-----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, R/8+1+mRxB5+PKlDuGErzaqt9WAfBgwWsBfjrkhqJ8KDUUuCEP7xqr0J6KTz/q2F 5UzJMC3W+HhivO/NAajjqg== 0000891618-97-003313.txt : 19970812 0000891618-97-003313.hdr.sgml : 19970812 ACCESSION NUMBER: 0000891618-97-003313 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970627 FILED AS OF DATE: 19970811 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: STORMEDIA INC CENTRAL INDEX KEY: 0000942787 STANDARD INDUSTRIAL CLASSIFICATION: MAGNETIC & OPTICAL RECORDING MEDIA [3695] IRS NUMBER: 770373062 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25796 FILM NUMBER: 97655833 BUSINESS ADDRESS: STREET 1: 390 REED ST CITY: SANTA CLARA STATE: CA ZIP: 95050-3118 BUSINESS PHONE: 4083278000 MAIL ADDRESS: STREET 1: 390 REED ST CITY: SANTA CLARA STATE: CA ZIP: 95050-3118 10-Q 1 FORM 10-Q QUARTERLY PERIOD ENDED JUNE 27, 1997 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 June 27, 1997 Commission file number 0-25796 STORMEDIA INCORPORATED (Exact name of registrant as specified in its charter) DELAWARE 77-0373062 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 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 August 1, 1997, 13,533,943 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. ================================================================================ 2 STORMEDIA INCORPORATED AND SUBSIDIARIES INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements (Unaudited) Condensed Consolidated Statements of Operations -- Three and Six Months Ended June 27, 1997 and June 28, 1996......................................................................... 3 Condensed Consolidated Balance Sheets -- As of June 27, 1997 and December 31, 1996..................4 Condensed Consolidated Statements of Cash Flows -- Six Months Ended June 27, 1997 and June 28, 1996.................................................................................. 5 Notes to Condensed Consolidated Financial Statements............................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................7 PART II. OTHER INFORMATION Item 1. Legal Proceedings.....................................................................................19 Item 2. Changes in Securities.................................................................................19 Item 3. Defaults Upon Senior Securities...................................................................... 19 Item 4. Submission of Matters to a Vote of Securities Holders................................................ 19 Item 5. Other Information.................................................................................... 20 Item 6. Exhibits and Reports on Form 8-K..................................................................... 20 SIGNATURES...........................................................................................................21
-2- 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)
THREE MONTHS ENDED SIX MONTHS ENDED ------------------ ---------------- JUNE 27, 1997 JUNE 28, 1996 JUNE 27, 1997 JUNE 28, 1996 ------------- ------------- ------------- ------------- Net sales $ 32,553 $ 57,652 $ 66,653 $118,808 Cost of sales 41,224 42,761 80,228 86,808 -------- -------- -------- -------- Gross profit (8,671) 14,891 (13,575) 32,000 Operating expenses: Research and development 3,480 4,419 6,670 8,127 Selling, general, and administrative 2,481 2,129 4,820 4,179 Bad debt expense 5,438 -- 5,438 -- -------- -------- -------- -------- Total operating expenses 11,399 6,548 16,928 12,306 Operating earnings (loss) (20,070) 8,343 (30,503) 19,694 Interest income (expense), net (804) 827 (1,366) 1,312 -------- -------- -------- -------- Earnings (loss) before income tax expense (benefit) (20,874) 9,170 (31,869) 21,006 -------- -------- -------- -------- Income tax expense (benefit) 29 1,375 (1,647) 3,742 Net earnings (loss) $(20,903) $ 7,795 $(30,222) $17,264 ======== ======== ======== ======== Earnings (loss) per share: Primary $ (1.17) $ 0.42 $(1.70) $ 0.94 ======== ======== ======== ======== Fully diluted $ (1.17) $ 0.42 $(1.70) $ 0.94 ======== ======== ======== ======== Shares used in per share computation: Primary 17,882 18,426 17,835 18,365 ======== ======== ======== ======== Fully diluted 17,882 18,426 17,835 18,368 ======== ======== ======== ========
-3- 4 STORMEDIA INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
JUNE 27, DECEMBER 31, 1997 1996 --------- -------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents and short-term investments $ 23,402 $ 47,711 Accounts receivable, less allowances of $8,750 at June 27, 1997 and $1,177 at December 31, 1996 18,626 31,047 Income taxes receivable 1,738 -- Inventories 21,737 14,848 Prepaid expenses 7,417 6,794 Deferred income taxes -- 2,819 --------- -------- Total current assets 72,920 103,219 Plant and equipment, net 140,985 137,162 Deferred income taxes -- 17 Deposits and other assets 1,136 1,338 --------- -------- $ 215,041 $ 241,736 ========= ======== LIABILITIES AND EQUITY Current liabilities: Trade accounts payable $ 26,697 $ 25,234 Current portion of long-term debt 16,692 5,014 Accrued salaries and benefits 5,299 4,151 Income taxes payable -- 2,556 Other accrued expenses 3,832 1,952 --------- -------- Total current liabilities 52,520 38,907 Deferred income taxes -- 245 Long-term debt, less current portion 33,447 45,024 Equity: Common stock, par value $.013 per share 237 233 Additional paid-in capital 126,418 124,686 Retained earnings 2,419 32,641 --------- -------- Total equity 129,074 157,560 --------- -------- $ 215,041 $ 241,736 ========= ========
