7 Fifth Amendment to Joint Venture Agreement by and among Komag, Inc.,
Asahi Glass Co., Ltd.; Vacuum Metallurgical Company; et al dated
November 4, 1994 (incorporated by reference from Exhibit 10.10.12
filed with the Company's report on Form 10-K for the year ended
January 1, 1995).
10.3.8 Joint Venture Agreement dated March 6, 1989 by and between Komag,
Incorporated; Komag Material Technology, Inc.; and Kobe Steel USA
Holdings Inc. (incorporated by reference from Exhibit 10.10.6 filed
with the Company's report on Form 10-K for the year ended December 31,
1989) (confidential treatment obtained as to certain portions).
10.3.9 Joint Development and Cross-License Agreement dated March 10, 1989 by
and between Komag, Incorporated; Kobe Steel, Ltd.; and Komag Material
Technology, Inc. (incorporated by reference from Exhibit 10.10.7 filed
with the Company's report on Form 10-K for the year ended December 31,
1989).
10.3.10 Blank Sales Agreement dated March 10, 1989 by and between Komag,
Incorporated; Kobe Steel, Ltd.; and Komag Material Technology, Inc.
(incorporated by reference from a similarly numbered exhibit filed
with the Company's report on Form 10-K for the year ended December 31,
1989).
10.3.11 Finished Substrate Agreement dated March 10, 1989 by and between
Komag, Incorporated; Kobe Steel, Ltd.; and Komag Material Technology,
Inc. (incorporated by reference from Exhibit 10.10.9 filed with the
Company's report on Form 10-K for the year ended December 31, 1989)
(confidential treatment obtained as to certain portions).
67
<PAGE>
10.3.12 Stock Purchase Agreement between Komag, Incorporated and Kobe Steel
USA Holdings Inc. dated November 17, 1995 (incorporated by reference
from a similarly numbered exhibit filed with the Company's report on
Form 10-K for the year ended December 31, 1995).
10.3.13 Substrate Agreement by and between Kobe Steel, Ltd. and Komag,
Incorporated dated November 17, 1995 (incorporated by reference from a
similarly numbered exhibit filed with the Company's report on Form
10-K for the year ended December 31, 1995) (confidential treatment
obtained as to certain portions).
10.3.14 License Amendment Agreement among Komag, Incorporated; Komag Material
Technology, Inc.; and Kobe Steel, Ltd. dated November 17, 1995
(incorporated by reference from a similarly numbered exhibit filed
with the Company's report on Form 10-K for the year ended December 31,
1995).
10.3.15 Substrate Sales Amendment Agreement among Komag, Incorporated; Komag
Material Technology, Inc.; and Kobe Steel, Ltd. dated November 17,
1995 (incorporated by reference from a similarly numbered exhibit
filed with the Company's report on Form 10-K for the year ended
December 31, 1995).
10.3.16 Joint Venture Amendment Agreement among Komag, Incorporated; Komag
Material Technology, Inc.; and Kobe Steel USA Holdings Inc. dated
November 17, 1995 (incorporated by reference from a similarly numbered
exhibit filed with the Company's report on Form 10-K for the year
ended December 31, 1995) (confidential treatment obtained as to
certain portions).
10.4.1 Restated 1987 Stock Option Plan, effective January 31, 1996 and forms
of agreement thereunder (incorporated by reference from a similarly
numbered exhibit filed with the Company's report on Form 10-Q for the
quarter ended June 30, 1996).
10.4.2 Komag, Incorporated Management Bonus Plan As Amended and Restated
January 22, 1997.
10.4.3 1988 Employee Stock Purchase Plan Joinder Agreement dated July 1, 1993
between Komag, Incorporated and Komag USA (Malaysia) Sdn.
(incorporated by reference from Exhibit 10.11.11 filed with the
Company's report on Form 10-K for the year ended January 2, 1994).
10.4.4 Komag, Incorporated Discretionary Bonus Plan (incorporated by
reference from Exhibit 10.4.4 filed with the Company's report on Form
10-K for the year ended December 29, 1996).
10.4.5 Komag, Incorporated 1997 Supplemental Stock Option Plan Amended June
12, 1998.
10.5.1 Komag, Incorporated Deferred Compensation Plan (incorporated by
reference from a similarly numbered exhibit filed with the Company's
report on Form 10-K for the year ended January 1, 1995).
10.5.2 Amendment No. 1 to Komag, Incorporated Deferred Compensation Plan
dated January 1, 1997 (incorporated by reference from Exhibit 10.5.2
filed with the Company's report on Form 10-K for the year ended
December 29, 1996).
68
<PAGE>
10.5.3 Komag Material Technology, Inc. 1995 Stock Option Plan (incorporated
by reference from Exhibit 10.11.12 filed with the Company's report on
Form 10-Q for the Quarter ended October 1, 1995).
10.6 Common Stock Purchase Agreement dated December 9, 1988 by and between
Komag, Incorporated and Asahi Glass Co., Ltd. (incorporated by
reference from Exhibit 1 filed with the Company's report on Form 8-K
filed with the Securities and Exchange Commission on December 20,
1988).
10.7 Common Stock Purchase Agreement dated February 6, 1990 by and between
Komag, Incorporated and Kobe Steel USA Holdings Inc. (incorporated by
reference from Exhibit 10.17 filed with the Company's report on Form
10-K for the year ended December 31, 1989).
10.8 Registration Rights Agreement dated March 21, 1990 by and between
Komag, Incorporated and Kobe Steel USA Holdings Inc. (incorporated by
reference from Exhibit 10.18 filed with the Company's report on Form
10-K for the year ended December 31, 1989).
10.9 Amendment No. 1 to Common Stock Purchase Agreement dated March 21,
1990 by and between Komag, Incorporated and Asahi Glass Co., Ltd.
(incorporated by reference from Exhibit 10.19 filed with Amendment No.
1 to the Registration Statement filed with the Securities and Exchange
Commission on May 26, 1987).
