-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ODs/K0aljnyQ2EMC8UM4VPQI90+yk8wzTAzeiRqi+KV+7ii7uJqCqmX1QGZ2/+8C kr9D+bqfm7T/qK63BY4+kg== 0000891618-99-002357.txt : 19990519 0000891618-99-002357.hdr.sgml : 19990519 ACCESSION NUMBER: 0000891618-99-002357 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990403 FILED AS OF DATE: 19990518 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MAXTOR CORP CENTRAL INDEX KEY: 0000711039 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 770123732 STATE OF INCORPORATION: DE FISCAL YEAR END: 1226 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-14016 FILM NUMBER: 99629897 BUSINESS ADDRESS: STREET 1: 510 COTTONWOOD DR CITY: MILPITAS STATE: CA ZIP: 95035 BUSINESS PHONE: 4084321700 10-Q 1 FORM 10-Q 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-Q ------------------------ (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE PERIOD ENDED APRIL 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: 0-14016 ------------------------ MAXTOR CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 77-0123732 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 510 COTTONWOOD DRIVE, MILPITAS, CA 95035 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 432-1700 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: COMMON STOCK, PAR VALUE $.01 PER SHARE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: 5.75% CONVERTIBLE SUBORDINATED DEBENTURES, DUE MARCH 1, 2012 ------------------------ Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the registrant's common stock, $.01 par value per share, held by nonaffiliates of the registrant was $401,331,889 on May 13, 1999 (based on the closing sales price of the registrant's common stock on that date). Shares of the registrant's common stock held by each officer and director and each person who owns more than 5% or more of the outstanding common stock of the registrant have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive determination for other purposes. As of May 13, 1999, 102,871,117 shares of the registrant's Common Stock, $.01 par value, were issued and outstanding. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 MAXTOR CORPORATION FORM 10-Q APRIL 3, 1999 INDEX
PAGE ------- PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets -- April 3, 1999 and December 26, 1998.............. 3 Condensed Consolidated Statements of Operations -- Three months ended April 3, 1999, and March 28, 1998...................................................... 4 Condensed Consolidated Statements of Cash Flows -- Three months ended April 3, 1999, and March 28, 1998...................................................... 5 Notes to Condensed Consolidated Financial Statements................................................ 6 - 8 Item 2. Management's Discussion and analysis of Financial Condition and Results of Operations......................................... 9 - 22 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................... 23 Item 5. Other Information................................... 24 Item 6. Exhibits and Reports on Form 8-K.................... 24 Signature................................................... 25
2 3 PART I. FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS MAXTOR CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
APRIL 3, 1999 DECEMBER 26, 1998 ------------- ----------------- (UNAUDITED) Current assets: Cash and cash equivalents................................. $ 185,588 $ 214,126 Marketable securities..................................... 94,802 13,503 Accounts receivable, net of allowance of doubtful accounts of $8,975 at April 3, 1999 and $8,409 at December 26, 1998................................................... 225,235 317,758 Inventories............................................... 127,095 153,192 Prepaid expenses and other................................ 56,261 45,198 --------- --------- Total current assets.............................. 688,981 743,777 Net property, plant and equipment........................... 113,122 108,290 Other assets................................................ 7,878 11,346 --------- --------- Total assets...................................... $ 809,981 $ 863,413 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Short-term borrowings, including current portion of long-term debt......................................... $ 5,258 $ 5,261 Accounts payable.......................................... 329,487 427,737 Accrued and other liabilities............................. 94,764 115,937 --------- --------- Total current liabilities......................... 429,509 548,935 Long-term debt due affiliate................................ -- 55,000 Long-term debt.............................................. 85,031 90,046 --------- --------- Total liabilities................................. 514,540 693,981 Common stock, $0.01 par value, 250,000,000 shares authorized; 102,871,234 shares issued and outstanding at April 3, 1999 and 94,293,499 shares issued and outstanding at December 26, 1998...................................... 1,029 943 Additional paid-in capital.................................. 980,477 880,175 Accumulated deficit......................................... (724,775) (741,780) Cumulative other comprehensive income -- unrealized gain on investments in equity securities.......................... 38,710 30,094 --------- --------- Total stockholders' equity........................ 295,441 169,432 --------- --------- Total liabilities and stockholders' equity........ $ 809,981 $ 863,413 ========= =========
See accompanying notes. 3 4 MAXTOR CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 ------------- -------------- Revenue..................................................... $ 681,506 $545,231 Revenue from affiliates..................................... 84 4,386 ------------ -------- Total revenue..................................... 681,590 549,617 Cost of revenue............................................. 595,117 483,798 Cost of revenue from affiliates............................. 60 3,564 ------------ -------- Total cost of revenue............................. 595,177 487,362 ------------ -------- Gross profit...................................... 86,413 62,255 Operating expenses: Research and development.................................. 46,840 33,372 Selling, general and administrative....................... 19,920 15,923 Stock compensation expenses............................... 865 14,696 ------------ -------- Total operating expenses.......................... 67,625 63,991 ------------ -------- Income (loss) from operations............................... 18,788 (1,736) Interest expense............................................ (3,680) (8,768) Interest and other income................................... 4,897 274 ------------ -------- Income (loss) before provision for income taxes............. 20,005 (10,230) Provision for income taxes.................................. 3,000 89 ------------ -------- Net Income (loss)........................................... 17,005 (10,319) Unrealized gain on investments in equity securities......... 8,616 9,124 ------------ -------- Comprehensive income (loss)................................. $ 25,621 $ (1,195) ============ ======== Net income (loss) per share -- basic........................ $ 0.17 $(672.16) Net income (loss) per share -- diluted...................... $ 0.17 $(672.16) Shares used in per share calculation -- basic.................................................. 98,912,770 15,352 -- diluted................................................ 101,515,783 15,352
See accompanying notes. 4 5 MAXTOR CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 ------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)........................................... $ 17,005 $(10,319) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization............................. 17,973 15,756 Stock compensation expense................................ 865 14,696 Gain on sale of other assets.............................. (1,565) -- Loss (gain) on disposal of property, plant & equipment.... -- 1,312 Change in assets & liabilities: Accounts receivable.................................... 91,288 (62,131) Inventories............................................ 26,097 (8,662) Other current assets................................... (2,447) (4,528) Accounts payable....................................... (98,250) 89,999 Accrued and other liabilities.......................... (21,173) (2,482) --------- -------- Net cash provided by operating activities......... 29,793 33,641 --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of property and equipment................ -- 2,972 Purchase of property, plant & equipment..................... (22,785) (8,332) Purchase of marketable securities........................... (81,299) -- Other....................................................... 13 7,038 --------- -------- Net cash provided by (used in) investing activities..................................... (104,071) 1,678 --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of debt, including short-term borrowings................................................ -- 29,904 Principal payments of debt, including short-term borrowings................................................ (55,000) (68,787) Principal payments under capital lease obligations.......... (18) (8) Net payments under accounts receivable securitization....... -- (48) Proceeds from issuance of common stock from public offering, employee stock purchase plan and stock options exercised................................................. 100,758 -- --------- -------- Net cash provided by (used in) financing activities..................................... 45,740 (38,939) --------- -------- Net change in cash & cash equivalents....................... (28,538) (3,620) Cash & cash equivalents at beginning of period.............. 214,126 16,925 --------- -------- Cash & cash equivalents at end of period.................... $ 185,588 $ 13,305 ========= ======== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest............................................... $ 4,155 $ 6,272 Income taxes........................................... $ 25 $ 298 SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Purchase of property, plant & equipment financed by accounts payable....................................... $ -- $ 8,919 Purchase of property, plant & equipment financed by capital lease.......................................... $ -- $ 13 Increase (decrease) in receivable from on affiliates...... $ (1,235) $ 2,325 Retirement of debt in exchange for bond redemption........ $ 5,000 $ -- Increase in unrealized gain on investments in equity securities............................................. $ 8,616 $ 9,124