See accompanying notes to condensed consolidated financial statements. -4- 5 STORMEDIA INCORPORATED AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
SIX MONTHS ENDED ------------------------------------- JUNE 27, 1997 JUNE 28, 1996 ------------- ------------- (UNAUDITED) (UNAUDITED) OPERATING ACTIVITIES Net earnings (loss) $(30,222) $ 17,264 Adjustments to reconcile earnings (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 14,666 6,961 Bad debt expense 5,438 -- Deferred income taxes 2,591 -- Net loss on disposition of plant and equipment 263 -- Changes in operating assets and liabilities: Accounts receivable 6,983 (6,485) Inventories (6,519) (5,673) Prepaid expenses (516) (2,050) Other assets 202 (302) Trade accounts payable 1,463 15,149 Accrued liabilities 3,028 610 Net income taxes payable/(receivable) (4,294) 3,492 -------- -------- Net cash (used in) provided by operating activities (6,917) 28,966 -------- -------- INVESTING ACTIVITIES Acquisition of plant and equipment (19,221) (53,110) Net purchases of and proceeds from sale of short-term investments 7,065 18,326 -------- -------- Net cash used in investing activities (12,156) (34,784) -------- -------- FINANCING ACTIVITIES Short-term borrowings -- 10,000 Issuance (payment) of long-term obligations 101 (111) Proceeds from issuance of Common stock, net of issuance costs 1,728 1,603 Settlement of Put Options -- (1,994) Repurchase of Class A Common Stock -- (7,212) -------- -------- Net cash provided by financing activities 1,829 2,286 -------- -------- (Decrease) in cash and cash equivalents $(17,244) (3,532) Cash and cash equivalents at beginning of period 23,788 37,407 -------- -------- Cash and cash equivalents at end of period $ 6,544 $ 33,875 ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid for interest $ 1,502 $ -- ======== ======== Cash paid for income taxes $ 40 $ -- ======== ======== Non-cash financing and investing activities: Tax benefit arising from early dispositions of stock issued upon exercise of stock options $ -- $ 901 ======== ========
See accompanying notes to condensed consolidated financial statements. -5- 6 STORMEDIA INCORPORATED AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (INFORMATION FOR THREE AND SIX MONTHS ENDED JUNE 27, 1997 AND JUNE 28, 1996 IS UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) NOTE 1 - BASIS OF PRESENTATION 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 and six months ended June 27, 1997 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997 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, 1996 which was filed with the Securities and Exchange Commission on March 25, 1997. NOTE 2 - BALANCE SHEET COMPONENTS
JUNE 27, 1997 DECEMBER 31, 1996 ------------- ----------------- (UNAUDITED) Inventories: Raw materials $ 8,350 $ 6,586 Work-in-process 7,024 5,638 Finished goods 6,363 2,624 --------- --------- Total inventories $ 21,737 $ 14,848 ========= ========= Plant and equipment: Land $ 220 $ 220 Building and leasehold improvements 33,366 32,009 Machinery and equipment 103,450 95,982 Construction-in-progress 40,803 32,161 --------- --------- $ 177,839 $ 160,372 Less allowance for depreciation and amortization (36,854) (23,210) --------- --------- Plant and equipment, net $ 140,985 $ 137,162 ========= =========
NOTE 3 - LONG-TERM DEBT For the three months ended March 28, 1997, the Banks granted the Company waivers of certain financial covenants and subsequently amended certain financial covenants of the Term Loan Facility. For the three months ended June 27, 1997, the Banks granted the Company a thirty day waiver of certain financial covenants. The Company is currently in discussions with the Banks to revise certain financial covenants under an amendment to the Term Loan Facility. NOTE 4 - BAD DEBT EXPENSE The Company charged $5.4 million to bad debt expense during the three months ended June 27, 1997. Such charges were for reserves related to receivables on sales of certain products for which the Company may not receive payment. -6- 7 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 During 1996, the Company sold its disks primarily to Seagate Technology, Inc. ("Seagate") and Maxtor Corporation ("Maxtor"), representing 71% and 25% of net sales, respectively. In November 1995, the Company entered into a multi-year Supply Agreement with Maxtor (the "Maxtor Supply Agreement") pursuant to which Maxtor agreed to purchase specified volumes over a four-year period. In June 1996, Maxtor repudiated the Maxtor Supply Agreement and caused