10.10 Amended and Restated Registration Rights Agreement dated March 21,
1990 by and between Komag, Incorporated and Asahi Glass Co., Ltd.
(incorporated by reference from Exhibit 10.20 filed with Amendment No.
1 to the Registration Statement filed with the Securities and Exchange
Commission on May 26, 1987).
10.11 Letter dated February 10, 1992 from the Malaysian Industrial
Development Authority addressed to Komag, Incorporated approving the
"Pioneer Status" of the Company's thin-film media venture in Malaysia
(incorporated by reference from Exhibit 10.28 filed with the Company's
report on Form 10-K for the year ended January 3, 1993).
10.12 Credit Agreement between Komag, Incorporated and The Industrial Bank
of Japan, Limited, San Francisco Agency dated December 15, 1995
(incorporated by reference from Exhibit 10.16 filed with the Company's
report on Form 10-K for the year ended December 31, 1995).
10.13 First Amendment to Credit Agreement by and between Komag, Incorporated
and The Industrial Bank of Japan, Limited, San Francisco Agency dated
November 19, 1996 (incorporated by reference to Exhibit 10.17 filed
with the Company's report on Form 10-K for the year ended December 29,
1996).
10.14 Second Amendment to Credit Agreement by and between Komag,
Incorporated and The Industrial Bank of Japan, Limited, San Francisco
Agency dated January 31, 1997 (incorporated by reference to Exhibit
10.18 filed with the Company's report on Form 10-K for the year ended
December 29, 1996).
10.15 Credit Agreement between Komag, Incorporated and The Dai-Ichi Kangyo
Bank, Limited, San Francisco Agency dated October 7, 1996
(incorporated by reference to Exhibit 10.19 filed with the Company's
report on Form 10-K for the year ended December 29, 1996).
69
<PAGE>
10.16 First Amendment to Credit Agreement between Komag, Incorporated and
The Dai-Ichi Kangyo Bank, Limited, San Francisco Agency dated November
25, 1996 (incorporated by reference to Exhibit 10.20 filed with the
Company's report on Form 10-K for the year ended December 29, 1996).
10.17 Credit Agreement dated as of February 7, 1997 among Komag,
Incorporated, institutional lenders and The Industrial Bank of Japan,
Limited, San Francisco Agency, as agent for the lenders(incorporated
by reference to Exhibit 10.22 filed with the Company's report on Form
10-K for the year ended December 29, 1996).
10.18 Amended and Restated Credit Agreement Among Komag, Incorporated and
BankBoston, N.A. as agent (incorporated by reference from Exhibit
10.23 filed with the Company's report on Form 10-Q for the quarter
ended June 29, 1997).
10.19 First Amendment to Amended and Restated Credit Agreement dated October
9, 1997 among Komag, Incorporated and BankBoston, N.A. as agent
(incorporated by reference from Exhibit 10.24 filed with the Company's
report on Form 10-Q for the quarter ended September 28, 1997).
10.20 Second Amendment to Amended and Restated Credit Agreement dated March
23, 1998 among Komag, Incorporated and BankBoston, N.A. as agent
(incorporated by reference from Exhibit 10.20 filed with the Company's
report on Form 10-Q for the quarter ended March 29, 1998).
21 List of Subsidiaries.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of Chuo Audit Corporation.
24 Power of Attorney. Reference is made to the signature pages of this
Report.
27 Financial Data Schedule.
- -----------------
The Company agrees to furnish to the Commission upon request a copy of any
instrument with respect to long-term debt where the total amount of securities
authorized thereunder does not exceed 10% of the total assets of the Company.
(b) Reports on Form 8-K.
Not Applicable
70
<PAGE>
Undertaking
For the purposes of complying with the amendments to the rules
governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933,
the undersigned registrant hereby undertakes as follows:
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
1933 Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered on the Form S-8 identified
below, the registrant will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the 1933 Act and will be governed by the final
adjudication of such issue.
The preceding undertaking shall be incorporated by reference into
registrant's Registration Statements on Form S-8 Nos. 33-16625 (filed August 19,
1987), 33-19851 (filed January 28, 1988), 33-25230 (filed October 28, 1988),
33-41945 (filed July 29, 1991), 33-45469 (filed February 3, 1992), 33-53432
(filed October 16, 1992), 33-80594 (filed June 22, 1994), 33-62543 (filed
September 12, 1995), 333-06081 (filed June 14, 1996), 333-23095 (filed March 11,
1997), 333-31297 (filed July 15, 1997) and 333-48867 (filed March 30, 1998).
71
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in San Jose, California on
this 31st day of March, 1999.
Komag, Incorporated
By /s/ Stephen C. Johnson
----------------------
Stephen C. Johnson
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears herein constitutes and appoints Stephen C. Johnson and William L. Potts,
Jr., and each of them, as his true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all amendments to this
Report on Form 10-K, and to file the same, with all exhibits thereto, and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in connection therewith, as fully to all intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or any of them, or their or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
72
<PAGE>
<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities and on
the dates indicated:
<CAPTION>
Name Title Date
<S> <C> <C>
TU CHEN Chairman of the Board March 31, 1999
- ----------------------- and Director
(Tu Chen)
STEPHEN C. JOHNSON President and Chief Executive
- ---------------------- Officer
(Stephen C. Johnson) March 31, 1999
WILLIAM L. POTTS, JR. Senior Vice President, Chief March 31, 1999
- ------------------------ Financial Officer and Secretary
(William L. Potts, Jr.) (Principal Financial and
Accounting Officer)
CRAIG R. BARRETT Director March 31, 1999
- --------------------
(Craig R. Barrett)
CHRIS A. EYRE Director March 31, 1999
- -----------------
(Chris A. Eyre)
IRWIN FEDERMAN Director March 31, 1999
- -----------------
(Irwin Federman)
GEORGE A. NEIL Director March 31, 1999
- -----------------
(George A. Neil)
MAX PALEVSKY Director March 31, 1999
- ---------------
(Max Palevsky)
ANTHONY SUN Director March 31, 1999
- --------------
(Anthony Sun)
MASAYOSHI TAKEBAYASHI Director March 31, 1999
- ------------------------
(Masayoshi Takebayashi)
*By WILLIAM L. POTTS, JR.
