<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
------------------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 27, 1998
COMMISSION FILE NUMBER 0-25796
------------------------
STORMEDIA INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 77-0373062
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OR INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
</TABLE>
385 REED STREET, SANTA CLARA, CALIFORNIA 95050-3118
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(ZIP CODE)
(408) 327-8400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
------------------------
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 [ ]
As of April 20, 1998, 16,291,423 shares of the Registrant's Class A Common
Stock, $0.013 par value, and 4,362,001 shares of the Registrant's Class B Common
Stock, $0.013 par value, were issued and outstanding.
================================================================================
<PAGE> 2
STORMEDIA INCORPORATED AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations --
Three Months Ended March 27, 1998 and March 28, 1997........ 3
Condensed Consolidated Balance Sheets --
As of March 27, 1998 and December 31, 1997.................. 4
Condensed Consolidated Statements of Cash Flows --
Three Months Ended March 27, 1998 and March 28, 1997........ 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of
Operations.................................................. 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings........................................... 19
Item 2. Changes in Securities....................................... 20
Item 3. Defaults Upon Senior Securities............................. 20
Item 4. Submission of Matters to a Vote of Securities Holders....... 20
Item 5. Other Information........................................... 20
Item 6. Exhibits and Reports on Form 8-K............................ 20
SIGNATURES........................................................... 21
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
STORMEDIA INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------
MARCH 27, MARCH 28,
1998 1997
----------- -----------
<S> <C> <C>
Net sales................................................... $ 39,220 $ 34,100
Cost of sales............................................... 55,508 39,004
-------- --------
Gross deficit............................................. (16,288) (4,904)
Operating expenses:
Research and development.................................. 5,791 3,190
Selling, general, and administrative...................... 3,456 2,339
-------- --------
Total operating expenses............................... 9,247 5,529
Operating loss......................................... (25,535) (10,433)
Other income (expense), net............................... (1,685) (562)
-------- --------
Loss before income tax expense (benefit).................... (27,220) (10,995)
Income tax expense (benefit)................................ 12 (1,676)
-------- --------
Net loss.................................................. $(27,232) $ (9,319)
======== ========
Loss per share:
Basic..................................................... $ (1.34) $ (0.52)
======== ========
Diluted................................................... $ (1.34) $ (0.52)
======== ========
Shares used in per share computation:
Basic..................................................... 20,387 17,787
======== ========
Diluted................................................... 20,387 17,787
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
STORMEDIA INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
MARCH 27, DECEMBER 31,
1998 1997
----------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 11,076 $ 8,753
Accounts receivable, less allowances of $11,580 at
March 27, 1998
and $9,171 at December 31, 1997...................... 9,727 14,011
Inventories............................................ 18,387 37,775
Assets held for sale................................... 16,334 16,914
Prepaid expenses....................................... 8,284 8,523
-------- --------
Total current assets................................. 63,808 85,976
Plant and equipment, net.................................. 97,117 100,694
Deposits and other assets................................. 264 1,004
-------- --------
$161,189 $187,674
======== ========
LIABILITIES AND EQUITY
Current liabilities:
Trade accounts payable................................. $ 34,841 $ 33,531
Bank and short-term debt............................... 48,362 48,364
Accrued salaries and benefits.......................... 4,278 6,689
Other accrued expenses................................. 16,364 20,265
Income taxes payable................................... 1,130 1,126
-------- --------
Total current liabilities............................ 104,975 109,975
Long-term debt less current portion....................... 77 78
Excess of fair value of assets acquired over purchase
price.................................................. 18,376 12,699
Commitment and contingencies
Equity:
Common stock, par value $.013 per share................ 272 270
Additional paid-in capital............................. 131,135 131,066
Accumulated deficit.................................... (93,646) (66,414)
-------- --------
Total equity......................................... 37,761 64,922
-------- --------
$161,189 $187,674
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
STORMEDIA INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------
MARCH 27, MARCH 28,
1998 1997
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................. $(27,232) $ (9,319)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization.......................... 5,037 7,142
Net loss on sale of plant and equipment................ -- 263
Write down of plant and equipment...................... 755 --
Changes in operating assets and liabilities:
Accounts receivable.................................. 6,599 6,131
Inventories.......................................... 23,188 154
Prepaid expenses..................................... 239 (40)
Other assets......................................... 741 (96)
Trade accounts payable............................... 1,310 1,462
Accrued liabilities.................................. (5,812) 1,514
Income taxes payable................................. 4 (1,624)
-------- --------
Net cash provided by operating activities............ 4,829 5,587
-------- --------
INVESTING ACTIVITIES
Acquisition of plant and equipment........................ (3,153) (11,325)
Sale of assets............................................ 580 --
Purchase of short-term investments........................ -- (250)
-------- --------
Net cash used in investing activities................ (2,573) (11,575)
-------- --------
FINANCING ACTIVITIES
Repayment of debt obligations............................. (3) (4)
Proceeds from issuance of Class A Common Stock, net of
issuance costs......................................... 70 250
-------- --------
Net cash provided by financing activities............ 67 246
-------- --------
Increase (decrease) in cash and cash equivalents.......... 2,323 (5,742)
Cash and cash equivalents at beginning of period.......... 8,753 23,788
-------- --------
Cash and cash equivalents at end of period................ $ 11,076 $ 18,046
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest.................................... $ 705 $ 566
======== ========
Cash paid for income taxes................................ $ -- $ 21
======== ========
Non-cash investing activities:
Increase in excess of fair value of assets acquired over
purchase price......................................... $ 6,615 $ --
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
STORMEDIA INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1 -- BASIS OF PRESENTATION
The Company's consolidated financial statements have been presented on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. During the three
months ended March 27, 1998 and for the year ended 1997 the Company incurred a
net loss from operations of $27,232 and $99,055, respectively. There was a
working capital deficiency of $41,167 and $23,999 at March 27, 1998 and December
31, 1997, respectively. As of March 27, 1998 the Company was in default of its
loan agreement which is secured by a substantial portion of the Company's assets
(see Note 7).
Management's financial plans for fiscal 1998 call for raising additional
debt and equity capital, the sale of certain assets and the renegotiation of its
bank agreement. While management believes it can achieve these plans, there can
be no assurances that management's financial plans will be fully executed. If
management is unable to execute its' plans, the banks may foreclose on their
security interest and the Company may not have sufficient liquidity to continue
as a going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the condensed consolidated
financial statements include all adjustments which are necessary for a fair
presentation. Operating results for the three months ended March 27, 1998 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 1998 or any other interim period. The accompanying unaudited
condensed consolidated financial statements should be read in conjunction with
the Company's audited financial statements included in its Annual Report on Form
10-K for the year ended December 31, 1997 which was filed with the Securities
and Exchange Commission on March 31, 1998.
NOTE 2 -- RECLASSIFICATIONS
Certain amounts in the accompanying December 31, 1997 condensed
consolidated balance sheet have been reclassified in order to conform to the
presentation of the March 27, 1998 condensed consolidated balance sheet.