the Company to experience excess capacity while it sought to qualify in additional products with new and existing customers. While Seagate and other customers have taken a portion of this capacity, during the first half of 1997, the Company continued to experience excess manufacturing capacity as it sought to qualify its products in new and existing customers' product programs. During the six months ended June 27, 1997, sales to Seagate represented 66% of net sales. Recently, the Company has qualified its products in the product programs of both new and existing customers. In December 1996, the Company entered into a multi-year agreement with Micropolis(s) Pte Ltd., a manufacturer of digital audio/video disk drives (the "Micropolis Agreement"). Under the terms of the Micropolis Agreement, the Company has set up and begun to operate a 15,000 square foot thin film manufacturing facility (the "Micropolis Facility") within Micropolis' 400,000 square foot disk drive manufacturing plant in Singapore. Micropolis has agreed to purchase all of the disks manufactured at the Micropolis Facility through December 31, 1999. The Company believes that the Micropolis Agreement will result in savings for both companies in areas such as packaging, transportation and response time. The Company expects that the Micropolis Facility will begin furnishing Micropolis with a portion of its thin film requirements in the third quarter of 1997. In addition, the Company has agreed to supply Micropolis with specified volumes of products from its other facilities until the Micropolis Facility is completed. During the six months ended June 27, 1997, sales to Micropolis represented 19% of net sales. While the Company expanded its customer base during the first half of 1997, some product qualifications that were expected to be completed were not and, as a result, unit volumes were less than projected by the Company, negatively impacting net sales. The Company is in various stages of product qualifications with other potential customers and expects to commence shipping under certain of these programs in the second half of 1997. However, the qualification of new products is a costly and time consuming process and there can be no assurance that the Company will successfully continue to find new customers or successfully qualify its products in their product programs on a timely basis. The Company's gross margins have fluctuated and will continue to fluctuate quarterly and annually based upon a variety of factors such 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 and engineering costs associated with initial production of new programs, changes in the cost of or limitations on availability of materials and labor shortages. The Company expects that a substantial portion of the Company's shipments in the remainder of 1997 will be of new products, including high performance magneto resistive (MR) disks. Generally, new products have higher average selling prices than more mature products but initially have lower manufacturing yields and generally are initially produced in lower quantities than more mature products. The Company expects its gross margins to continue to be negatively impacted by the introduction of these and other new products in the remainder of 1997. -7- 8 RESULTS OF OPERATIONS The following table sets forth certain financial data as a percentage of net sales for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED ----------------------- ------------------------ JUNE 27, JUNE 28, JUNE 27, JUNE 28, 1997 1996 1997 1996 ------- ------ ------- ------ Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 126.6% 74.2% 120.4% 73.1% ------- ------ ------- ------ Gross profit (26.6%) 25.8% (20.4%) 26.9% Operating expenses: Research and development 10.7% 7.7% 10.0% 6.8% Selling, general, and administrative 7.6% 3.7% 7.2% 3.5% Bad debt expense 16.7% -- 8.2% -- ------- ------ ------- ------ Total operating expenses 35.0% 11.4% 25.4% 10.3% ------- ------ ------- ------ Operating earnings (loss) (61.7%) 14.5% (45.8%) 16.6% Interest income (expense) net (2.5%) 1.4% (2.0%) 1.1% ------- ------ ------- ------ Earnings (loss) before income tax expense (benefit) (64.1%) 15.9% (47.8%) 17.7% Income tax expense (benefit) 0.1% 2.4% (2.5%) 3.1% ------- ------ ------- ------ Net earnings (loss) (64.2%) 13.5% (45.3%) 14.5% ======= ====== ======= ======