See accompanying notes. 5 6 MAXTOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The consolidated financial statements include the accounts of Maxtor Corporation (Maxtor or the Company) and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. All adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair statement of the results for the interim periods have been made. It is recommended that the interim financial statements be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the fiscal year ended December 26, 1998 incorporated in the Company's annual report on Form 10-K. Interim results are not necessarily indicative of the operating results expected for later quarters or the full fiscal year. 2. INVENTORIES
APRIL 3, 1999 DECEMBER 26, 1998 ------------- ----------------- Inventories comprised (in thousands): Raw materials................................. $ 39,640 $ 51,680 Work-in-process............................... 3,977 6,308 Finished goods................................ 83,478 95,204 -------- -------- $127,095 $153,192 ======== ========
3. STOCKHOLDERS' EQUITY In February 1999, the Company completed a public offering of 7.8 million shares of the Company's common stock. The Company received net proceeds of approximately $95.8 million from the offering, after deducting the underwriting discounts and estimated expenses payable by the Company. A portion of the proceeds from the offering was used to prepay without penalty outstanding aggregate principal indebtedness of $55.0 million owing to Hyundai Electronics America under a subordinated note due July 31, 2001 (see Note 7). 6 7 MAXTOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) 4. NET INCOME (LOSS) PER SHARE In accordance with the disclosure requirements of Statements of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share", a reconciliation of the numerator and denominator of basic and diluted net income (loss) per share calculations is provided as follows (in thousands, except share and per share amounts):
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 ------------- -------------- (UNAUDITED) NUMERATOR -- BASIC AND DILUTED Net income (loss)............................... $ 17,005 $(10,319) ============ ======== Net income (loss) available to common stockholders.................................. $ 17,005 $(10,319) ============ ======== DENOMINATOR Basic weighted average common shares outstanding................................... 98,912,770 15,352 Effect of dilutive securities: Common stock options.......................... 2,603,013 -- ------------ -------- Diluted weighted average common shares.......... 101,515,783 15,352 ============ ======== Basic net income (loss) per share............... $ 0.17 $(672.16) ============ ======== Diluted net income (loss) per share............. $ 0.17 $(672.16) ============ ========
5. CONTINGENCIES The Company currently is involved in a dispute with StorMedia Incorporated ("StorMedia"), which arises out of an agreement among the Company, StorMedia and Hyundai Electronics Industries Co. Ltd. ("HEI") which became effective on November 17, 1995. In that agreement, StorMedia agreed to supply disk media to the Company. StorMedia's disk media did not meet the Company's specifications and functional requirements as required by the agreement and the Company ultimately terminated the agreement. After a class action securities lawsuit was filed against StorMedia by certain of its shareholders in September 1996 which alleged, in part, that StorMedia failed to perform under the agreement, StorMedia sued HEI, Mong Hun Chung (HEI's chairman), Dr. Chong Sup Park (Hyundai Electronics America ("HEA")'s President and the individual who signed the StorMedia Agreement on behalf of the Company) and K.S. Yoo (the individual who signed the StorMedia Agreement on behalf of HEI) (collectively the "Original Defendants") in federal court (the "Federal Suit"). In the Federal Suit, StorMedia alleged that at the time HEI entered into the StorMedia Agreement, it knew that it would not and could not purchase the volume of products it committed to purchase, and that failure to do so caused damages to StorMedia in excess of $206 million. In December 1996, the Company filed a complaint against StorMedia and William Almon (StorMedia's Chairman and Chief Executive Officer) in a Colorado state court seeking approximately $100 million in damages and alleging, among other claims, breach of contract, breach of implied warranty of fitness and fraud under the StorMedia Agreement (the "Colorado Suit"). This proceeding was stayed pending resolution of the Federal Suit. The Federal Suit was permanently dismissed early in February 1998. On February 24, 1998, StorMedia filed a new complaint in a California state court for $206 million, alleging fraud and deceit against the Original Defendants and negligent misrepresentation against HEI and the Company (the "California Suit"). On May 18, 1998, the stay on the Colorado Suit was lifted by the Colorado state court. The Company's motion to dismiss, or in the alternative, stay the California Suit, is pending. On September 9, 1998, 7 8 MAXTOR CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (UNAUDITED) the California Suit was stayed pending resolution of the Colorado Suit. On October 11, 1998, StorMedia filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Act. This bankruptcy filing caused an automatic stay of proceedings against StorMedia, including the Colorado Suit. StorMedia has not prosecuted its claims against the Company since it filed for bankruptcy protection. The Company believes that it has valid defenses against the claims alleged by StorMedia and intends to defend itself vigorously. However, due to the nature of litigation and because the pending lawsuits are in the very early pre-trial stages, the Company cannot determine the possible loss, if any, that may ultimately be incurred either in the context of a trial or as a result of a negotiated settlement. The litigation could result in significant diversion of time by the Company's technical personnel, as well as substantial expenditures for future legal fees. After considering the nature of the claims and facts relating to the litigation, including the results of preliminary discovery, the Company's management believes that the resolution of this matter will not have a material adverse effect on the Company's business, financial condition or results of operations. However, the results of these proceedings, including any potential settlement, are uncertain and there can be no assurance that they will not have a material adverse effect on the Company's business, financial position and results of operations. The Company has been sued in the United States District Court for the Northern District of California by Papst-Motoren GmbH and Papst Licensing(collectively "Papst"). Papst alleges that the Company is infringing on 15 patents purportedly owned by Papst. The Company has not yet served its answer to the complaint by Papst. While the final outcome of these claims cannot be determined at this time, the Company believes that resolution of these claims will not have a material adverse effect on its business, financial condition or results of operations. This statement should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 26, 1998. No amounts have been reserved in the accompanying consolidated financial statements for any legal claims or actions. 6. RECLASSIFICATIONS Certain reclassifications have been made to prior year balances to conform to current classifications. 7. RELATED PARTY TRANSACTION During the quarter ended April 3, 1999, the Company paid off $55.0 million of note payable to HEA and incurred $2.3 million of interest payment related to the note (see Note 3). As of April 3, 1999, Maxtor has no outstanding indebtedness to HEA. The cost of revenue includes certain component parts purchased from MMC Technology, Inc., a wholly owned subsidiary of HEA, amounting to $38.2 million for the quarter ended April 3, 1999 and $27.6 million for the quarter ended March 28, 1998. The cost of revenue also includes certain component parts purchased from HEI which to date have not been significant. 8. SUBSEQUENT EVENT In April 1999, the Company sold a portion of its investment in Celestica Inc. resulting in approximately $22.1 million gain, which will be included in other income for the quarter ending July 3, 1999. 8 9 This report contains forward-looking statements within the meaning of the U.S. federal securities laws that involve risks and uncertainties. The statements contained in this report that are not purely historical, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future, are forward-looking statements including those discussed in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations: "Results of Operations"; "Liquidity and Capital Resources"; "Certain Factors Affecting Future Performance"; and elsewhere in this report. In this report, the words "anticipate," "believe," "expect," "intend," "future" and similar expressions also identify forward- looking statements. We make these forward-looking statements based upon information available on the date hereof, and we have no obligation to update any such forward-looking statements. Our actual results could differ materially from those anticipated in this report as a result of certain factors including, but not limited to, those set forth in the following risk factors and elsewhere in this report. Maxtor(R) and No Quibble(R) are registered trademarks of Maxtor. The Maxtor logo, DiamondMax(TM) and Formula 4(TM) are trademarks of Maxtor. All other brand names and trademarks appearing in this report are the property of their respective holders. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Part I. Financial Information, Item 1. Condensed Consolidated Financial Statements of this report. RESULTS OF OPERATIONS REVENUE AND GROSS PROFIT