----------------------
(William L. Potts, Jr.,
Attorney-in-Fact)
</TABLE>
73
<PAGE>
ITEM 14(d) FINANCIAL STATEMENT SCHEDULES
<TABLE>
KOMAG, INCORPORATED
Schedule II--VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<CAPTION>
Col. A Col. B Col. C Col. D Col. E
- ------ ------ ------ ------ ------
Additions
Balance at Charged to Balance
Beginning Costs and at End
Description of Period Expenses Deductions of Period
- ----------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C>
Year ended December 29, 1996
Allowance for doubtful accounts $3,006 $(1,011) $ 11 $ 1,984
Allowance for sales returns 1,273 3,528(1) 3,698(2) 1,103
------------- -------------- --------------- -----------------
$4,279 $ 2,517 $ 3,709 $ 3,087
============= ============== =============== =================
Year ended December 28, 1997
Allowance for doubtful accounts $1,984 $ 1,286 ($28) $ 3,298
Allowance for sales returns 1,103 7,145(1) 7,122(2) 1,126
------------- -------------- --------------- -----------------
Sub total 3,087 8,431 7,094 4,424
Restructuring liability - 52,157(3) 40,904(4) 11,253
------------- -------------- --------------- -----------------
$3,087 $60,588 $ 47,998 $15,677
============= ============== =============== =================
Year ended January 3, 1999
Allowance for doubtful accounts $3,298 ($1,125) $ 8 $ 2,165
Allowance for sales returns 1,126 7,654(1) 8,098(2) 682
------------- -------------- --------------- -----------------
Sub total 4,424 6,529 8,106 2,847
Restructuring liability 11,253 187,768(5) 194,893(6) 4,128
------------- -------------- --------------- -----------------
$15,677 $194,297 $202,999 $ 6,975
============= ============== =============== =================
<FN>
(1) Additions to the allowance for sales returns are netted against sales.
(2) Actual sales returns of subsequently scrapped product were charged against
the allowance for sales returns. Actual sales returns of product that was
subsequently tested and shipped to another customer were netted directly
against sales.
(3) The Company recorded a restructuring charge of $52,157,000 to consolidate
its U.S. manufacturing operations
(4) Charges against the restructuring liability included non-cash charges of
$33,013,000 for the write-off of the net book value of equipment and
leaseholds, and cash charges of approximately $7,891,000 for severance and
equipment related costs.
(5) The Company recorded a restructuring charge of $187,768,000 which primarily
related to an asset impairment charge due to industry price erosion for
disk media and the projected underutilization of the Company's production
equipment and facilities.
(6) Charges against the restructuring liability included non-cash charges of
$175,000,000 for the asset impairment charge and cash charges of
approximately $19,893,000 for severance and equipment related costs.
</FN>
</TABLE>
74
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
Asahi Komag Co., Ltd.
We have audited the accompanying consolidated balance sheets of Asahi Komag
Co., Ltd. and its subsidiary (the "Company") as of December 31, 1998 and 1997,
and the consolidated statements of income, cash flows, and changes in equity for
the years ended December 31, 1998, 1997 and 1996. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. These standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, based on our audit, the financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of the Company as of December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for the years ended December 31,
1998, 1997 and 1996 in conformity with generally accepted accounting principles
applicable in the United States of America.
The consolidated financial statements as of and for the year ended December
31, 1998 have been translated into United States Dollars solely for the
convenience of the reader. Our audit included the translation, and in our
opinion such translation has been made in accordance with the basis stated in
note 2h to the consolidated financial statements.
CHUO AUDIT CORPORATION
Tokyo, Japan
January 22, 1999
75
<PAGE>
[This Page Intentionally Left Blank]
76
Exhibit 10.4.2
KOMAG, INCORPORATED
MANAGEMENT BONUS PLAN
AS AMENDED AND RESTATED JANUARY 22, 1997
I. PURPOSES OF THE PLAN
1.01 The Komag, Incorporated ("Company") Management Bonus Plan
("Plan") is established to promote the interests of the Company by creating an
incentive program to (i) attract and retain employees who will strive for
excellence, and (ii) motivate those individuals to set and achieve above-average
objectives by providing them with rewards for contributions to the operating
profits and earning power of the Company.
II. ADMINISTRATION OF THE PLAN
2.01 The Plan is hereby adopted by the Company's Board of
Directors (the "Board"), subject to the approval of the Company's stockholders
at the 1997 Annual Stockholders Meeting, and shall be administered by the
Compensation Committee ("Committee") of the Board. The members of the Committee
shall at all times satisfy the requirements established for outside directors
under Internal Revenue Code Section 162(m) and the applicable Treasury
Regulations.
2.02 The interpretation and construction of the Plan and the
adoption of rules and regulations for administering the Plan shall be made by
the Committee. Decisions of the Committee shall be final and binding on all
parties who have an interest in the Plan.
2.03 Within 90 days after the start of each of the Company's
fiscal years, the Committee will determine which of the Company's subsidiaries,
if any, will participate in the Plan for such fiscal year.
III. DETERMINATION OF PARTICIPANTS
3.01 An individual shall be eligible to participate in the
Plan if employed by the Company or any of its participating subsidiaries for a
period of not less than six (6) consecutive months at the time the bonus is
earned under Article IV, is in job grade E06 or above, and remains eligible for
a bonus award under the terms of Section 4.01 or 4.03. An individual who is on a
leave of absence or whose employment
19
<PAGE>
terminates and is then re-hired in the same fiscal year shall remain eligible,
but his or her bonus award shall be adjusted, as provided in Article IV below.
3.02 For purposes of the Plan:
A. Except as set forth in Section 3.01,
an individual shall be considered an employee for so long as such individual
remains employed by the Company or one or more subsidiary corporations.