NOTE 3 -- BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
MARCH 27, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Inventories:
Raw materials...................................... $ 9,921 $ 9,226
Work-in-process.................................... 6,731 15,480
Finished goods..................................... 1,735 13,069
-------- --------
Total inventories.......................... $ 18,387 $ 37,775
======== ========
</TABLE>
6
<PAGE> 7
STORMEDIA INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 4 -- NUMBER OF SHARES USED IN PER SHARE COMPUTATION
The following table reconciles the number of shares used in basic net
income (loss) per share computation and the number of shares used in diluted net
income (loss) per share computation:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Basic:
Weighted average common shares used in computing
basic net income (loss) per share................. 20,387 17,787
====== ======
Diluted:
Weighted average common shares outstanding........... 20,387 17,787
Diluted options outstanding.......................... -- --
------ ------
Shares used in computing diluted net income (loss)
per share......................................... 20,387 17,787
====== ======
</TABLE>
As of March 27, 1998, there were 2,446 options outstanding to acquire
shares of common stock with a weighted-average exercise price of $5.57 which
could potentially dilute basic earnings per share in the future but which were
not included in diluted earnings per share as their effect was antidilutive in
the period presented.
NOTE 5 -- COMPREHENSIVE INCOME
In June 1997, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," which establishes standards
for reporting and disclosures of comprehensive income and its components
(revenues, expenses, gains and losses) in a full act of general-purpose
financial statements. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997 and requires reclassification of financial statements for
earlier periods to be provided for comparative purposes. The Company has not
determined the manner in which it will present the information required by SFAS
No. 130 in its annual consolidated financial statements for the year ending
December 31, 1998. The Company's total comprehensive income (loss) for all
periods presented herein would not have differed from those amounts reported as
net income (loss) in the consolidated statements of operations.
NOTE 6 -- AKASHIC ACQUISITION
On December 31, 1997, the Company acquired all of the outstanding stock of
Akashic Memories Corporation ("Akashic"). The acquisition was accounted for as a
purchase. During the first quarter of 1998 the Company adjusted the valuation of
Akashic's accounts receivable, inventory, and accrued liabilities. Consequently,
accounts receivable and inventory were increased by $2.3 and $3.8 million,
respectively, and accrued liabilities was reduced by $0.5 million resulting in a
net increase in the excess of fair value of assets acquired over purchase price
by $6.6 million. Assets held for sale principally include manufacturing
equipment for rigid disks and are based on preliminary valuation by an
independent appraiser, subject to final adjustment. Changes in valuation of
these assets may result in a material change in the excess of fair value of
assets acquired over purchase price.
7
<PAGE> 8
STORMEDIA INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 7 -- SHORT-TERM BORROWINGS AND DEBT
The Company is currently in active discussions with CIBC (Canadian Imperial
Bank of Commerce) and certain other banks to amend the terms of the CIBC Term
Loan Facility. The amendment contemplates among other things, a change to the
amortization schedule of principal, extension of the maturity date, repayment of
a portion of principal outstanding from various sources of funds upon the
successful completion of new debt and equity financings and the sale of certain
assets. The amendment will also require compliance with various financial
covenants.
NOTE 8 -- LITIGATION
STORMEDIA INCORPORATED V. HYUNDAI ELECTRONICS INDUSTRIES CO., ET AL.
On July 23, 1996, the Company was informed by Maxtor Corporation that it
intended to terminate a November 17, 1995 Volume Purchase Agreement between
Maxtor and Hyundai Electronics Industries Co. Ltd., on the one hand, and the
Company. Prior to such notification, Maxtor had failed to purchase in the
Company's second quarter the disks required to be purchased by it under the
Volume Purchase Agreement. As a consequence of Maxtor and Hyundai's breach of
the Volume Purchase Agreement, the Company on September 25, 1996 filed suit in
the United States District Court for the Northern District of California against
Hyundai, C.S. Park, K.S. Yoo and Mong Hun Chung alleging breach of the Volume
Purchase Agreement and fraud. The Complaint seeks damages in excess of $206
million. In response to a motion to dismiss brought by Hyundai the Court
dismissed the Complaint because it found that Maxtor was an indispensable party
to the litigation. The Court, however, conditioned its dismissal on defendants
agreements to certain terms and conditions designed to preserve the progress
made in the federal action. In response, StorMedia has filed a substantially
similar complaint against Maxtor, Hyundai Electronics Industries and certain
individuals in California state court.
On February 18, 1998, StorMedia filed suit in Superior Court for the State
of California, County of Santa Clara, against Hyundai Electronics Industries
Co., Ltd. ("HEI"), Maxtor, and Messrs. Park, Yoo and Chung. Apart from the
addition of Maxtor, the complaint is substantively identical to the
above-described Federal action. Defendants HEI and Park have answered the
complaint, denying its material allegations. Defendant Maxtor has moved to
dismiss or stay the action because of the pendency of the Colorado action,
described below. Defendants Yoo and Chung have moved to dismiss the complaint
for failure to plead fraud with particularity. These motions are set for hearing
on May 14, 1998. In the meantime, StorMedia has propounded additional discovery
and noticed depositions. Responses to this discovery are stayed pending the
outcome of the hearing on May 14, 1998. StorMedia intends to pursue this action
vigorously.
MAXTOR CORPORATION V. STORMEDIA, INC., ET AL.
On December 19, 1996, Maxtor Corporation filed an action in Colorado state
court for the County of Boulder against the Company, its subsidiary, StorMedia
International Limited, and William J. Almon alleging breach of contract, breach
of warranty, fraud and negligent misrepresentation. The action alleges that the
Company's products failed to meet certain of Maxtor's requirements under the
November 17, 1995 Volume Purchase Agreement. The action seeks compensatory
damages of $100 million. The Colorado state court stayed all proceedings in that
action in favor of the above-described federal action against Hyundai. In
response to the federal court's order dismissing StorMedia's complaint against
Hyundai, described above, Maxtor moved to lift the stay of its Colorado State
court proceeding. That motion is currently pending.
8
<PAGE> 9
STORMEDIA INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
WERCZBERGER, ET AL. V. STORMEDIA INCORPORATED
On September 18, 1996, a purported securities class action complaint,
Werczberger, et al. v. StorMedia, Inc. et al., No. CV760825, was filed in the
Superior Court of the State of California in the County of Santa Clara. The
complaint alleges that StorMedia and certain of its officers and directors
violated California state securities laws by making false and misleading
statements of material fact about StorMedia's prospects between November 27,
1995 and August 9, 1996. Plaintiff purports to represent a class of persons who
purchased StorMedia stock during this period. In particular, the complaint
alleges that the StorMedia defendants made allegedly false statements regarding
volumes of disks to be purchased by Maxtor and Hyundai pursuant to the contract
that is the subject of the two above-described actions. On August 19, 1997, the
California Supreme Court granted review of the Superior Court's order overruling
the defendants' demurrer. In addition, on June 18, 1997, a federal securities
action, Werczberger v. StorMedia, et al., C-97 20538, was filed against the same
defendants in the United States District Court for the Northern District of
California, San Jose Division. The federal complaint alleges violations of
federal securities laws and contains virtually identical allegations to those in
the state court complaint. Defendants intend to continue to defend these cases
vigorously.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations contains trend analysis and other
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Actual results could differ materially from those set forth in such
forward-looking statements as a result of the factors set forth under "Factors
Affecting Operating Results" and other risks detailed from time to time in the
Company's reports filed with the Securities and Exchange Commission.