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 CHANGE ------------- -------------- ------ (UNAUDITED) (In millions) Total revenue......................... $681.6 $549.6 $132.0 Gross profit.......................... $ 86.4 $ 62.3 $ 24.1 Net Income (loss)..................... $ 17.0 $(10.3) $ 27.3 As a percentage of revenue: Total revenue......................... 100.0% 100.0% Gross profit.......................... 12.7% 11.3% Net Income (loss)..................... 2.5% -1.9%
Revenue Total revenue increased 24.0% in the quarter ended April 3, 1999 compared to the quarter ended March 28,1998 primarily due to an increase in unit shipments of approximately 58.5%, partially offset by average unit prices which were lower by 21.7%. Revenue from the OEM channel for the quarter ended April 3, 1999 represented 72.0% of total revenue compared to 75.8% for the corresponding quarter in 1998. Revenue from the distribution and retail channel represented 28.0% of total revenue for the first quarter in 1999 compared to 24.2% for the same quarter in fiscal year 1998. Revenue and unit volume growth in 1999 were favorably impacted by better time to market performance, strengthening of the OEM customer base, increased penetration of the distribution channel, and a continued trend to shipping higher capacity drives. This was offset somewhat by continued pricing pressures which resulted in lower average unit selling prices. Gross profit Gross profit as a percentage of revenue improved to 12.7% in first quarter of 1999 from 11.3% in the first quarter of 1998. The increase in gross profit is due mainly to the increase in unit volumes and the timely introduction of new, higher margin products, which achieved market acceptance and higher manufacturing yields. Gross margin was also favorably affected by improved product designs which led to improved 9 10 manufacturing yields and lower component costs. However, growth of our gross margin was partially constrained by continued rapid price erosion in the hard disk drive market as a whole, which resulted in lower average selling prices per unit. We believe that the decline in average selling prices is likely to continue in the future and could constrain future growth in gross margin. OPERATING EXPENSES
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 CHANGE ------------- -------------- ------ (UNAUDITED) (In millions) Research and development.............. $46.8 $33.4 $ 13.4 Selling, general and administrative... $19.9 $15.9 $ 4.0 Stock compensation expenses........... $ 0.9 $14.7 $(13.8) As a percentage of revenue: Research and development.............. 6.9% 6.1% Selling, general and administrative... 2.9% 2.9% Stock compensation expenses........... 0.1% 2.7%
Research and Development (R&D) R&D expense as a percentage of revenue increased slightly to 6.9% for the first quarter of 1999 compared to 6.1% for the same quarter in 1998. The absolute dollar level of R&D expenditures increased significantly due primarily to our efforts to develop new products for the desktop computer market, including the efforts to transition from the magneto-resistive head technology to the giant magneto-resistive head technology, as well as products for a new market segment. In March 1999, we announced our newest hard disk drive product, the DiamondMax Plus 5120, which is our first product utilizing the giant magneto-resistive head technology. Selling, General and Administrative (SG&A) SG&A expense remained flat at 2.9% as a percentage of revenue while increasing in absolute dollars. The increase in absolute dollar in the first quarter of 1999 was primarily due to the costs associated with supporting Maxtor's higher sales volume. Controlled marketing, general and administrative expenses enabled us to hold SG&A expenses as a percentage of revenue flat from the first quarter of 1998. Stock Compensation In 1996 we adopted the 1996 Stock Option Plan (the Plan), pursuant to which substantially all of our domestic employees and certain international employees received options which were required to be accounted for as variable options. These options, which were granted between May 1996 and October 1997, required remeasurement of any intrinsic compensation element at each reporting date determined by the difference between the estimated current fair value of our stock and the exercise price of the options. In the first quarter of 1998, we amended and restated the Plan to remove the variable features and all grants subsequent to October 1997 have been subject to fixed terms. In the second quarter of 1998, we offered and re-issued new fixed-award options in exchange for options previously issued under variable terms, thereby eliminating the requirement to remeasure these options in subsequent periods. In connection therewith, we recorded compensation expense related to the difference between the estimated fair market value of our stock as of March 28, 1998 and the stated value of our options. Compensation cost was reflected in accordance with Financial Accounting Standards Board Interpretation No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans." Accordingly, we recorded non-cash compensation expense of $14.7 million in the first quarter of 1998 and $0.9 million in the first quarter of 1999. The remaining unrecognized compensation element will be reflected in quarterly charges, decreasing sequentially through the second quarter of 2001. 10 11 INTEREST EXPENSE AND INTEREST INCOME
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 CHANGE ------------- -------------- ------ (UNAUDITED) (In millions) Interest expense....................... $3.7 $8.8 $ (5.1) Interest and other income.............. $4.9 $0.3 $ 4.6 As a percentage of revenue: Interest expense....................... 0.5% 1.6% Interest and other income.............. 0.7% 0.0%
Interest Expense Interest expense as a percentage of revenue declined from 1.6% in the first quarter of 1998 to 0.5% in the first quarter of 1999. In absolute dollar terms, interest expense decreased significantly from $8.8 million in the first quarter of 1998 to $3.7 million in the first quarter of 1999. The decrease in interest expense was due primarily to the retirement of debts between the second quarter of 1998 and first quarter of 1999. Our total short-term and long-term outstanding borrowings were $350.5 million at March 28, 1998 compared to $90.3 million at April 3, 1999. Interest and Other Income Interest and other income in the first quarter of 1999 increased significantly in both absolute dollar amount and as a percentage of revenue when compared to the first quarter of 1998. The increase was primarily due to the increase in total cash and cash equivalents and marketable securities, which were generated from our public offerings in July 1998 and February 1999. Our total cash and cash equivalents and marketable securities were $280.4 million at April 3, 1999 compared to $13.3 million at March 28, 1998. PROVISION FOR INCOME TAXES
THREE MONTHS ENDED ------------------------------- APRIL 3, 1999 MARCH 28, 1998 CHANGE ------------- -------------- ------ (UNAUDITED) (In millions) Income (loss) before provision for income taxes........................ $20.0 $(10.2) $ 30.2 Provision for income taxes............. $ 3.0 $ 0.1 $ 2.9