B. Each corporation (other than the
Company) in an unbroken chain of corporations beginning with the Company shall
be considered to be a subsidiary of the Company, provided each such corporation
(other than the last corporation in the unbroken chain) owns, at the time of
determination, stock possessing more than fifty percent of the total combined
voting power of all classes of stock in one of the other corporations in such
chain.
IV. BONUS AWARDS
4.01 No eligible employee shall earn any portion of a bonus
award made hereunder for any fiscal year until the last day of that fiscal year,
and then only if there has been an allocation of a portion of the bonus pool for
such fiscal year to that employee in accordance with the procedures set forth in
Section 4.03. If an eligible employee receives no allocation under Section 4.03,
then that employee shall not earn, and shall not otherwise be entitled to, any
bonus under the Plan for that fiscal year. In no event shall any employee
receive an allocation under Section 4.03 for a fiscal year if that employee
ceases to be employed by either the Company or one or more of its participating
subsidiary corporations for any reason, other than retirement after the age of
65, permanent disability or death, on or before the date the allocation of the
bonus pool for that fiscal year is made under section 4.03. Notwithstanding the
foregoing, if an employee is employed during part of the fiscal year by the
Company or any other participating subsidiary in the Plan and for all or part of
the remainder of that fiscal year by a subsidiary that is not covered under the
Plan, then any bonus to which that employee would otherwise be entitled for such
fiscal year had he/she continued in the employ of the Company or participating
subsidiary shall be reduced by the proportion of such fiscal year during which
the employee was employed by the non-participating subsidiary.
4.02 The Committee shall calculate the aggregate bonus pool to
be paid under the Plan for each fiscal year. The specific percentage in effect
for the fiscal year shall be determined in accordance with the Company's level
of success in achieving the budgeted operating income specified for that fiscal
year in the annual Financial Plan ("Budgeted Operating Income") which is
approved by the Board and ratified for purposes of the Plan by the Committee not
later than 90 days after the start of the fiscal year, as follows:
20
<PAGE>
X = The percentage of the Operating Income of the
Company and its subsidiaries covered by the Plan that comprises the
bonus pool.
Y = Actual Operating Income for the fiscal year
divided by Budgeted Operating Income.
If Y is 0.6667 or greater, then X = 9(Y)-4
If Y is less than 0.6667, then X = 3Y
No amount shall be paid if Y is zero (0) or less.
The maximum value for X shall be limited to seven
percent (7%), and in no event shall X exceed eight percent (8%) of the Company's
Consolidated Operating Income.
For purposes of this Section 4.02 bonus formula,
the following definitions shall be in effect:
"Operating Income" means the Company's operating
income for the fiscal year attributable to the Company and the
participating subsidiaries for that year.
"Consolidated Operating Income" means the
Company's consolidated operating income for the fiscal year
attributable to the Company and all its subsidiaries.
In each case, the calculations of Operating Income
and Consolidated Operating Income shall be in accordance with generally accepted
accounting principles, adjusted to exclude the following: (i) any amounts
accrued by the Company or its subsidiaries pursuant to Management Bonus Plans or
Cash Profit Sharing Plans and related employer payroll taxes for such fiscal
year, (ii) any Discretionary or Matching Contributions made to the Savings and
Deferred Profit-Sharing Plan or to the Non-Qualified Deferred Compensation Plan
for such fiscal year, (iii) all items of gain, loss or expense for such fiscal
year determined to be extraordinary or unusual in nature or infrequent in
occurrence, or related to the disposal of a segment of a business, all as
determined in accordance with the standards established by Opinion No. 30 of the
Accounting Principles Board (APB No. 30), (iv) any adjustments to earnings,
gain, loss or expense attributable to a change in accounting principles or
standards, (v) all items of gain, loss or expense for such fiscal year related
to restructuring charges of subsidiaries whose operations are not included in
Operating Income for such fiscal year, (vi) all items of gain, loss or expense
for such
21
<PAGE>
fiscal year related to discontinued operations which do not qualify as a segment
of a business as defined under APB No. 30 and (vii) any profit or loss
attributable to the business operations of any entity acquired by the Company
during such fiscal year. Operating Income shall not be adjusted for a minority
interest holder's share of a consolidated subsidiary's operating income or loss.
4.03 The aggregate bonus pool calculated in the manner
provided in Section 4.02 shall be allocated among the eligible employees in
accordance with this Section 4.03.
A. Each of the Company's executive
officers (salary grades E11 and above) will be assigned an index which is the
product of his or her base salary, measured as of the close of the fiscal year
for which the bonus allocation is made, times a multiplier. The multiplier for
the President and Chief Executive Officer and the Chairman of the Board will be
two (2). For each Senior Vice President (E12), the multiplier will be
one-point-five (1.5), and for every other Vice President (E11) the multiplier
will be one (1).
B. Bonuses will be awarded to each
executive officer by multiplying the aggregate bonus pool for the fiscal year by
a fraction the numerator of which will be the individual officer's index and the
denominator of which will be the sum of the indices for all executive officers.
C. The Committee may, in its sole
judgment and discretion, reduce the bonus allocation to any or all of the
executive officers.
D. The sum of all amounts not paid to
executive officers pursuant to Section 4.03C shall serve as a separate bonus
pool for the fiscal year which may be allocated in whole or in part to other
officers and exempt employees grade E06 and above. One or more executive
officers of the Company may make recommendations to the Chairman and the
President with respect to the non-executive-officer employees who should share
in such bonus pool and the portion of such pool to be allocated to each such
individual. The Chairman and the President shall review such recommendations and
shall, in their discretion, submit one or more of such recommendations (with
such adjustments as they deem appropriate) to the Committee for consideration.
On the basis of such recommendations, the Committee shall select one or more
such non-executive-officer employees to share in such bonus pool and determine
the amount of such pool to be allocated to each selected individual. The
determinations of the Committee shall be final.
E. The bonus award made under this Plan
to any participant for any fiscal year shall not exceed $5 million.
22
<PAGE>
4.04 Following completion of the bonus calculation and
allocation referenced above, the Committee shall issue a written report
containing the final calculation and allocation.