OVERVIEW
1998 Compared to 1997
During 1997 and for the three months ended March 27, 1998, the Company sold
its disks primarily to Seagate Technology, Inc. ("Seagate"), Western Digital
Corporation ("Western Digital"), Samsung Electronics Corporation ("Samsung"),
Micropolis (S) Pte. Ltd. ("Micropolis") and Syquest Technology Inc. ("Syquest").
The Company's gross margins have fluctuated and will continue to fluctuate
quarterly and annually based upon a variety of factors such as excess capacity
and a general downturn in the industry, as well as the level of utilization of
the Company's production capacity, changes in product mix, average selling
prices, demand or manufacturing yields, increases in production of new programs,
changes in cost of or limitations on availability of materials and labor
shortages. During 1997 and for the three months ended March 27, 1998, the
Company reported a gross deficit as a percentage of net sales of 30.6% and
41.5%, respectively, principally due to the underutilzation of production
capacity as a result of the liquidation of Micropolis and the overall decrease
in demand in the disk drive industry. In November 1997, Singapore Technologies
announced without notice that it was closing its Micropolis operations. This
resulted in a precipitous cancellation of orders of the Company's products as
well as the writeoff by the Company of certain assets and equipment which the
Company had installed in the Micropolis Facility in Singapore.
The Company expects that a substantial portion of the Company's shipments
in 1998 will consist of new products, including high performance
magnetoresistive (MR) disks. While new products generally have higher average
selling prices than more mature products, new products also have lower
manufacturing yields and consequently are initially produced in lower quantities
than more mature products. There can be no assurance that the Company's gross
margins will not be negatively impacted by the introduction and shipment of new
products during 1998.
10
<PAGE> 11
RESULTS OF OPERATIONS
The following table sets forth certain financial data as a percentage of
net sales for the periods indicated:
STORMEDIA INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------
MARCH 27, MARCH 28,
1998 1997
--------- ---------
<S> <C> <C>
Net sales................................................... 100.0% 100.0%
Cost of sale................................................ 141.5 114.4
------- -------
Gross deficit............................................. (41.5) (14.4)
Operating expenses:
Research and development.................................. 14.8 9.3
Selling, general and administrative....................... 8.8 6.9
------- -------
Total operating expenses.......................... 23.6 16.2
Operating loss............................................ (65.1) (30.6)
Other income (expense), net............................... (4.3) (1.6)
------- -------
Loss before income tax expense............................ (69.4) (32.2)
Income tax expense (benefit).............................. 0.0 (4.9)
------- -------
Net loss.................................................. (69.4)% (27.3)%
======= =======
</TABLE>
1998 COMPARED TO 1997
The results for the three months ended March 27, 1998 include those of
Akashic Memories Corporation ("Akashic"), which the Company acquired on December
31, 1997 in a transaction which was accounted for as a purchase (the
"Acquisition.")
Net sales
Net sales increased 15.0% to $39.2 million for the three months ended March
27, 1998 from $34.1 million for the three months ended March 28, 1997. As a
result of the Acquisition, the Company acquired the Akashic thin film disk and
substrate business which has expanded its customer base and has increased the
range of products which it is offering, leading to an increase of unit volume
for the Company during the three months ended March 27, 1998 as compared to the
three months ended March 28, 1997. The increase in unit volume was offset by a
slight decrease in average selling prices. The Company's customers during the
three months ended March 27, 1998 were Seagate, Samsung, Western Digital, and
Syquest. The Company's primary customers during the three months ended March 28,
1997 were Seagate and Micropolis.
Gross deficit
The Company's gross deficit increased to $16.3 million for three months
ended March 27, 1998 from $4.9 million for the three months ended March 28,
1997. Gross deficit as a percentage of net sales for the three months ended
March 27, 1998 was 41.5% as compared to 14.4% for the three months ended March
28, 1997. The Company's has incurred a gross deficit throughout 1997 and for the
three months ended March 27, 1998. This was principally due to the
under-utilization of its facilities and the liquidation of Micropolis which
resulted in both a precipitous termination of orders and a writeoff of assets
and equipment installed by the Company in the Micropolis facility. While the
Company has taken steps to better align its resources and expenses with sales
expectations and reduce its costs and expenses, its operations have a high level
of fixed costs and expenses. Despite the temporary closure of certain
facilities, continued under-utilization of capacity has had and is expected to
continue to have a significant negative impact on gross margins. If the Company
11
<PAGE> 12
continues to have excess capacity, the Company's business, results of operations
and financial condition will continue to be materially affected. However, the
Company expects gross margins for 1998 to remain at levels below those
experienced in 1996 because the Company's customer base is still limited and the
Company has been unable to complete certain product qualifications.
An increase in net sales (other than as a result of the Acquisition)
depends on industry demand improving and the Company's ability to successfully
qualify products with new and existing customers. In an effort to utilize the
excess capacity created by Hyundai's repudiation of the Maxtor Supply Agreement
and the resulting excess capacity, the Company continues its qualification and
production efforts with new and existing customers. There can be no assurance
that demand in the disk drive industry will improve or that the Company will be
able to successfully qualify products with new and existing customers. The
failure to do so will have a material adverse effect on the Company's business,
results of operations, and financial condition.
Research and development
Research and development expenses increased to $5.8 million for the three
months ended March 27, 1998 from $3.2 million for the three months ended March
28, 1997, increasing as a percentage of net sales to 14.8% for the three months
ended March 27, 1998 from 9.3% for the comparable prior year three month period.
The increase in research and development expense for the three month period
ended March 27, 1998 was due principally to increased staffing as a result of
the Acquisition and increased spending on development work related to volume
manufacturing of MR disks, substrates, new magnetic alloys and sputtering
techniques.
Selling, general & administrative Expenses. Selling, general &
administrative expenses increased to $3.5 million for the three months ended
March 27, 1998 from $2.3 million for the three months ended March 28, 1997,
increasing as a percentage of net sales to 8.8% for the three months ended March
27, 1998 from 6.9% for the comparable prior year three month period. The
increase in selling, general & administrative expenses for the three month
period ended March 27, 1998 was due principally to increased staffing as a
result of the Acquisition and a slight increase in professional fees as a result
of the Acquisition and the restructuring of the bank credit agreement.
Other income (expense), net. Other income (expense), net for the three
months ended March 27, 1998 was $1.7 million expense compared to $0.6 million
expense for the three months ended March 28, 1997. The change was principally
attributable to a decrease in interest income as a result of lower net cash
levels during the three months ended March 27, 1998 as compared to the
comparable prior year three month period in addition to transaction exchange
loss recognized during the three months ended March 27, 1998.
Income tax expense. The Company recorded a minimal tax expense for the
three months ended March 27, 1998 as compared to a tax benefit of 15% for the
comparable prior year three month period primarily due to the lack of any
available net operating loss carryback in 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company had cash and cash equivalents and short-term investments of
$11.1 million as of March 27, 1998 as compared to cash and cash equivalents and
short-term investments of $8.8 million as of December 31, 1997. The increase,
despite the net cash loss of $22.2 million for the three months ended March 27,
1998 (after add back of depreciation and amortization of $5.0 million), was
principally due to the Company's ability to generate cash from operations
through management of working capital which included a significant reduction of
inventory and accounts receivable. This was a result of the Company implementing
various cash generation measures in early 1998. Such increases in working
capital were offset by a reduction in accrued liabilities.
For the three months ended March 27, 1998, the Company used $3.0 million
for capital expenditures. The Company expects to incur no more than $20 million
in capital expenditures during 1998, primarily for maintenance capital. The
Company had $51.2 million of noncancellable purchase commitments outstanding at
March 27, 1998.