The provision for income taxes consists primarily of federal alternative minimum tax and foreign taxes. Due to our net operating losses ("NOL"), NOL carryforwards and favorable tax status in Singapore, we have not incurred any significant foreign, U.S. federal, state or local income taxes for prior fiscal periods. The Company's effective tax rate for the periods 1998 and 1999 differs from the combined federal and state rates due to the repatriation of foreign earnings absorbed by current year domestic tax losses, and our domestic losses not providing current tax benefits, offset in part by the tax savings associated with our Singapore operations, which is not taxable as a result of our pioneer tax status in Singapore. YEAR 2000 COMPLIANCE Year 2000 Issue Described Many currently installed computer systems and software products are coded to accept, store or report only two digit entries in date code fields. Beginning in the Year 2000, these date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. This is the "Year 2000 Issue." As a result, computer systems and/or software used by many companies, including Maxtor and our vendors and customers, will need to be upgraded to comply with such Year 2000 requirements. We could be impacted by Year 2000 Issues occurring in our own infrastructure or faced by our major distributors, suppliers, customers, 11 12 vendors and financial service organizations. Such Year 2000 Issues could include information errors, significant information system failures, or failures of equipment, vendors, suppliers or customers. Any disruption in our operations as a result of Year 2000 Issues, whether by us or a third party, could have a material adverse effect on our business, financial condition and results of operations. Our Hard Disk Drives Comply Our hard disk drives are able to operate in the Year 2000 and beyond. The Year 2000 Issue is only relevant to hardware and software components that use or affect time and date data or system settings. In the case of our hard disk drives, the ability to operate correctly in the next century is dependent on the software and programming loaded on our hard disk drives by the system. Since our hard disk drives have no inherent time or date function, they will not determine whether a given system, or any software on a given system, will operate correctly or incorrectly in the next century. As a result, all of our hard disk drives are able to receive, store and retrieve data, and operate with a system or software that is Year 2000 compliant without modification. Our State of Readiness Overview. To address Year 2000 readiness, we have implemented a corporate program to coordinate efforts across all business functions and geographic areas, which includes addressing risks associated with business partners and other third-party relationships. Our internal Year 2000 readiness program is separated into four phases: (1) Awareness, (2) Inventory, (3) Assessment and (4) Resolution. We have substantially completed the "assessment" phase and expect to have substantially completed all four phases by June of 1999. Additionally, we have formed a Year 2000 Program Office to coordinate the foregoing corporate program and also have engaged external Year 2000 consultants to assist with methodology and process of the inventory, assessment and resolution phases. There can be no assurance that we will be able to complete all four phases in a timely manner, or that the process will adequately address the Year 2000 Issue. Core IT Systems. We have implemented the R3 system from SAP A.G. The SAP system is designed to automate more fully our business processes and is certified by SAP A.G. as Year 2000 compliant. The initial step of this implementation was completed in early October 1998 and included most of the major functional areas of our business. Other Information Technology Systems. Our other information technology systems include factory information and control systems, computer aided design systems, banking interface systems, electronic data interchange systems, credit card processing, customer call management, human resources systems, non-United States payroll processing, and shipment and just in time delivery management systems. We have determined that most of our human resources systems, factory information systems, call management system, non-United States payroll processing and supplier just-in-time delivery management systems are not Year 2000 compliant. We have completed our assessment of all non Year 2000 compliant systems and have engaged vendors to repair or replace these systems. The inventory and assessment portion of our networked PC's has been completed and we are now in the remediation stage for the hardware and software applications. We will assign the highest resolution priority to repair or replace items that affect new product development, volume production and distribution. Networking Systems. In a recent corporate level business decision, we have concluded that instead of upgrading our current Banyan Vines based networking system, it would be much more beneficial to us if we implemented NT-servers and Microsoft Exchange Mailman System. The decision has been made to go forward with the NT-server implementation now, in order to avoid impacting critical development programs at a later time. The current out look of the NT-server implementation schedule is for completion by September 30, 1999. The NT-server network is Y2K compliant. Non-Information Technology Systems. Our non-information technology systems include departmental and personal automated applications used in all of our functional areas, building systems such as heating, cooling, and air purification, component and hard disk drive test equipment, and manufacturing equipment. We currently are assessing our non-information technology systems to determine the level of risk of business 12 13 interruption associated with a failure of each system and to prioritize our resolution activities. We will assign the highest resolution priority to repair or replace items that affect new product development, volume production and distribution. Vendors and Suppliers. Our vendors and suppliers include the sources of materials used in our hard disk drives, the JIT (Just In Time) and forward carrier logistics operations, the sources of the equipment and supplies used by us in the conduct of our business, as well as our landlords, financial institutions, and other service providers. Inventory of our material suppliers has been completed and on site assessments of our logistics suppliers are under way. The Maxtor Year 2000 Program Office has created an extensive repository of detailed data and information collected from our inventory and remediation activities as well as our supplier assessments. Assessments include determination of the level of risk of business interruption associated with a failure of a vendor or supplier because of the Year 2000 Issue and assignment of priority to resolution activities. Customers. Our assessment of our Year 2000 issues with our customers will dovetail with similar activities which our customers will engage in with respect to Maxtor. Several of our customers, including Compaq, Dell and IBM, have begun the process of asking us for written and/or in person assurances that our ability to supply product to them in volume will not be affected by the Year 2000 Issue. The Costs to Address Our Year 2000 Issues We made capital expenditures of approximately $33.0 million and incurred related expenses of approximately $7.5 million in fiscal 1998 in connection with our implementation of the SAP system. We expect to make capital expenditures of approximately $10.0 million and incur expenses of approximately $4.0 million in fiscal 1999 in connection with the resolution of our Year 2000 issues. During the quarter ended April 3, 1999, we incurred approximately $0.4 million in capital expenditures and $1.0 million in expenses related to our Year 2000 issues. No significant system projects have been deferred due to Year 2000 issues. As we progress in our Year 2000 readiness program, these costs may change. In addition, our cost estimates do not include potential costs related to any customer or other claims resulting from our failure to adequately correct our Year 2000 issues. The Risks of Our Year 2000 Issues We believe that resolution of our Year 2000 Issues has been and will be complex, expensive and time intensive. In addition, resolution of our Year 2000 Issues could be adversely affected by various risk factors, including without limit: - any failure to provide adequate training to employees; - any failure to retain skilled personnel to implement the SAP system or find suitable replacements for such personnel; - any expansion of the scope of the implementation plan due to unanticipated changes in our business or unanticipated findings in the Awareness, Inventory or Assessment phases of our Year 2000 readiness program; - any failure to devise and run appropriate testing procedures that accurately reflect the demands that will be placed on new systems following implementation; - any failures by vendors or other third parties to accurately assess their own Year 2000 readiness or the Year 2000 readiness of their respective vendors and other third parties and any resulting failures; and - any failure to develop and implement adequate fall-back, work around or other contingency plans in the event that difficulties or delays arise. It has been widely predicted that a significant amount of litigation surrounding business interruptions will arise out of Year 2000 Issues. It is uncertain whether, or to what extent, we may be affected by such litigation. Because our hard disk drives are able to operate in the Year 2000 and beyond, we do not anticipate exposure to material product defect or similar litigation. Any such litigation, however, could have a material adverse effect 13 14 on our business, financial condition and results of operations. We also may not receive any assistance, damages or other relief as a result of our initiation of any litigation related to the Year 2000 Issue. Our inability to implement our Year 2000 plans or to otherwise address Year 2000 Issues in a timely manner could have a material adverse effect on our business, financial condition and results of operations. Our Contingency Plans As part of the four-step process outlined above, specific contingency plans are being developed in connection with the assessment and resolution of the risks identified. We have established certain information technology contingency plans, and we are continuing to develop such plans regarding each specific area of risk associated with the Year 2000 Issue. In addition, we have begun to develop contingency plans to cover any material shortages or logistics related delays, which we identified as