V. PAYMENT OF BONUS AWARDS
5.01 The individual bonus award allocated to each employee
pursuant to Section 4.03 shall be paid to such employee within thirty (30) days
after completion of the annual audit of the Company's financial statements by
its independent auditors.
VI. GENERAL PROVISIONS
6.01 The Plan shall become effective when adopted by the Board
and the Company's stockholders. The Board may at any time amend, suspend or
terminate the Plan, provided such action is effected by written resolution and
does not adversely affect rights and interests of Plan participants to
individual bonuses allocated to them prior to such amendment, suspension or
termination. All material amendments to the Plan shall require stockholder
approval.
6.02 On January 22, 1997, the Board adopted an amendment to
the Plan that changed the bonus formula under Section 4.02 effective for all
fiscal years following the 1996 fiscal year ended December 27, 1996 (the "1997
Amendment"). The 1997 Amendment is subject to stockholder approval at the 1997
Annual Meeting. If the stockholders do not approve the 1997 Amendment, then the
bonus formula in effect under Section 4.02 immediately prior to the 1997
Amendment shall automatically be reinstated, and the bonus pool shall continue
to be calculated in accordance with the reinstated formula.
6.03 No amounts awarded or accrued under this Plan shall
actually be funded, set aside or otherwise segregated prior to payment. The
obligation to pay the bonuses awarded hereunder shall at all times be an
un-funded and unsecured obligation of the Company. Plan participants shall have
the status of general creditors and shall look solely to the general assets of
the Company for the payment of their bonus awards.
6.04 No Plan participant shall have the right to alienate,
pledge or encumber his/her interest in this Plan, and such interest shall not
(to the extent permitted by law) be subject in any way to the claims of the
employee's creditors or to attachment, execution or other process of law.
6.05 Neither the action of the Company in establishing the
Plan, nor any action taken under the Plan by the Committee, nor any provision of
the Plan, nor shareholder approval of the Plan itself shall be construed so as
to grant any person
23
<PAGE>
the right to remain in the employ of the Company or its subsidiaries for any
period of specific duration. Rather, each employee will be employed "at-will,"
which means that either such employee or the Company may terminate the
employment relationship at any time for any reason, with or without cause.
6.06 This is the full and complete agreement between the
eligible employees and the Company on the terms described herein.
24
Exhibit 10.4.5
KOMAG, INCORPORATED
1997 SUPPLEMENTAL STOCK OPTION PLAN
-----------------------------------
(Amended June 12, 1998)
ARTICLE ONE
GENERAL PROVISIONS
------------------
I. PURPOSES OF THE PLAN
This 1997 Non-Executive Officer Stock Option Plan (the "Plan")
is intended to promote the interests of Komag, Incorporated, a Delaware
corporation (the "Corporation"), by providing a method whereby eligible
individuals may be offered incentives and rewards which will encourage them to
acquire a proprietary interest, or otherwise increase their proprietary
interest, in the Corporation and continue to render services to the Corporation
(or its parent or subsidiary corporations).
II. ADMINISTRATION OF THE PLAN
A. The Plan shall be administered by one or more committees
comprised of Board members (the "Committee") or the Board may retain the power
to administer the Plan. The members of the Committee shall each serve for such
period of time as the Board may determine and shall be subject to removal by the
Board at any time.
B. The Committee (or the Board if no Committee has been
designated) shall serve as the Plan Administrator and shall have full power and
authority (subject to the express provisions of the Plan) to establish such
rules and regulations as it may deem appropriate for the proper administration
of such program and to make such determinations under the program and any
outstanding option as it may deem necessary or advisable. Decisions of the Plan
Administrator shall be final and binding on all parties with an interest in the
Plan or any options or shares issued hereunder.
III. ELIGIBILITY FOR OPTION GRANTS
A. The persons eligible to participate in the Plan shall be
- employees (excluding officers and directors)
of the Corporation (or its parent or subsidiary corporations), or
- independent contractors and consultants who
provide valuable services to the Corporation (or its parent or
subsidiary corporations).
B. The Plan Administrator shall have full authority to select
the eligible individuals who are to receive option grants under the Plan, the
number of shares to be covered by each granted option, the time or times at
which such option is to become exercisable and the maximum term for which the
option is to be outstanding.
C. For purposes of the Plan, the following provisions shall be
applicable in determining the parent and subsidiary corporations of the
Corporation:
<PAGE>
Any corporation (other than the Corporation) in an
unbroken chain of corporations ending with the Corporation shall be
considered to be a parent corporation of the Corporation, provided each
such corporation in the unbroken chain (other than the Corporation)
owns, at the time of the determination, stock possessing fifty percent
(50%) or more of the total combined voting power of all classes of
stock in one of the other corporations in such chain.
Each corporation (other than the Corporation) in an
unbroken chain of corporations beginning with the Corporation shall be
considered to be a subsidiary of the Corporation, provided each such
corporation (other than the last corporation) in the unbroken chain
owns, at the time of the determination, stock possessing fifty percent
(50%) or more of the total combined voting power of all classes of
stock in one of the other corporations in such chain.
IV. STOCK SUBJECT TO THE PLAN
A. The stock issuable under the Plan shall be shares of the
Corporation's authorized but unissued or reacquired Common Stock. The aggregate
number of shares which may be issued over the term of the Plan shall not exceed
Six Million One Hundred Thousand (6,100,000) shares (subject to adjustment from
time to time in accordance with paragraph IV.C of this Article One).
B. Should an option be terminated for any reason prior to
exercise in whole or in part, the shares subject to the portion of the option
not so exercised shall be available for subsequent option grants under this
Plan. In addition, unvested shares issued under the Plan and subsequently
repurchased by the Corporation at the original exercise price paid per share,
pursuant to the Corporation's repurchase rights under the Plan shall be added
back to the number of shares of Common Stock reserved for issuance under the
Plan and shall accordingly be available for reissuance through one or more
subsequent option grants under the Plan.