12
<PAGE> 13
The Company's liquidity may be adversely effected in the future by
continued losses from operations and factors such as higher interest rates,
inability to borrow without collateral, availability of capital financing
transactions and a reduction of terms with vendors. Further, significant
fluctuations in quarterly operating results has had and, in the future, may
continue to have a negative effect on the Company's liquidity. Factors such as
weakness in industry demand, price reductions, unsuccessful product
qualifications, the introduction and market acceptance of new products, product
returns, availability of critical components have had and may continue to have
an adverse effect on the Company's performance and have contributed and may
continue to contribute to this quarterly variability. As such, the results of
operations in some future period may be below the expectations of investors,
which would likely result in a significant reduction in the market price of the
Common Stock. A decline in the market price of the Common Stock would have a
negative effect on the Company's ability to raise needed capital on terms and
conditions which are favorable to the Company and its Stockholders.
Recent working capital needs have been financed primarily through a
combination of existing cash resources, improved management of accounts
receivable, and the extension of trade terms with vendors. The Company's
principal sources of cash at March 27, 1998 consisted of $11.1 million of cash
and cash equivalents. During the three months ended March 27, 1998, the Company
has not paid the $5.0 million principal payment due during the quarter but
remains current on its interest payments for its CIBC Term Loan Facility. The
Company is currently in default of its CIBC Term Loan Facility which is secured
by a substantial portion of the Company's assets. The Company is in active
discussions with the Banks to amend the terms of the facility. The amendment
being negotiated contemplates among other things, a change to the amortization
schedule of principal, extension of the maturity date, repayment of a portion of
outstanding principal outstanding from the successful completion of new debt and
equity financings and the sale of certain assets. The amendment will also
require compliance with various financial covenants. There can be no assurance
that the Company will successfully complete this restructuring of its bank debt
or the necessary debt and equity financings. If these transactions are not
completed, the Bank may foreclose on their security interest and the Company may
not have sufficient liquidity to continue in business.
The Company is implementing various cash generation measures including a
program to significantly reduce inventories and the sale of certain fixed assets
acquired in the Acquisition in order to meet its ongoing liquidity requirements.
In addition, management's financial plans for fiscal 1998 anticipate raising
additional debt and/or equity capital. There can be no assurance, however, that
such financing would be available when needed, if at all, or on favorable terms
and conditions. The precise amount and timing of the funding needs cannot be
determined accurately at this time, and will depend on a number of factors,
including completion of ongoing discussions with debt and equity financing
sources and its current bank group. If management is unable to raise additional
financing the Company may not be able to continue as a going concern.
FACTORS THAT MAY AFFECT FUTURE RESULTS
StorMedia operates in a rapidly changing environment that involves a number
of risks, some of which are beyond StorMedia's control. The following discussion
highlights some of these risks.
Sustained Losses; Need for Additional Financing; Future Capital Needs. The
Company incurred a net loss during fiscal year 1997 and for the three months
ended March 27, 1998 totaling $99.1 million and $27.2 million, respectively.
There can be no assurances that the Company will cease incurring losses despite
new product introductions, as there can be no assurances that the Company's
products will be accepted in the marketplace. Continued losses have and will
continue to result in liquidity and cash flow problems and could affect product
delivery efforts. Further sustained losses will necessitate future additional
financings that if raised through the issuance of equity securities, will reduce
the percentage ownership of the stockholders of the Company. Existing
stockholders may experience additional dilution, and securities issued in
conjunction with new financings may have rights, preferences and privileges
senior to those of holders of the Company's Common Stock. There can be no
assurance, however, that additional financing will be available when needed, if
at all, or on favorable terms.
Difficulties of Integrating Akashic. The anticipated benefits of the
acquisition of Akashic will not be achieved unless the operations of Akashic are
successfully combined with those of StorMedia on a timely and cost-effective
manner. The successful combination of the two companies will also require
integration of the companies' product offerings and the coordination of their
research and development and sales and marketing
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efforts, and may require the Company to close certain of its facilities and
reorganize the Company's operations in order to achieve cost savings from
economies of scale. The difficulties of assimilation may be increased by the
need to integrate personnel and to combine different corporate cultures. The
combination of StorMedia and Akashic has required and will continue to require
substantial attention from management. Any difficulties encountered in the
transition process will divert the attention of management away from the
Company's business, which could have an adverse impact on the revenues and
operating results of the combined Company. In addition, the process of combining
the two organizations could cause the interruption of, or a loss of momentum in,
the activities of either or both of the companies' businesses, which could have
a material adverse effect on their combined operations. There can be no
assurance that the companies can be successfully integrated or that such
integration will take place in a timely and cost-effective manner, or that it
will realize any of the anticipated benefits of the Acquisition.
Just In Time Inventory. The disk drive industry supplies components for
client server and PC manufacturers. Until recently, component suppliers have
been characterized by long product cycles, built up inventories and production
based on forecasts. With the recent slowdown in the disk drive industry, disk
drive manufacturers have reduced inventories, shortened product cycles and based
production on actual customer orders. While the long term benefits of such
streamlined production may be shorter, milder business cycles, the short-term
effect has been to significantly reduce demand for components, such as those
supplied by the Company. This just in time inventory strategy has exacerbated
the impact of the overall reduction in demand in the disk drive industry. While
the Company is modifying its product cycles and production processes to adapt to
the just in time inventory strategy of its customers, there can be no assurance
that the Company will successfully do so. The failure of the Company to adapt
its product cycles and production processes to the just in time strategy of its
customers may result in reduced sales and the inability of the Company to
successfully qualify its products, which would have a material adverse effect on
the Company.
Fluctuations in Quarterly Operating Results. StorMedia's and Akashic's
quarterly results have fluctuated in the past and the combined Company's
operating results may continue to fluctuate in the future. The Company's
operating results are dependent on many factors, including the economic
conditions in the disk drive industry, the size and timing of the receipt of
orders from current customers, product qualifications for new and existing
customers, utilization of production capacity, manufacturing yields, customer
cancellations or delays of shipments, the Company's ability to develop,
introduce and market new and enhanced products on a timely basis, the
introduction of new products by its competitors and changes in average selling
prices and product mix, among others. The Company's expense levels will be
based, in part, on expectations of future revenues. Both StorMedia and Akashic
derive their revenues primarily from the sale of thin film media and plated and
polished substrates. The Company's results of operations for a particular
quarter could be adversely affected if anticipated product orders or
qualifications are not received, if anticipated shipments are delayed or
canceled by one or more customers or if shipments are delayed or rejected. The
slowdown in the disk drive industry in general combined with the construction of
new media and substrate facilities have resulted in decreased demand for media
and substrates and consequently, overcapacity and underutilization of existing
facilities. There can be no assurance that this slowdown will not continue.
There can be no assurance that these and other factors will not materially
adversely affect the Company's business, results of operations and financial
results.