potential occurrences as a result of our on site supplier assessments. There is no assurance that we will complete contingency plans that address risks which actually arise or that any such contingency plans will properly address their intended purposes if they are implemented. In addition, we do not have and do not anticipate obtaining any insurance policy which contains material coverage for potential injuries or damages related to or caused by the Year 2000 Issue. LIQUIDITY AND CAPITAL RESOURCES At April 3, 1999, we had $280.4 million in cash, cash equivalents and marketable securities as compared to $227.6 million at December 26,1998. In February 1999, we completed an underwritten secondary public offering of 7,800,000 newly-issued shares of our common stock and received $95.8 million, net of offering costs and expenses. Operating activities provided net cash of $29.8 million for the quarter ended April 3, 1999. The cash provided from operating activities was principally generated from net income, adjustment of other non-cash charges, collection of accounts receivable and decrease in inventory, which was partially offset by the decrease in accounts payable and accrued expenses. We used $104.1 million in investing activities during the first quarter of 1999, principally for the purchase of marketable securities and property, plant and equipment. During the quarter ended April 3,1999, we reduced short and long-term debt by $60.0 million using approximately $55.0 million of the proceeds from our February 1999 public offering and cash from operations. As of April 3, 1999, our outstanding debts comprised $90.0 million of publicly-traded Subordinated Debentures, due March 1, 2012 and approximately $0.3 million in capital lease obligations. Our outstanding 5.75% Subordinated Debentures are entitled to annual sinking fund payments of $5.0 million which commenced March 1, 1998. These debentures no longer are convertible into our common stock or any other security of Maxtor. We also have a $200.0 million asset securitization program with Fleet National Bank under which we sell our eligible trade accounts receivable on a non-recourse basis through a special purpose entity. At December 26, 1998, $100.0 million of accounts receivable was securitized under the program and excluded from our accounts receivable balance. We believe the existing capital resources together with cash generated from operations and borrowing capacity, will be sufficient to fund our operations through at least the next 12 months. We require substantial working capital to fund our business, particularly to finance accounts receivable and inventory, and to invest in property, plant and equipment. During 1999, capital expenditures are expected to be between approximately $130.0 million and $145.0 million, to be used principally for adding manufacturing capacity and implementing new and updating existing information technology systems. We intend to seek financing arrangements, including a line of credit, to fund our future capacity expansion plans, as necessary. However, our ability to generate cash will depend on, among other things, demand in the desktop hard disk drive market and pricing conditions. If we need additional capital, there can be no assurance that such additional financing can be obtained, or, if obtained, that it will be available on satisfactory terms. See discussion below under the heading "Certain Factors Affecting Future Performance." 14 15 CERTAIN FACTORS AFFECTING FUTURE PERFORMANCE WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT OF $724.8 MILLION We have a history of significant losses. During each of the 19 consecutive quarters ended September 27, 1997, we incurred significant operating losses ranging from $125.5 million to $3.1 million per quarter, with net losses ranging from $130.2 million to $4.5 million. These losses were primarily a result of the following: - delayed product introductions; - product performance and quality problems; - low manufacturing yields and under-utilization of manufacturing capacity; - high operating and interest expenses; and - overall market conditions in the hard disk drive industry, including fluctuations in demand and declining average selling prices. As of April 3, 1999, we had an accumulated deficit of approximately $724.8 million. If we do not address successfully the factors that led to our history of losses, we will not be profitable in the future. Even if we successfully address these factors, we still may not be profitable in the future. OUR AVERAGE SELLING PRICES ARE DECLINING We anticipate that average selling prices in the hard disk drive industry will continue to decline for the foreseeable future. The average selling price of a hard disk drive rapidly declines over its commercial life due to technological enhancement, productivity improvement, increases in industry supply, competitors lowering prices to absorb excess capacity, liquidation of excess inventories, or when competitors attempt to gain market share. These factors make it very challenging to maintain consistent revenue growth and profitability in the hard disk drive industry. UNLESS WE CONSISTENTLY EXECUTE, WE WILL HAVE SIGNIFICANT LOSSES Most of our products are sold to desktop computer manufacturers. Such manufacturers use the quality, storage capacity, performance and price characteristics of hard disk drives to select, or qualify, their hard disk drive suppliers. Such manufacturers typically seek to qualify three or four suppliers for each hard disk drive product generation. To qualify consistently with these manufacturers, and thus succeed in the desktop hard disk drive industry, we must execute consistently on our product development and manufacturing processes to be among the first-to-market introduction and first-to-volume production at leading storage capacity per disk with competitive prices and high quality. Once a manufacturer has chosen its hard disk drive suppliers for a given desktop computer product, it generally will purchase hard disk drives from those suppliers for the commercial life of that product line. If we miss a qualification opportunity, we may not have another opportunity to do business with that manufacturer until we introduce our next generation of products. The effect of missing a product qualification opportunity is magnified by the limited number of high volume manufacturers of personal computers. If we do not reach the market or deliver volume production in a timely manner, we may lose opportunities to qualify our products, our gross margins probably will decline due to rapidly declining average selling prices, and we probably will lose market share. SUBSTANTIAL DEPENDENCE ON THE DESKTOP COMPUTER MARKET While there has been significant growth in the demand for desktop computers over the past several years, according to International Data Corporation, the growth rate in the desktop computer market has slowed in recent quarters. Because of our reliance on the desktop segment of the personal computer market, we will be affected more by changes in market conditions for desktop computers than would a company with a broader range of products. Any decrease in the demand for desktop computers could cause a decrease in the demand for our products. 15 16 Although our current products are designed for the largest segment of the hard disk drive market, the desktop computer market, demand may shift to other market segments over time. We also believe that to remain a significant supplier of hard disk drives to major manufacturers of personal computers, we will need to offer a broader range of hard disk drive products to our customers. Therefore, we will need to develop and manufacture new products that address additional hard disk drive market segments and emerging technologies to remain competitive in the hard disk drive industry. Examples of potentially important market segments that our current products are not designed to address include: - the client-server market; - lower cost, lower performance personal computer systems (typically below $699); and - laptop personal computers. To specifically address these or additional market segments, we would have to reengineer some of our existing technology and develop new technology. Certain of our competitors have significant advantages over us in one or more of these and other potentially significant new or growing market segments. Any failure by us to successfully develop and introduce new products to address specifically these additional market segments could have a material adverse effect on our business, financial condition and results of operations. A SIGNIFICANT AMOUNT OF OUR REVENUE COMES FROM A FEW CUSTOMERS We sell most of our products to a limited number of customers. During the quarter ended April 3, 1999, one customer, Dell, accounted for approximately 25.8% of our revenue, and our top ten customers accounted for approximately 68.8% of our revenue. During the quarter ended March 28, 1998, two customers, Dell and IBM, accounted for approximately 25.9% and 18.7%, respectively, of our revenue, and our top ten customers accounted for approximately 73.8% of our revenue. We believe that a relatively small number of customers will continue to account for a significant portion of our revenue for the foreseeable future, and that the proportion of our revenue from such customers could continue to increase in the future. These customers have a wide variety of suppliers to choose from and therefore can make substantial demands on us. Even if we successfully qualify a product for a given customer, such customer generally is not obligated to purchase any minimum volume of products from us and generally is able to