C. In the event any change is made to the Common Stock
issuable under the Plan (whether by reason of (i) merger, consolidation or
reorganization or (ii) recapitalization, stock dividend, stock split,
combination of shares, exchange of shares or other similar change affecting the
outstanding Common Stock as a class without the Corporation's receipt of
consideration), then unless such change results in the termination of all
outstanding options pursuant to the provisions of paragraph II of Article Two of
the Plan, appropriate adjustments shall be made to (i) the aggregate number
and/or class of shares issuable under the Plan, and (ii) the number and/or class
of shares and price per share in effect under each outstanding option under the
Plan. The purpose of such adjustments to the outstanding options shall be to
preclude the enlargement or dilution of rights and benefits under such options.
2
<PAGE>
ARTICLE TWO
OPTION GRANT PROGRAM
--------------------
I. TERMS AND CONDITIONS OF OPTIONS
Options granted pursuant to this Article Two shall be
authorized by action of the Plan Administrator and shall be Non-Statutory
Options. The granted options shall be evidenced by instruments in such form as
the Plan Administrator shall from time to time approve; provided, however, that
each such instrument shall comply with and incorporate the terms and conditions
specified below.
A. Option Price.
1. The option price per share shall be fixed by
the Plan Administrator. In no event, however, shall the option price per share
be less than one hundred percent (100%) of the fair market value per share of
Common Stock on the date of the option grant.
2. The option price shall become immediately
due upon exercise of the option and shall be payable as follows:
(i) full payment in cash or check drawn
to the Corporation's order;
(ii) full payment in shares of Common
Stock held by the optionee for the requisite period necessary to avoid
a charge to the Corporation's earnings for financial reporting purposes
and valued at fair market value on the Exercise Date (as such term is
defined below) equal to the option price; or
(iii) full payment through a combination
of shares of Common Stock held by the optionee for the requisite period
necessary to avoid a charge to the Corporation's earnings for financial
reporting purposes and valued at fair market value on the Exercise Date
and cash or check, equal in the aggregate to the option price.
(iv) to the extent the option is
exercised for vested shares, the option price may also be paid through
a broker-dealer sale and remittance procedure pursuant to which the
optionee shall provide irrevocable instructions to (I) a
Corporation-designated brokerage firm to effect the immediate sale of
the purchased shares and remit to the Corporation, out of the sale
proceeds available on the settlement date, an amount equal to the
aggregate option price payable for the purchased shares plus all
applicable Federal and State income and employment taxes required to be
withheld by the Corporation by reason of such purchase and (II) the
Corporation to deliver the certificates for the purchased shares
directly to such brokerage firm.
For purposes of this subparagraph 2, the Exercise
Date shall be the date on which notice of the exercise of the option is
delivered to the Corporation. Except to the extent
3
<PAGE>
the sale and remittance procedure is utilized in connection with the exercise of
the option, payment of the option price for the purchased shares must accompany
such notice.
3. The fair market value of a share of Common
Stock on any relevant date under subparagraph 1 or 2 above (and for all other
valuation purposes under the Plan) shall be determined in accordance with the
following provisions:
(i) If the Common Stock is at the time
traded on the Nasdaq National Market, then the fair market value shall
be the closing selling price per share of Common Stock on the day prior
to the date in question, as such price is reported by the National
Association of Securities Dealers on the Nasdaq National Market or any
successor system. If there is no closing selling price for the Common
Stock on the day prior to the date in question, then the fair market
value shall be the closing selling price on the last preceding date for
which such quotation exists.
(ii) If the Common Stock is at the time
listed on either the New York Stock Exchange or the American Stock
Exchange, then the fair market value shall be the closing selling price
per share of Common Stock on the day prior to the date in question on
such exchange, as such price is officially quoted in the composite tape
of transactions on that exchange. If there is no closing selling price
for the Common Stock on the day prior to the date in question, then the
fair market value shall be the closing selling price on the last
preceding date for which such quotation exists.
B. Term and Exercise of Options.
Each option granted under this Article Two shall be
exercisable at such time or times, during such period, and for such number of
shares as shall be determined by the Plan Administrator and set forth in the
instrument evidencing such option; provided, however, that no option granted
under this Article Two shall have a maximum term in excess of ten (10) years
from the grant date.
C. Limited Transferability of Options.
During the lifetime of the optionee, the option shall
be exercisable only by the optionee and shall not be assignable or transferable
by the optionee otherwise than by will or by the laws of descent and
distribution following the optionee's death. However, the Plan Administrator may
grant one or more options under this Article Two which may, in connection with
the optionee's estate plan, be assigned in whole or in part during the
optionee's lifetime to one or more members of the optionee's immediate family or
to a trust established exclusively for one or more such family members. The
assigned portion may only be exercised by the person or persons who acquire a
proprietary interest in the option pursuant to the assignment. The terms
applicable to the assigned portion shall be the same as those in effect for the
option immediately prior to such assignment and shall be set forth in such
documents issued to the assignee as the Plan Administrator may deem appropriate.
4
<PAGE>
D. Termination of Service.
1. Should an optionee cease to remain in
Service for any reason (including death, permanent disability or retirement at
or after age 65) while the holder of one or more outstanding options granted to
such optionee under the Plan, then such option or options shall not (except to
the extent otherwise provided pursuant to paragraph VII below) remain
exercisable for more than a twelve (12)-month period (or such shorter period as
is determined by the Plan Administrator and set forth in the option agreement)
following the date of cessation of Service; provided, however, that under no
circumstances shall any such option be exercisable after the specified
expiration date of the option term. Except to the extent otherwise provided
pursuant to subparagraph I.D.4 below, each such option shall, during such twelve
(12)-month or shorter period, be exercisable for any or all vested shares for
which that option is exercisable on the date of such cessation of Service. Upon
the expiration of such twelve (12)-month or shorter period or (if earlier) upon
the expiration of the option term, the option shall terminate and cease to be
exercisable for any such vested shares for which the option has not been
exercised. However, the option shall, immediately upon the optionee's cessation
of Service, terminate and cease to be outstanding with respect to any option
shares in which the optionee is not otherwise at that time vested or for which
the option is not otherwise at that time exercisable.