During 1996 the Company reported a gross margin of 17.3% and reported a
gross deficit of 30.6% during 1997. During the three months ended March 27,
1998, the Company reported a gross deficit of 41.5%. The Company's gross margins
in 1997 and the three months ended March 27, 1998 were lower than the levels
experienced in 1995 and 1996 principally due to the Company's inability to
replace sales which it had expected to make to Maxtor under the Maxtor Supply
Agreement and the resulting under-utilization of its facilities, as well as the
liquidation of Micropolis which resulted in both a precipitous termination of
orders and a writeoff of assets and equipment installed by the Company in the
Micropolis facility. While the Company has taken steps to better align its
resources and expenses with sales expectations and reduce its costs and
expenses, its operations have a high level of fixed costs and expenses. Despite
the temporary closure of certain facilities, continued under-utilization of
capacity has had a significant negative impact on gross margins. If the Company
continues to have excess capacity, the Company's business, results of operations
and financial condition will continue to be materially adversely affected.
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In addition, new products generally have higher average selling prices than
more mature products. Therefore, the Company's ability to introduce new
products, which have been designed into its customers' products, in a timely
fashion is an important factor in its ability to maintain gross and operating
margins. However, initially new products often have lower manufacturing yields,
are produced in lower quantities than more mature products and, therefore,
generally have lower gross margins. The Company expects that a substantial
portion of its shipments in 1998 will be of new products, which will negatively
impact the Company's overall yield at least for that period and, consequently,
the Company's gross margins. Manufacturing yields also vary depending on the
complexity and uniqueness of product specifications. Because the thin film disk
industry is capital intensive and requires a high level of fixed costs, gross
margins are also extremely sensitive to changes in volume. Assuming fixed
product prices, small variations in manufacturing yields and productivity
generally have a significant impact on gross margins. Additionally, decreasing
demand for the Company's products generally results in reduced average selling
prices and low capacity utilization which, in turn, adversely affects gross
margins and operating results. Even during periods of reduced revenues, in order
to remain competitive, the Company will be required to continue to invest in
research and development and to maintain a level of manufacturing capacity
capable of addressing increased demand. A significant portion of the Company's
business is also characterized by short term orders and shipment schedules which
typically can be modified or rescheduled without significant penalty to the
customer. Therefore, the Company typically plans its production and inventory
based on forecasts of customer demands, which often fluctuate substantially.
These factors have caused and will continue to cause fluctuations in the
Company's gross margins and results of operations. See "-- Just In Time
Inventory" and " -- Dependence on a Limited Number of Customers."
Current Slowdown and Volatility in the Disk Drive Industry. Both
StorMedia's and Akashic's businesses have depended and the business of the
Company will continue to depend upon the current and anticipated market demand
for disk drives and products utilizing disk drives. The disk drive industry has
been cyclical in nature and is currently experiencing a downturn. The disk drive
industry also has been characterized by periods of oversupply, reductions in
customer forecasts, price erosion and reduced production levels. The effect of
these cycles on suppliers, including thin film media and plated and polished
substrate manufacturers, has been magnified by hard disk drive manufacturers'
practice of ordering components in excess of their needs during periods of rapid
growth, which increases the severity of the drop in the demand for components
during periods of contraction. During 1995 and early 1996, the Company's
principal customers and many of its competitors and potential customers engaged
in substantial efforts to increase disk manufacturing capacity in light of the
imbalance between previously existing levels of demand for disks and existing
industry capacity. These efforts, along with the adoption by disk drive
manufacturers of "Just In Time" inventory practices, have resulted in
significant additional capacity in the industry which has exacerbated the
negative impact on the Company of the slowdown in demand for media and
substrates. To the extent industry capacity continues to exceed demand, the
Company will continue to experience increased levels of competition which could
materially adversely impact the Company's business, results of operations, and
financial condition. In addition, in the event of an oversupply of disks,
customers who have developed an internal supply of disks are likely to utilize
their internal capacity prior to purchasing disks from independent suppliers.
These conditions have adversely affected StorMedia and Akashic, and may continue
to adversely affect the Company's revenues, margins and operating results, and
no assurance can be given that the Company's revenue, margins and operating
results will not be adversely affected by future downturns in the disk drive
industry.
Dependence on a Limited Number of Customers. During the three months ended
March 27, 1998, the Company sold its disks to Samsung, Western Digital, Seagate
and Syquest representing 59%, 7%, 17% and 13%, respectively, of net sales.
During 1997, shipments to Seagate and Micropolis represented 62% and 18%,
respectively, of net sales. As discussed above, Maxtor terminated the Maxtor
Supply Agreement in 1996 and Micropolis was liquidated in 1997. While Seagate
and other new customers such as Western Digital and Samsung have taken a portion
of the Company's capacity which became available as a result of these
terminations and the Company is now shipping to additional new customers as a
result of the Acquisition, the Company continues to have excess manufacturing
capacity as it seeks to qualify its products in additional product programs of
both new and existing customers. Qualification is a costly and time-consuming
process and the Company continues to experience increased levels of competition
in the qualification process. There
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can be no assurance that the Company will continue to qualify products with its
present customers, continue to find new customers or successfully qualify its
products in the product programs of such new customers on a timely basis or with
acceptable yields. Accordingly, the Company expects excess capacity to continue
to negatively impact its results of operations at least during 1998.
Given the relatively small number of independent high performance disk
drive manufacturers, the Company's dependence on a few customers will continue
for the foreseeable future. The Company's existing and several of its potential
customers have expanded their ability to produce thin film disks internally. As
a result, these customers could reduce the level of purchases and could cease
purchasing from suppliers such as the Company, could sell thin film disks in
competition with the Company or decrease their level of orders as the slowdown
in the industry continues. Specifically, Seagate currently produces a portion of
its own thin film disk requirements internally and historically has produced a
majority of its requirements. Seagate's expressed corporate strategy has been to
significantly increase its internal capacity to manufacture disks. If Seagate
were to continue to reduce the level of orders from the Company as a result of
the expansion of its internal disk production, an acquisition of, or the
establishment of a strategic relationship with, another disk supplier or
otherwise, or if Seagate were to begin selling disks in competition with the
Company, the Company's business, results of operations and financial condition
would be materially adversely affected.
Recently, there has been a slowdown in demand for disk drive products and a
commensurate decrease in demand for thin film media. The extent that a decrease
in demand has created excess industry capacity, which in turn has caused
customers, such as Seagate, who have developed an internal supply of disks to
utilize their internal capacity prior to purchasing disks from independent
suppliers such as the Company. Additionally, due to the lengthy product
qualification process, changes in customers and product mix have had and could
continue to have a material adverse effect on the Company's business, results of
operations and financial condition during such transition. Consequently, any
loss of Seagate or one or more of the Company's current or potential customers
through consolidations, adverse financial or market circumstances or otherwise,
would have a material adverse effect on the Company's business, results of
operations and financial condition.