terminate its relationship with us at any time. Our ability to maintain strong relationships with our principal customers is essential to our future performance. If we lose a key customer or if any of our key customers reduce their orders of our products or require us to reduce our prices before we are able to reduce costs, our business, financial condition and results of operations could be materially and adversely affected. OUR QUARTERLY RESULTS FLUCTUATE SIGNIFICANTLY Our recent revenue growth rates may not be sustainable. Our quarterly results may not be indicative of our future performance. Our quarterly operating results have fluctuated significantly in the past and may fluctuate significantly in the future. Our future performance will depend on many factors, including the following: - our ability to be consistently among the first-to-volume production with competitive products; - fluctuations in the demand for hard disk drives as a result of the cyclical and seasonal nature of the desktop computer industry; - the availability of and efficient use of manufacturing capacity; - changes in product or customer mix; - our existing competitors introducing better products at competitive prices before we do; - new competitors entering our market; - our ability to manage successfully the complex and difficult process of qualifying our products with our customers; 16 17 - our customers canceling, rescheduling or deferring significant orders for our products, particularly in anticipation of new products or enhancements from us or our competitors; - the ability of certain of our distribution and retail customers to return unsold products for credit; - the ability of certain of our distribution and retail customers to receive lower prices retroactively on their inventory of our products when we lower prices on our products; - our ability to purchase enough components and raw materials at competitive prices which allow us to make a profit; - the availability of adequate capital resources; - increases in research and development expenditures, particularly as a percentage of revenue, required to maintain our competitive position; - changes in our strategy; - personnel changes; and - other general economic and competitive factors. Many of our operating expenses are relatively fixed and difficult to reduce or modify. As a result, the fixed nature of our operating expenses will magnify any adverse effect of a decrease in revenue on our results of operations. As a result of these and other factors, we believe that period to period comparisons of our historical results of operations are not a good predictor of our future performance. If our future operating results are below the expectations of stock market analysts, our stock price may decline. OUR CUSTOMERS ARE PLACING NEW AND COSTLY DEMANDS ON US Our customers are adopting more sophisticated business models that place additional strains on our business. For example, many personal computer manufacturers, including some of our largest personal computer manufacturing customers, are starting to adopt build-to-order manufacturing models that reduce their component inventories and related costs and enable them to tailor their products more specifically to the needs of their customers. Some of our personal computer manufacturing customers also are considering or have implemented a "channel assembly" model in which the manufacturer ships a minimal computer system to the dealer or other assembler, and component suppliers (including hard disk drive manufacturers such as us) ship parts directly to the dealer or other assembler for installation at its location. Finally, certain of our manufacturing customers have adopted just-in-time inventory management processes that require component suppliers to maintain inventory at or near the customer's production facility. These new business models require us to hold our products in inventory longer, which increases our risk of inventory obsolescence and average selling price decline. These changing models also increase our capital requirements and costs, complicate our inventory management strategies, and make it difficult for us to match our manufacturing plans with projected customer demand. THE HARD DISK DRIVE MARKET IS HIGHLY COMPETITIVE Although our share of the desktop hard disk drive market has increased steadily since the first quarter of 1997, this market segment and the hard disk drive market in general are intensely competitive even during periods when demand is stable. We compete primarily with manufacturers of 3.5-inch hard disk drives for the personal computer industry, including: - Fujitsu Limited; - Quantum Corporation; - Samsung Electronic Company Limited; - Seagate Technology, Inc.; and - Western Digital Corporation. 17 18 We also could face significant competition from other companies, such as International Business Machines Corporation, in our current markets or in other markets into which we may expand our product portfolio. Many of our competitors have a number of significant advantages over us, including: - a larger market share; - a broader array of product lines; - preferred vendor status with some of our customers; - extensive name recognition and marketing power; and - significantly greater financial, technical and manufacturing resources. Unlike us, some of our competitors make many of their own components which may provide them with certain benefits including lower costs. Our competitors also may: - consolidate or establish strategic relationships among themselves to lower their product costs or to otherwise compete more effectively against us; - lower their product prices to gain market share; or - bundle their products with other products to increase demand for their products. In addition, new competitors could emerge and rapidly capture market share. If we fail to compete successfully against current or future competitors, our business, operating results and financial condition may be materially and adversely affected. DEMAND FOR OUR PRODUCTS FLUCTUATES We currently offer a single product family that is designed for desktop computers. As a result, the demand for our products depends on the overall demand for desktop computers. The desktop computer and hard disk drive markets tend to go through periods of rapid growth followed by periods of oversupply and rapid price and gross margin erosion. This environment makes it difficult for us and our customers to reliably forecast demand for our products. We do not have long-term supply contracts with our customers, and our customers often can defer or cancel orders with limited notice and without significant penalty. WE MUST EFFECTIVELY RESPOND TO CHANGING TECHNOLOGY; WE MUST EFFECTIVELY TRANSITION TO GIANT MAGNETO-RESISTIVE HEAD TECHNOLOGY Our future performance will depend on our ability to enhance current products and to develop and introduce volume production of new competitive products on a timely and cost-effective basis. We also must keep pace with and correctly anticipate technological developments and evolving industry standards and methodologies. Advances in magnetic, optical or other technologies, or the development of entirely new technologies, could lead to new competitive products that have better performance and/or lower prices than our products. Examples of such new technologies include giant magneto-resistive head technology (which already has been introduced by IBM and Fujitsu and which Western Digital reportedly will use in its products under an agreement with IBM) and optically-assisted recording technologies (which currently are being developed by companies such as TeraStor Corporation and Seagate). We have incorporated giant magneto-resistive head technology into our newest product. We have decided not to pursue optically-assisted recording technologies at this time. Our inability to introduce or achieve volume production of new competitive products, (regardless of whether they include giant magneto-resistive head technology) on a timely and cost-effective basis has in the past and in the future could have a material adverse effect on our business, financial condition and results of operations. 18 19 TO DEVELOP NEW PRODUCTS, WE MUST EFFECTIVELY INTEGRATE PARTS FROM THIRD PARTIES Unlike some of our competitors, we do not manufacture any of the parts used in our products. Instead, our products incorporate parts designed by and purchased from third parties. Consequently, the success of our products depends on our ability to gain access to and integrate parts that use leading-edge technology. To successfully manage these integration projects we must: - obtain high quality parts; - hire skilled personnel; - effectively integrate different products from a variety of vendors; and - manage difficult scheduling and delivery problems. Our success will depend on our ability to develop and maintain relationships with key suppliers. WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS A number of the parts used in our products are available from only one or a limited number of outside suppliers. Currently, we purchase digital signal processor/controller and spin/servo integrated circuits only from Texas Instruments, Inc. and purchase channel integrated circuits only from Lucent Technologies, Inc. As we have experienced in the past, some of the parts we require may periodically be in short supply. As a result, we must allow for significant ordering lead times for certain parts. In addition, we may have to pay significant cancellation charges to suppliers if we cancel orders for parts because we reduce production due to production cut-backs caused by market oversupply, reduced demand, transition to new products or technologies or