2. Should the optionee die while in Service, or
cease to remain in Service and thereafter die while the holder of one or more
outstanding options under the Plan, each such option may be exercised by the
personal representative of the optionee's estate or by the person or persons to
whom the option is transferred pursuant to the optionee's will or in accordance
with the laws of descent and distribution but, except to the extent otherwise
provided pursuant to subparagraph I.D.4 below, only to the extent of the number
of vested shares (if any) for which the option is exercisable on the date of the
optionee's death. Such exercise must be effected prior to the earlier of (i) the
first anniversary of the date of the optionee's death or (ii) the specified
expiration date of the option term. Upon the occurrence of the earlier event,
the option shall terminate and cease to be exercisable.
3. If (i) the optionee's Service is terminated
for cause (including, but not limited to, any act of dishonesty, willful
misconduct, fraud or embezzlement or any unauthorized disclosure or use of
confidential information or trade secrets) or (ii) the optionee makes or
attempts to make any unauthorized use or disclosure of confidential information
or trade secrets of the Corporation or its parent or subsidiary corporations,
then in any such event all outstanding options granted the optionee under the
Plan shall terminate and cease to be exercisable immediately upon such cessation
of Service or (if earlier) upon such unauthorized use or disclosure of
confidential or secret information or attempt thereat.
4. The Plan Administrator shall have complete
discretion, exercisable either at the time the option is granted or at the time
the optionee dies, retires at or after age 65, or ceases to remain in Service,
to establish as a provision applicable to the exercise of one or more options
granted under the Plan that during the limited period of exercisability
following death, retirement at or after age 65, or cessation of Employee status
as provided in subparagraph I.D.1 or I.D.2 above, the option may be exercised
not only with respect to the number of vested shares for which it is exercisable
at the time of the optionee's cessation of Service, but also with respect to one
or more subsequent installments in which the optionee would have otherwise
vested had such cessation of Service not occurred.
5. For purposes of the foregoing provisions of
this paragraph I.D (and all other provisions of the Plan),
5
<PAGE>
- The optionee shall be deemed to remain in
the Service of the Corporation for so long as such individual renders
services on a periodic basis to the Corporation (or any parent or
subsidiary corporation) in the capacity of an Employee, a non-employee
member of the Board or an independent consultant or advisor.
- The optionee shall be considered to be an
Employee for so long as such individual remains in the employ of the
Corporation or one or more of its parent or subsidiary corporations,
subject to the control and direction of the employer not only as to the
work to be performed but also as to the manner and method of
performance.
D. Stockholder Rights.
An option holder shall have none of the rights of a
stockholder with respect to any shares covered by the option until such
individual shall have exercised the option, paid the option price and been
issued a stock certificate for the purchased shares. No adjustment shall be made
for dividends or distributions (whether paid in cash, securities or other
property) for which the record date is prior to the date the stock certificate
is issued.
E. Repurchase Rights.
The shares of Common Stock acquired upon the exercise
of options granted under this Article Two may be subject to repurchase by the
Corporation in accordance with the following provisions:
The Plan Administrator shall have the discretion to
authorize the issuance of unvested shares of Common Stock under this Article
Two. Should the Optionee cease Service while holding such unvested shares, the
Corporation shall have the right to repurchase any or all of those unvested
shares at the option price paid per share. The terms and conditions upon which
such repurchase right shall be exercisable (including the period and procedure
for exercise and the appropriate vesting schedule for the purchased shares)
shall be established by the Plan Administrator and set forth in the instrument
evidencing such repurchase right.
All of the Corporation's outstanding repurchase
rights shall automatically terminate, and all shares subject to such terminated
rights shall immediately vest in full, upon the occurrence of any Corporate
Transaction under paragraph II of this Article Two, except to the extent: (i)
any such repurchase right is to be assigned to the successor corporation (or
parent thereof) in connection with the Corporate Transaction or (ii) such
termination is precluded by other limitations imposed by the Plan Administrator
at the time the repurchase right is issued.
The Plan Administrator shall have the discretionary
authority, exercisable either before or after the optionee's cessation of
Service, to cancel the Corporation's outstanding repurchase rights with respect
to one or more shares purchased or purchasable by the optionee under this
Article Two and thereby accelerate the vesting of such shares in connection with
the optionee's cessation of Service.
II. CORPORATE TRANSACTIONS
6
<PAGE>
A. In the event of any of the following
stockholder-approved transactions (a "Corporate Transaction"):
(i) a merger or acquisition in which the
Corporation is not the surviving entity, except for a transaction the
principal purpose of which is to change the State of the Corporation's
incorporation,
(ii) the sale, transfer or other
disposition of all or substantially all of the assets of the
Corporation, or
(iii) any reverse merger in which the
Corporation is the surviving entity,
then each option outstanding under this Article Two
shall automatically become exercisable, during the five (5) business day period
immediately prior to the specified effective date for the Corporate Transaction,
with respect to the full number of shares of Common Stock purchasable under such
option and may be exercised for all or any portion of such shares as fully
vested shares of Common Stock. An outstanding option under the Plan shall not be
so accelerated, however, if and to the extent (i) such option is, in connection
with the Corporate Transaction, either to be assumed by the successor
corporation or parent thereof or be replaced with a comparable option to
purchase shares of the capital stock of the successor corporation or parent
thereof or (ii) the acceleration of such option is subject to other limitations
imposed by the Plan Administrator at the time of grant.
B. Immediately following the consummation of the
Corporate Transaction, all outstanding options under the Plan shall, to the
extent not previously exercised or assumed by the successor corporation or its
parent company, terminate and cease to be exercisable.
C. Each outstanding option under this Article Two which
is assumed in connection with the Corporate Transaction or is otherwise to
continue in effect shall be appropriately adjusted, immediately after such
Corporate Transaction, to apply and pertain to the number and class of
securities which would have been issuable, in consummation of such Corporate
Transaction, to an actual holder of the same number of shares of Common Stock as
are subject to such option immediately prior to such Corporate Transaction.