Rapid Changes in Customer and Product Mix. Due to the rapid and frequent
development of new disk drive products, it is common in the industry for the
relative mix of customers and products to change rapidly, even from quarter to
quarter. For example, in the fourth quarter of 1996 sales to Seagate represented
approximately 95% of net sales, while in the first quarter of 1998 sales to
Seagate represented approximately 17% of net sales. In addition, the Company's
unit sales of MR disks represented 0% of units sold in the second quarter of
1996 compared to 77% of units sold for the comparable quarter of 1997. At any
one time the Company typically supplies disks in volume for only five to ten
disk drive products, with the mix of such products shifting continually. Disk
drive manufacturers demand a variety of thin film disks with differing design,
performance and cost characteristics. Thin film disk suppliers, such as the
Company, are required to work closely with such manufacturers in order to
develop products that will be used in the manufacturers' designs. Thin film disk
suppliers seek to have their products "designed in" to a particular disk drive
and to be qualified as a primary supplier for new programs. The design-in
process is ongoing, lengthy and frequent and the Company must compete for
participation in each product program including those of existing customers. As
discussed above, due to the downturn in demand in the disk drive industry,
liquidation of Micropolis and excess capacity, the Company continues to seek
additional customers to utilize its manufacturing capacity. While Seagate and
other customers have taken a portion of this capacity, the Company continues to
have excess manufacturing capacity as it seeks to qualify its products in
product programs of both new and existing customers. Qualification is a costly
and time consuming process and there can be no assurance that the Company will
successfully find new customers or successfully qualify its products in their
product programs on a timely basis or with acceptable yields. In the event the
Company's products do not become designed into or qualified in a particular disk
drive program on a timely basis, the Company could be excluded as a supplier of
disks for such program entirely or could become a secondary source of supply for
such program, which typically results in lower sales and lower gross margins.
Consistent inability to become designed into a disk drive program would have a
material adverse effect on the Company's business results of operations and
financial condition.
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Uncertainties Associated with Supply Agreement with Seagate. In June 1995,
the Company entered into a Supply Agreement with Seagate (the "Seagate Supply
Agreement") pursuant to which the Company has established the Dedicated Facility
in Singapore to manufacture disks for Seagate. The Company has expended
significant financial and management resources to construct and operate at such
facility. While Seagate was required to purchase the disks manufactured at the
Dedicated Facility through March 31, 1999, Seagate and the Company amended the
Seagate Supply Agreement (the "Amended Agreement") to allow the Company to
manufacture disks for Seagate at any one of its three facilities. The Amended
Agreement also eliminates the pricing formula of the Seagate Supply Agreement.
All of the products manufactured under the Amended Agreement must still be
qualified by Seagate before products can be delivered to Seagate. As a result,
while Seagate continues to be obligated to purchase certain volumes and
continues to be a significant customer, the volumes purchased have not been
sufficient to fill plants and the Company has facilities that are currently idle
in Singapore. To the extent the Company's facilities continue to operate at less
then full capacity, the Company's business, results of operating and financial
condition will continue to be materially adversely affected. See "-- Variability
in Gross Margins and Operating Results."
Rapid Technological Change. The thin film disk industry is characterized by
rapid technological change, short product life cycles, and price erosion.
Product lives are typically six to twelve months in duration. Although the
Company is continually developing new products and production techniques, there
can be no assurance that the Company will be able to anticipate technological
advances and develop products incorporating such advances in a timely manner,
with acceptable yields or to compete effectively against competitors' new
products. In addition, there can be no assurance that the Company's new products
can be produced in full volume at reasonable yields or that the Company will
develop new products or processes which ultimately are adopted by the industry.
The Company's operating results and financial condition could be materially
adversely affected if these efforts are not successful or if the technologies
that the Company has chosen not to develop prove to be competitive alternatives.
See "-- Variability in Gross Margins and Operating Results."
Intense Competition. The disk drive industry and thin film disk industry
are both characterized by intense competition. The Company's primary competitors
are Fuji Electric Company Ltd., HMT Technology Corporation, Hoya Corporation,
Komag Incorporated, Mitsubishi Kasei Corporation and Showa Denko K.K. among
independent disk manufacturers. Most of these companies have significantly
greater financial, technical and marketing resources than the Company. IBM and
several disk drive manufacturers, including Seagate and Western Digital
Corporation, currently produce thin film disks internally for their own use.
Seagate's expressed corporate strategy is to be vertically integrated for a
majority of its disk drive components and to pursue sales to third parties of
its disk drive components. Hyundai has built a manufacturing facility to produce
disks for use in Maxtor disk drives to supplement Maxtor's current supplier
base. These companies could increase their internal production to supply their
requirements and cease purchasing from independent disk suppliers. Moreover,
these companies could make their products available for distribution in the
market as direct competitors of the Company. Additionally, other disk drive
manufacturers, such as Quantum, may decide to produce disks for internal use.
Any of these changes would reduce the already small number of current and
potential customers and increase competition for the remaining market. Such
competition could materially adversely affect the Company's business and results
of operations. See "-- Dependence on a Limited Number of Customers."
Dependence on Suppliers. The Company relies on a limited number of
suppliers and, in some cases, a sole supplier, for certain materials used in its
manufacturing processes, including glass/ceramic substrates, plating chemicals,
tapes, slurries, certifier beads, sputter targets and certain other materials.
In addition, the Company relies on a single source for most of its equipment. In
the past, the Company has had to provide financial assistance to equipment
vendors in order to maintain sources for such equipment. Shortages may occur in
the future or supplies could be available only with lead times of approximately
three to six months. Changing suppliers for certain materials such as the lube
or buffing tape used in the Company's products would require that the product be
requalified with each customer. Requalification could prevent early design-in
wins or could prevent or delay continued participation in disk drive programs
into which the Company's products have been qualified. In addition, long lead
times of three to six months are required to obtain many
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materials. Regardless of whether these materials are available from established
or new sources of supply, these lead times could impede the Company's ability to
respond quickly to changes in demand. Any limitations on the supply of
components, materials or equipment could disrupt or limit the Company's
production volume and could have a material adverse effect on the Company's
business, results of operations and financial condition. Further, a significant
increase in the price of one or more of these components could adversely affect
the Company's results of operations.
Risks Associated With Substrate Manufacturing. The Company's substrate
manufacturing facility in Singapore became fully operational during the third
quarter of 1997 and the Company acquired a substrate facility located in
Malaysia as part of the Merger. These facilities require the expenditure of
significant management resources. Additionally, the Company is vertically
expanding its business to include the process of grinding aluminum blanks which
occurs prior to the nickel plating process. While the Company believes it has
the expertise to establish this process, it has incurred delays and lower yields
than expected during its start-up phase. There can be no assurance that these
facilities will produce high quality and low cost aluminum substrates.
Manufacturing and other problems which may occur in connection with the
operation at these facilities could materially adversely affect the Company's
results of operations and financial condition.
Liability Related to Year 2000 Compliance. The Year 2000 Issue arises from
computer programs that use two digits rather than four to define the applicable
year. Such computer programs may cause computer systems to recognize a date
using "00" as the calendar year 1900 rather than the calendar year 2000. Systems
that do not properly recognize such information could generate erroneous data or
cause a system to fail.
The Company is in the process of conducting a comprehensive review of its
internal computer systems to identify the systems that could be affected by the
Year 2000 Issue and is developing an enterprise-wide implementation plan to
resolve the issue. The Company believes that, with modifications to existing
operational software, the Year 2000 Issue will not pose significant operational
problems for the Company's internal computer systems. The Company expects to
incur internal staff costs as well as consulting and other expenses related to
the enhancements necessary to prepare the systems for the Year 2000. The Company
cannot estimate the amount of costs that will be associated with the transition
of the Company's remaining systems. While the Company currently expects that the
Year 2000 Issue will not pose significant operational problems, delays in the
modification or conversion of its systems or the failure to fully identify all
Year 2000 dependencies in the Company's systems could have a material adverse
effect on the Company's business, results of operations and financial condition.