1997 COMPARED TO 1996 Net Sales Net sales decreased 43.5% to $32.6 million for the three months ended June 27, 1997 from $57.7 million for the three months ended June 28, 1996. For the six months ended June 27, 1997, nets sales decreased 43.9% to $66.7 million from $118.8 million for the six months ended June 28, 1996. The decrease in net sales was primarily due to a decrease in unit volume and secondarily due to a slight decrease in average selling prices. In addition, the Company increased its reserves for receivables based on higher returns experienced during the three months ended June 27, 1997. The Company's principal customers during the six months ended June 27, 1997 were Seagate Technology, Inc. ("Seagate") and Micropolis (S) Pte Ltd. ("Micropolis"). The Company's customers during the six months ended June 28, 1996 were Seagate and Maxtor Corporation ("Maxtor"). Net sales for the six months ended June 27, 1997 as compared to the six months ended June 28, 1996 were negatively impacted by the failure of Maxtor and Hyundai to purchase the volumes committed under the Maxtor Supply Agreement. In June 1996, Maxtor notified the Company that it did not intend to purchase the full committed volumes required by the Maxtor Supply Agreement. Maxtor subsequently repudiated the Maxtor Supply Agreement. However, in the third quarter of 1996 the Company continued to ship products to Maxtor (although in lesser volumes and at lower average -8- 9 selling prices than in the second quarter of 1996 and the comparable prior year quarter). In September 1996, the Company filed a lawsuit in the United States District Court of Northern California, San Jose Division, against Hyundai Electronics Industries Co., Ltd., seeking damages caused by Hyundai's alleged breach of the volume purchase contract among the Company, Hyundai, and its wholly-owned subsidiary, Maxtor Corporation. The Company is seeking additional customers to utilize the manufacturing capacity as it seeks to qualify its products in additional new and existing customers' product programs. Although the Company expanded its customer base during the first half of 1997, some product qualifications that were expected to be completed were not, resulting in lower than anticipated net sales. These qualification problems are being addressed and the Company hopes to increase net sales during the second half of 1997. Gross Profit The Company's gross profit decreased 158.2% to $(8.7) million for three months ended June 27, 1997 from $14.9 million for the three months ended June 28, 1996. For the six months ended June 27, 1997, gross profit decreased 142.4% to $(13.6) million from $32.0 million for the six months ended June 28, 1996. Gross profit as a percentage of net sales for the three and six months ended June 27, 1997 were (26.6%) and (20.4%) as compared to 25.8% and 26.9% for the three and six months ended June 28, 1996. The principal factors contributing to the decrease in gross profit were continuing decreased unit volumes as a result of the failure of Maxtor to purchase the volumes committed to under the Maxtor Supply Agreement and the resulting under-utilization of production capacity. As a result of Maxtor's failure to purchase committed volumes, the Company's Tuas facility in Singapore was significantly underutilized. Additionally, during the first half of 1997, the Company significantly increased reserves for finished goods inventory for certain products which were manufactured for specific customer programs and may not be salable for those programs. The Company expects gross margins in 1997 will remain at levels below those experienced in 1995 and the first half of 1996 due primarily to the continuing excess manufacturing capacity resulting from Hyundai's repudiation. The Company continues to seek to expand its customer base to utilize this capacity. The Company expects that a substantial portion of its shipments in the remainder of 1997 will be of new products for new and existing customers. New products often initially have lower manufacturing yields, initially are produced in lower quantities than more mature products and, as a result, initially have lower gross margins. Manufacturing yields and gross margins generally improve as the product matures and production volumes increase. Research and development Research and development expenses decreased 21.2% to $3.5 million for the three months ended June 27, 1997 from $4.4 million for the three months ended June 28, 1996, increasing as a percentage of net sales to 10.7% for the three months ended June 27, 1997 from 7.7% for the comparable prior year three month period. For the six months ended June 27, 1997, research and development expenses decreased 17.9% to $6.7 million from $8.1 million for the six months ended June 28, 1996, increasing as a percentage of net sales to 10.0% for the six months ended June 27, 1997 from 6.8% for the comparable prior year six month period. The decrease in research and development expense was due primarily to the reduction in the volume of samples produced. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 16.5% to $2.5 million for the three months ended June 27, 1997 from $2.1 million for the three months ended June 28, 1996, increasing as a percentage of net sales to 7.6% for the three months ended June 27, 1997 from 3.7% for the comparable prior year three month period. For the six months ended June 27, 1997, selling, general & administrative expenses increased 15.3% to $4.8 million from $4.2 million for the six months ended June 28, 1996, increasing as a percentage of net sales to 7.2% for the six months ended June 27, 1997 from 3.5% for the comparable prior year six month period. The increase in selling, general and administrative expenses are due primarily to increased staffing in Singapore and increased professional fees. Bad Debt Expense -9- 10 The Company charged $5.4 million to bad debt expense during the three months ended June 27, 1997, representing 16.7% of net sales. Such charges were for reserves related to receivables on sales of certain products for which the Company may not receive payment. Interest, Net Interest, net for the three months ended June 27, 1997 was $0.8 million net expense compared to $0.8 million net income for the three months ended June 28, 1996. Interest, net for the six months ended June 28, 1997 was $1.4 million net expense compared to $1.3 million net income for the comparable prior year six month period. The change was primarily attributable to lower net cash levels during the three months and six months ended June 27, 1997 as compared to the comparable prior year three and six months periods. Income Tax Expense The Company's effective tax rate (which includes federal and state income tax expense) for the three and six months ended June 28, 1996 were 15% and 17.8%, respectively. The Company has been granted a seven year tax holiday in Singapore which expires in 2005. The benefit of the Company's income tax holiday in Singapore is the primary factor contributing to the lower tax rate. The Company's tax benefit recorded for the six months ended June 27, 1997 approximates expected recoverability on previously paid taxes. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents and short-term investments of $23.4 million as of June 27, 1997 decreased $24.3 million from December 31, 1996, primarily due to the acquisition of plant and equipment offset by changes in working capital. During the six months ended June 27,1997, the Company used $6.9 million in operating activities. Uses included $30.2 million of net loss, $6.5 million increase in inventory, offset by $14.7 million of depreciation and amortization and a $7.0 million decrease in accounts receivable. The Company used $12.2 million in investing activities for the six months ended June 27, 1997. Investing activities consisted primarily of investments of $19.2 million for capital expenditures for facilities expansion for its Singapore operations, including its substrate facility, offset by $7.1 million sale of short-term investments. While the Company has invested $19.2 million in acquisition of plant and equipment for the six months ended June 27, 1997, capital expenditures are being reduced to better align the resources and expenses with sales expectations. Capital expenditures are expected to approximate no more than $35 million during 1997, primarily for maintenance capital in Singapore and Santa Clara, California. The Company had $8.2 million of noncancellable purchase commitments for replacement of existing plant and equipment outstanding at June 27, 1997. The Company's principal sources of liquidity at June 27, 1997 consisted of $23.4 million of cash and cash equivalents and short-term investments. The Bank Group led by CIBC Wood Gundy, an affiliate of Canadian Imperial Bank of Commerce and Banque National de Paris (the "Banks") funded the $50.0 million Term Loan Facility in August 1996. The Term Loan Facility has a three year term, bears an interest rate of LIBOR plus 3% and is secured by the Company's assets located in Singapore and is guaranteed by the parent. In July 1997, the Company terminated its $25.0 million Revolving Credit Facility with the Banks. For the three months ended March 28, 1997, the Banks granted the Company waivers of certain financial covenants and subsequently amended certain financial covenants of the Term Loan Facility. For the three months ended June 27, 1997, the Banks granted the Company a thirty day waiver of certain financial covenants. The Company is currently in discussions with the Banks to revise certain financial covenants under an amendment to the Term Loan Facility. There can be no assurance that the Banks will continue to provide such waivers. Should the Company be in noncompliance with such financial covenants in the future, the inability to receive such waivers could put the Company in default under the Term Loan Facility. A default under this facility could have a material adverse effect on the Company's business, results of operations and financial condition. In light of the Company's recent actions to reduce costs, expenses and capital expenditures, the Company believes that the existing cash balances and cash flow from operations will be sufficient to meet the Company's operating and capital expenditure requirements for the next twelve months. If the Company requires additional capital, it may require additional debt or equity financing. There can be no assurance that such financing will be available to the Company or, if available, will be available on terms which are favorable to the Company or its stockholders. If the Company is unable to obtain sufficient capital, it could be required -10- 11 to curtail its capital equipment, reduce its work force, close plants, working capital and research and development expenditures