Appropriate adjustments shall also be made to the option price payable per
share, provided the aggregate option price payable for such securities shall
remain the same. In addition, the class and number of securities available for
issuance under the Plan following the consummation of the Corporate Transaction
shall be appropriately adjusted.
D. Option grants under this Article Two shall in no way
affect the right of the Corporation to adjust, reclassify, reorganize or
otherwise change its capital or business structure or to merge, consolidate,
dissolve, liquidate or sell or transfer all or any part of its business or
assets.
III. CANCELLATION AND REGRANT
The Plan Administrator shall have the authority to effect, at
any time and from time to time, with consent of the affected option holders, the
cancellation of any or all outstanding options under the Plan and to grant in
substitution therefor new options covering the same or different numbers of
shares of Common Stock but having an exercise price per share
7
<PAGE>
equal to one hundred percent (100%) of the fair market value of the Common Stock
on the new grant date.
IV. EXTENSION OF EXERCISE PERIOD
The Plan Administrator shall have full power and authority,
exercisable from time to time in its sole discretion, to extend, either at the
time the option is granted or at any time while such option remains outstanding,
the period of time for which the option is to remain exercisable following the
optionee's cessation of Service or death from the twelve (12)-month or shorter
period set forth in the option agreement to such greater period of time as the
Plan Administrator shall deem appropriate; provided, however, that in no event
shall such option be exercisable after the specified expiration date of the
option term.
8
<PAGE>
ARTICLE THREE
MISCELLANEOUS
-------------
I. AMENDMENT OF THE PLAN
The Board shall have complete and exclusive power and
authority to amend or modify the Plan in any or all respects whatsoever.
However, no such amendment or modification shall, without the consent of the
holders, adversely affect rights and obligations with respect to options at the
time outstanding under the Plan.
II. EFFECTIVE DATE AND TERM OF PLAN
A. The Plan shall become effective upon its adoption by the
Board. Unless sooner terminated in accordance with paragraph II of Article Two,
the Plan shall terminate upon the earlier of (i) September 26, 2007 or (ii) the
date on which all shares available for issuance under the Plan shall have been
issued or cancelled pursuant to the exercise or surrender of options granted
hereunder. If the date of termination is determined under clause (i) above, then
options outstanding on such date shall not be affected by the termination of the
Plan and shall continue to have force and effect in accordance with the
provisions of the instruments evidencing such options.
B. On January 30, 1998, the Board approved an amendment to the
Plan to increase the number of shares of Common Stock reserved for issuance over
the term of the Plan by an additional 1,000,000 shares.
C. On June 12, 1998, the Board approved an amendment to the
Plan to increase the number of shares of Common Stock reserved for issuance over
the term of the Plan by an additional 1,500,000 shares.
III. USE OF PROCEEDS
Any cash proceeds received by the Corporation from the sale of
shares pursuant to options granted under the Plan shall be used for general
corporate purposes.
IV. TAX WITHHOLDING
The Corporation's obligation to deliver shares or cash upon
the exercise or surrender of any option granted under the Plan shall be subject
to the satisfaction of all applicable federal, state and local income and
employment tax withholding requirements.
V. NO EMPLOYMENT/SERVICE RIGHTS
Neither the action of the Corporation in establishing or
restating the Plan, nor any action taken by the Plan Administrator hereunder,
nor any provision of the restated Plan shall be construed so as to grant any
individual the right to remain in the employ or service of the Corporation (or
any parent or subsidiary corporation) for any period of specific duration, and
the Corporation (or any parent or subsidiary corporation retaining the services
of such individual) may terminate such individual's employment or service at any
time and for any reason, with or without cause.
9
<PAGE>
VI. REGULATORY APPROVALS
A. The implementation of the Plan, the granting of any option
hereunder, and the issuance of stock upon the exercise or surrender of any such
option shall be subject to the Corporation's procurement of all approvals and
permits required by regulatory authorities having jurisdiction over the Plan,
the options granted under it and the stock issued pursuant to it.
B. No shares of Common Stock or other assets shall be issued
or delivered under the Plan unless and until there shall have been compliance
with all applicable requirements of Federal and state securities laws, including
the filing and effectiveness of the Form S-8 registration statement for the
shares of Common Stock issuable under the Plan, and all applicable listing
requirements of any stock exchange (or the Nasdaq National Market, if
applicable) on which Common Stock is then listed for trading.
10
KOMAG, INCORPORATED
Exhibit 21
List of Subsidiaries
Asahi Komag Co., Ltd., a Japanese corporation
Komag USA (Malaysia) Sdn., a Malaysian corporation
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 333-31297, 333-23095, 333-06081, 33-62543, 33-80594, 33-53432,
33-45469, 33-41945, 33-25230, 33-19851, 33-16625, and 33-48867) pertaining to
the Komag, Incorporated Deferred Compensation Plan, the Komag, Incorporated
Restated 1987 Stock Option Plan, the Komag Material Technology, Inc. 1995 Stock
Option Plan, the Komag, Incorporated Employee Stock Purchase Plan, the Komag,
Incorporated Restated 1987 Stock Option Plan, the Dastek International Stock
Option Plan, the Dastek, Inc. 1992 Stock Option Plan, and the 1997 Supplemental
Stock Option Plan of our report dated January 22, 1999, with respect to the
consolidated financial statements and schedule of Komag, Incorporated included
in this Annual Report (Form 10-K) for the year ended January 3, 1999.
ERNST & YOUNG LLP
San Jose, California
April 1, 1999
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the inclusion in this annual report on Form 10-K of our report
dated January 22, 1999 on our audit of the consolidated financial statements of
Asahi Komag Co., Ltd. and subsidiary as of December 31, 1998 and 1997 and for
the three years in the period ended December 31, 1998.
CHUO AUDIT CORPORATION
Tokyo, Japan
March 31, 1999
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