In addition, the Company cannot be sure that systems of suppliers to the Company
or of other companies on which the Company's systems rely will be converted in a
timely manner. The failure of these other companies to convert their systems,
may have a material adverse effect on the Company's business, results of
operations and financial condition. The Company's products do not have embedded
calendars and therefore the Company does not expect the Year 2000 problem to
impact its products.
Dependence on Personnel. The Company's future operating results depend in
significant part upon the continued contributions of its officers and personnel,
many of whom would be difficult to replace. At present the Company does not have
employment agreements with any employee. The Company maintains a $4.0 million
key person life insurance policy (with $3.0 million of proceeds payable to the
Company) on the life of its Chairman of the Board and Chief Executive Officer,
William J. Almon, but not on the lives of other key persons. The loss of any of
its officers or other key personnel could have a material adverse effect on the
business, financial condition and results of operations of the Company. In
addition, the production of thin film disks requires employees skilled in highly
technical and precise production processes with expertise specific to thin film
disk production. The Company's future operating results depend in part upon its
ability to attract, train, retain and motivate other qualified management,
technical, manufacturing, sales and support personnel for its operations in
California, Singapore and Malaysia. Competition for such personnel is intense,
especially since many of the Company's competitors are located near the
Company's facilities in Santa Clara, California. There can be no assurance that
the Company will be successful in attracting or retaining such personnel. Hiring
qualified personnel in Singapore is made more difficult because Singapore has
substantially full employment at the present time and because the Company was
the first manufacturer of thin film disks and is the first manufacturer of
substrates with operations in Singapore. The loss of the services of existing
personnel
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as well as the failure to recruit, train and retain additional personnel in a
timely manner could have a material adverse effect on the Company's business,
results of operations and financial condition.
Intellectual Property and Proprietary Rights. The Company regards elements
of its manufacturing process, product design and equipment as proprietary and
seeks to protect its proprietary rights through a combination of employee and
third party non-disclosure agreements, internal procedures and, increasingly,
patent protection. The Company has had ten U.S. patents issued to it, has an
additional application allowed and has twelve additional patent applications
(one of which are provisional applications) pending in the United States. In
addition, the company purchased over one hundred patents issued and applications
pending from Kubota Corporation in December 1997 in conjunction with the
acquisition of Akashic. The Company intends to file additional U.S. applications
as appropriate for patents covering its products and manufacturing processes.
There can be no assurance that patents will be issued with respect to any of the
Company's allowed patent applications, that patents will be issued or be allowed
with respect to any of the Company's other pending applications, or that claims
allowed on any existing or future patents will be sufficiently broad to protect
the Company's technology. There can also be no assurance that any patents now or
hereafter held by the Company will not be challenged, invalidated or
circumvented, or that the rights granted thereunder will provide proprietary
protection to the Company. In addition, the laws of certain foreign countries
may not protect the Company's proprietary rights to the same extent as do the
laws of the United States. Although the Company continues to implement
protective measures and intends to defend its proprietary rights, there can be
no assurance that these measures will be successful. The Company believes,
however, that, because of the rapid pace of technological change in the disk and
disk drive industries, the legal protections for its products are less
significant factors in the Company's success than the innovative skills,
experience and technical competence of its employees.
The Company has from time to time been notified of, or has otherwise been
made aware of, claims that it may be infringing upon patents or other
proprietary intellectual property owned by others. If it appears necessary or
desirable, the Company may seek licenses under such patents or proprietary
intellectual property. Although patent holders commonly offer such licenses, no
assurance can be given that licenses under such patents or proprietary
intellectual property will be offered or that the terms of any offered licenses
will be acceptable to the Company. The Company has been contacted by IBM
concerning the Company's interest in licensing a patent. Based upon an opinion
of its patent counsel, the Company believes that no license is required because
the Company does not believe that it is practicing any invention covered by the
IBM patent. There can be no assurance, however, that IBM will not pursue its
claim. Additionally, Virgle L. Hedgcoth has allegedly patented certain disk
preparation techniques (the "Hedgcoth Patents") and has asserted that the
Company is infringing such patents. Mr. Hedgcoth has since asserted patent
infringement claims against certain disk drive manufacturers, including one
customer of the Company who has demanded that the Company defend and indemnify
it in the patent litigation. The Company believes that the Hedgcoth Patents are
not valid because of prior commercial activities by other companies utilizing
the technology covered. However, should Mr. Hedgcoth prevail in such litigation
and elect to pursue the Company, the Company would be forced to either litigate
any infringement claims, execute a license, if available, or design around the
patents, which the Company believes is possible, and may be required to
indemnify its customers. The failure to obtain a key patent license or a license
to key proprietary intellectual property from a third party could cause the
Company to incur substantial liabilities and possibly to suspend the manufacture
of the products utilizing the patented or proprietary invention either of which
could have a material adverse effect on the Company's business, results of
operations and financial condition. See "Item 3. Legal Proceedings" and
"Business -- Intellectual Property and Proprietary Rights."
Environmental Issues. The Company's operations and manufacturing processes
are subject to certain federal, state, local and foreign environmental
protection laws and regulations. These laws and regulations relate to the
Company's use, handing, storage, discharge and disposal of certain hazardous
materials and wastes, the pre-treatment and discharge of process waste waters,
and the control of process air pollutants. The Company has from time to time
been notified of minor violations concerning its waste water discharge permits,
air quality regulations and hazardous material regulations. The Company has
implemented corrective action plans to remedy these violations and has put in
place procedures to effectuate continued compliance with these laws and
regulations. The Company has also initiated safety programs and training of
personnel on
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safe storage and handling of hazardous materials and wastes. The Company
believes that it is in compliance in all material respects with applicable
environmental regulations and does not anticipate any material capital
expenditures for environmental related matters. Environmental laws and
regulations, however, may become more stringent over time and there can be no
assurances that the Company's failure to comply with either present or future
regulations would not subject the Company to significant compliance expenses,
production suspensions or delay, restrictions on expansion at its present
locations or the acquisition of costly equipment.
The Company's California facilities are located near major earthquake
faults. Disruption of operations at any of the Company's production facilities
for any reason, including work stoppages or natural disasters such as fire,
floods or earthquakes, would cause delays in or an interruption of production
and shipment of products and would negatively affect the Company's business,
results of operations and financial condition.
Risks of International Sales and Manufacturing. In 1996, 1997 and for the
three months ended March 27, 1998, international sales (sales delivered to
customers in the Far East and Ireland, including foreign subsidiaries of
domestic companies) accounted for over 85% of the Company's net sales, and the
Company anticipates that international sales will continue to represent the
substantial majority of its net sales. Accordingly, the Company's operating
results are subject to the risks inherent in international sales, including
compliance with or changes in the law and regulatory requirements of foreign
jurisdictions, fluctuations in exchange rates, tariffs or other barriers,
exposure to taxes in multiple jurisdictions and transportation delays and
interruptions. Although presently all of the Company's sales are made in U.S.
dollars, including sales from its Singapore and Malaysia facilities, a portion
of the Company's expenses must be paid in Singapore dollars and Malaysia. Future
international sales may be denominated in foreign currencies. Gains and losses
on the conversion to U.S. dollars of accounts receivable and accounts payable
arising from international operations may contribute to fluctuations in the
Company's results of operations. Additionally, the Company's international
business may be materially adversely affected by fluctuations in currency
exchange rates, increases in duty rates, exchange or price controls or other
restrictions on foreign currencies and difficulties in obtaining export
licenses. Moreover, the Company's efforts to expand its manufacturing operations
have been concentrated in Southeast Asia. This expansion requires the Company to
implement and monitor new systems, procedures and controls and to attract,
train, motivate and manage qualified employees effectively. These risks are
exacerbated by the distance of the Southeast Asian facilities from the Company's
California headquarters. Due to the anticipated expansion of the Company's
manufacturing operations in Southeast Asia, the impact of the foregoing factors
on the Company's business, results of operations and financial condition could
be material and adverse.