for other reasons. We order the majority of our parts on a purchase order basis and only have limited long-term volume purchase agreements with certain existing suppliers. If we cannot obtain sufficient quantities of high quality parts when we need them, our business, financial condition and results of operations could be materially and adversely affected. WE DEPEND ON OUR KEY PERSONNEL Our success depends upon the continued contributions of our key employees, many of whom would be extremely difficult to replace. We also do not have key person life insurance on any of our personnel. Most of our senior management and a significant number of our other employees have been with us for less than three years. Worldwide competition for skilled employees in the hard disk drive industry is extremely intense. We believe that some of our competitors recently have made targeted efforts to recruit employees from us and such efforts have resulted in us losing some skilled managers. There is no guarantee that we will be successful in retaining our key employees. If we are unable to retain our existing employees or to hire and integrate new employees, our business, financial condition and results of operations could be materially and adversely affected. WE HAVE ONLY ONE MANUFACTURING FACILITY AND HAVE TAKEN STEPS TO ADD A FACILITY Our volume manufacturing operations currently are based in a single facility in Singapore. In line with our forecast for additional customer demands, we have secured an additional manufacturing facility in Singapore. A fire, flood, earthquake or other disaster or condition affecting our facility could have a material adverse effect on our business, financial condition and results of operations. Additionally, the current forecast for our products may not be indicative of our customers' demand in the future and any material change could result in manufacturing over capacity and have a material adverse effect on our business, financial condition and results of operations. 19 20 WE MAY NEED MORE CAPITAL IN THE FUTURE BECAUSE THE HARD DISK DRIVE BUSINESS IS CAPITAL INTENSIVE Our business is capital intensive, and we may need more capital in the future. Our future capital requirements will depend on many factors, including: - the rate of our sales growth; - the level of our profits or losses; - the timing and extent of our spending to support facilities upgrades and product development efforts; - the timing and size of business or technology acquisitions; and - the timing of introductions of new products and enhancements to our existing products. We may issue additional equity to raise capital. Any future equity financing will decrease existing stockholders' percentage equity ownership and may, depending on the price at which the equity is sold, result in significant economic dilution to such stockholders. Furthermore, our board of directors is authorized under our charter documents to issue preferred stock with rights, preferences or privileges senior to those of our common stock without stockholder approval. While we currently do not have a revolving credit facility, it is our goal to obtain one in the near future. However, we believe that current market conditions for such facilities are not as favorable as they have been at certain times in the past, that for various reasons the number of potential lenders actively providing credit facilities to companies in the data storage industry has decreased recently, and that the terms on which the remaining potential lenders are willing to offer such facilities, in many cases, are restrictive and/or costly. Consequently, the terms and conditions under which we might obtain such a facility are uncertain. Any failure to obtain adequate credit facilities on acceptable terms could have a material and adverse effect on our business, financial condition and results of operations. PROTECTION OF OUR INTELLECTUAL PROPERTY IS LIMITED; WE FACE RISK OF THIRD PARTY CLAIMS OF INFRINGEMENT We have patent protection on some of our technology. We may not receive patents for our current or future patent applications, and any patents that we have or that are issued to us may be invalidated, circumvented or challenged. Moreover, the rights granted under any such patents may not provide us with any competitive advantages. Finally, our competitors may develop or otherwise acquire equivalent or superior technology. We also rely on trade secret, copyright and trademark laws, as well as the terms of our contracts to protect our proprietary rights. We may have to litigate to enforce patents issued or licensed to us, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of our proprietary rights and the proprietary rights of others. Enforcing or defending our proprietary rights could be expensive and might not bring us timely and effective relief. We may have to obtain licenses of other parties' intellectual property and pay royalties. If we are unable to obtain such licenses, we may have to stop production of our products or alter our products. In addition, the laws of certain countries in which we sell and manufacture our products, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States. Our protective measures in these countries may be inadequate to protect our proprietary rights. Any failure to enforce and protect our intellectual property rights could have a material adverse effect on our business, financial condition and results of operations. When we were a majority-owned subsidiary of Hyundai Electronics America, we had the benefit of certain third party intellectual property rights on terms that may have been more favorable than would have been available to us if we had not been a majority-owned subsidiary of Hyundai Electronics America. We may not be able to obtain similar rights in the future on terms as favorable. We have been sued by Papst-Motoren GmbH and Papst Licensing (collectively "Papst") claiming infringement of a number of hard disk drive motor patents. The lawsuit is pending in the United States District Court for the Northern District of California. This lawsuit relates to the alleged infringement of 15 of 20 21 the hard disk drive motor patents described above. The patents in question relate to motors that we purchase from motor vendors and the use of such motors in hard disk drives. While we believe that we have valid defenses to the Papst claim, the results of any litigation are inherently uncertain and there is no assurance that Papst will not assert other infringement claims relating to current patents, pending patent applications and future patents or patent applications. Additionally, there is no assurance that we will be able to successfully defend ourselves against any such lawsuit. A favorable outcome for Papst in the lawsuit could result in the issuance of an injunction against us or our products and/or the payment of monetary damages equal to a reasonable royalty or recovered lost profits or, in the case of a finding of a willful infringement, treble damages and could have a material adverse effect on our business, financial condition and results of operations. WE ARE DEPENDENT ON OUR INTERNATIONAL OPERATIONS; WE FACE RISKS FROM OUR INTERNATIONAL SALES We conduct most of our manufacturing and testing operations and purchase a substantial portion of our key parts outside the U.S. We also sell a significant portion of products to foreign distributors and retailers. Our dependence on revenue from international sales and our need to manage international operations each involves a number of inherent risks, including: - economic slowdown and/or downturn in the computer industry in such foreign markets; - international currency fluctuations; - general strikes or other disruptions in working conditions; - political instability; - trade restrictions; - changes in tariffs; - the difficulties associated with staffing and managing international operations; - generally longer periods to collect receivables; - unexpected changes in or impositions of legislative or regulatory requirements; - reduced protection for intellectual property rights in some countries; - potentially adverse taxes; and - delays resulting from difficulty in obtaining export licenses for certain technology and other trade barriers. The specific economic conditions in each country will impact our international sales. For example, our international contracts are denominated primarily in U.S. dollars. Significant downward fluctuations in currency exchange rates against the U.S. dollar could cause our products to become relatively more expensive to distributors and retailers in those countries. In addition, we attempt to manage the impact of foreign currency exchange rate changes by entering into short-term, foreign exchange contracts. If we do not effectively manage the risks associated with international operations and sales, our business, financial condition and results of operations could be materially and adversely affected. WE HAVE EXPOSURE FROM OUR WARRANTIES Our products may contain defects. We generally warrant our products for three years. Our standard warranty contains a limit on damages and an exclusion of liability for consequential damages and for negligent or improper use of the product. We establish a reserve, at the time of product shipment, in an amount equal to our estimated warranty expenses. We had warranty reserves of $44.0 million as of April 3, 1999 and $25.1 million as of March 28, 1998. While we believe that our warranty reserves will be sufficient, the failure to maintain sufficient warranty reserves or the unenforceability of our liability limitations could have a material adverse effect on our business, financial condition and results of operations. 