Volatility of Stock Price. The trading price of the Company's Class A
Common Stock has been volatile since the Company's initial public offering in
May 1995 and has been and is likely to continue to be subject to wide
fluctuations in response to a variety of factors, including quarterly variations
in operating results, revised earnings estimates, general conditions in the disk
drive or computer industry, announcements of changes in capacity, the level of
orders from new or existing customers, consolidations in the industry,
technological innovations or new products by the Company or its competitors,
developments in patents or other intellectual property rights, comments or
recommendations issued by analysts who follow the Company, its competitors or
the disk drive industry and general economic and market conditions. In addition,
it is possible that from time to time the Company's operating results may be
below the expectations of public market analysts and investors. In such event,
the price of the Company's Class A Common Stock could be materially adversely
affected. Additionally, the stock market in general, and the market for
technology stocks in particular, have experienced extreme price volatility in
recent years. Volatility in price and volume has had a substantial effect on the
market prices of many technology companies for reasons unrelated or
disproportionate to the operating performance of such companies. These broad
market fluctuations could have a significant impact on the market price of the
Class A Common Stock.
20
<PAGE> 21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
STORMEDIA INCORPORATED V. HYUNDAI ELECTRONICS INDUSTRIES CO., ET AL.
On July 23, 1996, the Company was informed by Maxtor Corporation that it
intended to terminate a November 17, 1995 Volume Purchase Agreement between
Maxtor and Hyundai Electronics Industries Co. Ltd., on the one hand, and the
Company. Prior to such notification, Maxtor had failed to purchase in the
Company's second quarter the disks required to be purchased by it under the
Volume Purchase Agreement. As a consequence of Maxtor and Hyundai's breach of
the Volume Purchase Agreement, the Company on September 25, 1996 filed suit in
the United States District Court for the Northern District of California against
Hyundai, C.S. Park, K.S. Yoo and Mong Hun Chung alleging breach of the Volume
Purchase Agreement and fraud. The Complaint seeks damages in excess of $206
million. In response to a motion to dismiss brought by Hyundai the Court
dismissed the Complaint because it found that Maxtor was an indispensable party
to the litigation. The Court, however, conditioned its dismissal on defendants
agreements to certain terms and conditions designed to preserve the progress
made in the federal action. In response, StorMedia has filed a substantially
similar complaint against Maxtor, Hyundai Electronics Industries and certain
individuals in California state court.
On February 18, 1998, StorMedia filed suit in Superior Court for the State
of California, County of Santa Clara, against Hyundai Electronics Industries
Co., Ltd. ("HEI"), Maxtor, and Messrs. Park, Yoo and Chung. Apart from the
addition of Maxtor, the complaint is substantively identical to the
above-described Federal action. Defendants HEI and Park have answered the
complaint, denying its material allegations. Defendant Maxtor has moved to
dismiss or stay the action because of the pendency of the Colorado action,
described below. Defendants Yoo and Chung have moved to dismiss the complaint
for failure to plead fraud with particularity. These motions are set for hearing
on May 14, 1998. In the meantime, StorMedia has propounded additional discovery
and noticed depositions. Responses to this discovery are stayed pending the
outcome of the hearing on May 14, 1998. StorMedia intends to pursue this action
vigorously.
MAXTOR CORPORATION V. STORMEDIA, INC., ET AL.
On December 19, 1996, Maxtor Corporation filed an action in Colorado state
court for the County of Boulder against the Company, its subsidiary, StorMedia
International Limited, and William J. Almon alleging breach of contract, breach
of warranty, fraud and negligent misrepresentation. The action alleges that the
Company's products failed to meet certain of Maxtor's requirements under the
November 17, 1995 Volume Purchase Agreement. The action seeks compensatory
damages of $100 million. The Colorado state court stayed all proceedings in that
action in favor of the above-described federal action against Hyundai. In
response to the federal court's order dismissing StorMedia's complaint against
Hyundai, described above, Maxtor moved to lift the stay of its Colorado State
court proceeding. That motion is currently pending.
WERCZBERGER, ET AL. V. STORMEDIA INCORPORATED
On September 18, 1996, a purported securities class action complaint,
Werczberger, et al. v. StorMedia, Inc. et al., No. CV760825, was filed in the
Superior Court of the State of California in the County of Santa Clara. The
complaint alleges that StorMedia and certain of its officers and directors
violated California state securities laws by making false and misleading
statements of material fact about StorMedia's prospects between November 27,
1995 and August 9, 1996. Plaintiff purports to represent a class of persons who
purchased StorMedia stock during this period. In particular, the complaint
alleges that the StorMedia defendants made allegedly false statements regarding
volumes of disks to be purchased by Maxtor and Hyundai pursuant to the contract
that is the subject of the two above-described actions. On August 19, 1997, the
California Supreme Court granted review of the Superior Court's order overruling
the defendants' demurrer. In addition, on June 18, 1997, a federal securities
action, Werczberger v. StorMedia, et al., C-97 20538, was filed against the same
defendants in the United States District Court for the Northern District of
California, San Jose Division. The federal complaint alleges violations of
federal securities laws and contains
21
<PAGE> 22
virtually identical allegations to those in the state court complaint.
Defendants intend to continue to defend these cases vigorously.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
The Company is currently in default of its Term Loan Facility and is in
active discussions with CIBC and certain other banks to amend the terms of the
facility. The amendment contemplates among other things, a change to the
amortization schedule of principal, extension of the maturity date, repayment of
a portion of principal outstanding from the successful completion of new debt
and equity financings and the sale of certain assets. The amendment will also
require compliance with various financial covenants.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- ------------------------------------------------------------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
22
<PAGE> 23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
STORMEDIA INCORPORATED
(Registrant)
Date: May 12, 1998 By: /s/ STEPHEN M. ABELY
------------------------------------
Stephen M. Abely, Vice President and
Chief Financial Officer (Principal
Financial
and Accounting Officer)
23
<PAGE> 24
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-27-1998
<CASH> 11,076
<SECURITIES> 0
<RECEIVABLES> 21,307
<ALLOWANCES> 11,580
<INVENTORY> 18,387
<CURRENT-ASSETS> 63,808
<PP&E> 140,845
<DEPRECIATION> 43,728
<TOTAL-ASSETS> 161,189
<CURRENT-LIABILITIES> 104,975
<BONDS> 48,362
0
0
<COMMON> 272
<OTHER-SE> 37,489
<TOTAL-LIABILITY-AND-EQUITY> 161,189
<SALES> 39,220
<TOTAL-REVENUES> 39,220
<CGS> 55,508
<TOTAL-COSTS> 55,508
<OTHER-EXPENSES> 9,247
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,685
<INCOME-PRETAX> (27,220)
<INCOME-TAX> 12
<INCOME-CONTINUING> (27,232)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (27,232)
<EPS-PRIMARY> (1.34)
<EPS-DILUTED> (1.34)
</TABLE>