21 22 OUR STOCK PRICE HAS BEEN HIGHLY VOLATILE Our stock price and the number of shares traded each day has varied greatly. We expect these fluctuations to continue due to factors including: - quarterly fluctuations in operating results; - announcements of new products by us or our competitors; - gains or losses of significant customers; - changes in stock market analysts' estimates; - the presence or absence of short-selling of our common stock; and - events affecting other companies that the market deems comparable to us. Our stock price also may be affected by events relating to Hyundai Electronics America and Hyundai Electronics Industries, including sales of our common stock by Hyundai Electronics America or the perception that such sales may occur (due to the financial condition of Hyundai Electronics America or otherwise). There have been reports that Hyundai Electronics Industries is planning to sell some operations that do not directly relate to its core semiconductor business. Hyundai Electronics America and Hyundai Electronics Industries have informed Maxtor that following the closing of its February 1999 public offering and the expiration of the 90-day period during which Hyundai Electronics America has agreed not to offer or sell additional shares without the consent of Salomon Smith Barney Inc., they may consider selling additional Maxtor shares at a time they deem appropriate. Finally, our stock price may be subject to extreme fluctuations in response to general economic conditions in the U.S., Korea, Southeast Asia and elsewhere, such as interest rates, inflation rates, exchange rates, unemployment rates, and trade surpluses and deficits. It is likely that in some future quarter or quarters our operating results will be below the expectations of stock market analysts or investors. In such event, our stock price probably will decline. In February 1999, DECS Trust IV, a newly-formed trust, sold 12,500,000 DECS. The terms of the DECS provide that DECS Trust IV may distribute shares of our common stock owned by Hyundai Electronics America on or about February 15, 2002, or upon earlier liquidation of DECS Trust IV under certain circumstances. We do not know how or whether investors in the DECS offering will resell the DECS. Any market that develops for the DECS could reduce the demand for our common stock or otherwise negatively affect the market for our common stock. 22 23 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company currently is involved in a dispute with StorMedia Incorporated ("StorMedia"), which arises out of an agreement among the Company, StorMedia and Hyundai Electronics Industries Co. Ltd. (HEI) which became effective on November 17, 1995. In that agreement, StorMedia agreed to supply disk media to the Company. StorMedia's disk media did not meet the Company's specifications and functional requirements as required by the agreement and the Company ultimately terminated the agreement. After a class action securities lawsuit was filed against StorMedia by certain of its shareholders in September 1996 which alleged, in part, that StorMedia failed to perform under the agreement, StorMedia sued HEI, Mong Hun Chung (HEI's chairman), Dr. Chong Sup Park (Hyundai Electronics America (HEA)'s President and the individual who signed the StorMedia Agreement on behalf of the Company) and K.S. Yoo (the individual who signed the StorMedia Agreement on behalf of HEI) (collectively the "Original Defendants") in federal court (the "Federal Suit"). In the Federal Suit, StorMedia alleged that at the time HEI entered into the StorMedia Agreement, it knew that it would not and could not purchase the volume of products it committed to purchase, and that failure to do so caused damages to StorMedia in excess of $206 million. In December 1996, the Company filed a complaint against StorMedia and William Almon (StorMedia's Chairman and Chief Executive Officer) in a Colorado state court seeking approximately $100 million in damages and alleging, among other claims, breach of contract, breach of implied warranty of fitness and fraud under the StorMedia Agreement (the "Colorado Suit"). This proceeding was stayed pending resolution of the Federal Suit. The Federal Suit was permanently dismissed early in February 1998. On February 24, 1998, StorMedia filed a new complaint in a California state court for $206 million, alleging fraud and deceit against the Original Defendants and negligent misrepresentation against HEI and the Company (the "California Suit"). On May 18, 1998, the stay on the Colorado Suit was lifted by the Colorado state court. The Company's motion to dismiss, or in the alternative, stay the California Suit, is pending. On September 9, 1998, the California Suit was stayed pending resolution of the Colorado Suit. On October 11, 1998, StorMedia filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Act. This bankruptcy filing caused an automatic stay of proceedings against StorMedia, including the Colorado Suit. StorMedia has not prosecuted its claims against the Company since it filed for bankruptcy protection. The Company believes that it has valid defenses against the claims alleged by StorMedia and intends to defend itself vigorously. However, due to the nature of litigation and because the pending lawsuits are in the very early pre-trial stages, the Company cannot determine the possible loss, if any, that may ultimately be incurred either in the context of a trial or as a result of a negotiated settlement. The litigation could result in significant diversion of time by the Company's technical personnel, as well as substantial expenditures for future legal fees. After considering the nature of the claims and facts relating to the litigation, including the results of preliminary discovery, the Company's management believes that the resolution of this matter will not have a material adverse effect on the Company's business, financial condition or results of operations. However, the results of these proceedings, including any potential settlement, are uncertain and there can be no assurance that they will not have a material adverse effect on the Company's business, financial position and results of operations. The Company has been sued in the United States District Court for the Northern District of California by Papst-Motoren GmbH and Papst Licensing (collectively "Papst"). Papst alleges that the Company is infringing on 15 patents purportedly owned by Papst. The Company has not yet served its answer to the complaint by Papst. While the final outcome of these claims cannot be determined at this time, the Company believes that resolution of these claims will not have a material adverse effect on its business, financial condition or results of operations. This statement should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 26, 1998. No amounts have been reserved in the accompanying consolidated financial statements for any legal claims or actions. 23 24 ITEM 5. OTHER INFORMATION The net proceeds to Maxtor from the sale of 49,731,225 shares of Maxtor common stock in our initial public offering (Registration Statement No. 333-56099), effective July 30, 1998, including the underwriter's exercise of their overallotment on August 14, 1998, were approximately $328.8 million after deducting underwriting discounts and estimated offering expenses payable by Maxtor. From the date of the closing of the initial public offering through April 3, 1999, we applied the net proceeds as follows: approximately $200.0 million was used to pay certain outstanding indebtedness under certain credit facilities due to various banks; approximately $128.8 million was used for general corporate purposes. The net proceeds to Maxtor from the sale of 7,800,000 shares of Maxtor common stock in our secondary public offering (Registration Statement No. 333-69307), effective February 9, 1999, were approximately $95.8 million after deducting underwriting discounts and estimated offering expenses payable by Maxtor. From the date of the closing of the secondary public offering through April 3, 1999, we applied the net proceeds as follows: $55.2 million was used to pay outstanding principal indebtedness and accrued interest owing to Hyundai Electronics America under a subordinated note due July 31, 2001; $40.6 million was used for general corporate purposes. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (SEE INDEX TO EXHIBITS ON PAGE E-1 OF THIS REPORT.) There were no reports filed on Form 8-K during the reporting period ended April 3, 1999. ITEMS 2, 3 AND 4 ARE NOT APPLICABLE AND HAVE BEEN OMITTED. 24 25 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. MAXTOR CORPORATION By: /s/ PAUL J. TUFANO ------------------------------------ Paul J. Tufano Senior Vice President, Finance, Chief Financial Officer and Principal Accounting Officer Date: May 17, 1999 25 26 INDEX TO EXHIBITS
EXHIBIT SEQUENTIALLY NO DESCRIPTION NUMBERED PAGES - ------- ----------- -------------- 27 Financial Data Schedule.....................................
E-1 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS JAN-01-2000 DEC-27-1999 APR-03-1999 185,588 94,802 234,210 8,975 127,095 688,981 334,483 221,361 809,981 429,509 90,000 0 0 1,029 294,412 809,981 681,590 681,590 595,177 595,177 67,625 0 3,680 20,005 3,000 17,005 0 0 0 17,005 0.17 0.17 OTHER SE INCLUDES ADDITIONAL PAID-IN CAPITAL OF $980,477 UNREALIZED GAIN ON INVESTMENTS IN EQUITY SECURITIES OF $38,710, AND ACCUMULATED DEFICIT OF $724,775. OTHER EXPENSES INCLUDE RESEARCH AND DEVELOPMENT OF $46,840 AND SELLING, GENERAL AND ADMINISTRATIVE COSTS OF $19,920, AND STOCK COMPENSATION EXPENSE OF $865.
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