which could adversely affect the Company's future years' operations and competitive position. FACTORS AFFECTING OPERATING RESULTS Dependence on a Limited Number of Customers. During 1996, the Company sold its disks primarily to Seagate Technology, Inc. ("Seagate") and Maxtor Corporation ("Maxtor"). Aggregate sales to Seagate and Maxtor in 1995 and 1996 represented 99% and 98% respectively, of net sales. During the first half of 1997, sales to Seagate and Micropolis represented 66% and 19%, respectively, of net sales. While the Company continues to seek additional customers to utilize the manufacturing capacity in which it has been manufacturing products for Maxtor, there are a relatively small number of independent high performance disk drive manufacturers. Accordingly, the Company's dependence on a few customers will continue in the future. The significant reduction in purchases by Maxtor and its repudiation of the Maxtor Supply Agreement has and will materially adversely affect the Company's operating results at least through the end of 1997. The Company's existing and several of its potential customers are expanding their ability to produce thin film disks internally and, as a result, could reduce the level of purchases or cease purchasing from the Company, could sell thin film disks in competition with the Company or might not sustain or increase their level of orders. The loss of any of the Company's current customers or of any significant future customer, the inability to design into new customers' products, or a significant reduction in the level of orders for any reason would materially adversely affect the Company's business, operating results and financial condition. Additionally, due to the lengthy product qualification process, changes in customers or product mix could have a material adverse effect on the Company's business, results of operations and financial condition during any such transition. Consequently, the 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. 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 through construction of a disk manufacturing facility in Singapore, which was completed in September 1996. In February 1996, Seagate also completed its merger with Conner Peripherals, Inc. ("Conner") and acquired Conner's internal disk production capacity, which supplied substantially all of Conner's disk requirements. In addition, prior to the merger, Conner had stated its intention to double its internal disk capacity through a newly established facility in Singapore and this facility has begun producing disks. Seagate's increased internal disk manufacturing capacity as described above may reduce Seagate's disk needs from external suppliers. If Seagate were 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. Rapid Changes in Customer and Product Mix; Risks of Qualification Process. 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 1997 sales to Seagate and Micropolis represented approximately 56% and 21% of net sales, respectively. 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 -11- 12 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, Maxtor has terminated the Maxtor Supply Agreement. The Company continues to seek additional customers to utilize the manufacturing capacity in which it had been manufacturing products for Maxtor. 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. While the Company expanded its customer base during the first half of 1997, some product qualifications that were expected to be completed were not and, as a result, unit volumes were less than projected by the Company, negatively impacting net sales. The Company is in various stages of product qualifications with other potential customers and expects to commence shipping under certain of these programs in the second half of 1997. However, the qualification of new products is a costly and time consuming process and there can be no assurance that the Company will successfully continue to find new customers or successfully qualify its products in their product programs on a timely basis. In the event the Company's products do not become qualified or 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 qualified or designed into a disk drive program would have a material adverse effect on the Company's business results of operations and financial condition. Consolidation Within the Disk Drive Industry. Consolidation within the disk drive industry has reduced the number of potential customers to whom the Company could market its products. In addition to the Seagate acquisition of Conner, Quantum Corporation ("Quantum") closed all of its manufacturing operations in the United States and overseas and transferred all manufacturing production to Matsushita Kotobuki Electronics of Japan ("MKE"), its long-term contract manufacturing partner. While Quantum was a customer of the Company in 1994, MKE has never been a significant customer of the Company. Additionally, during 1995 Maxtor was acquired by Hyundai, which is building a manufacturing facility to manufacture disks for Maxtor disk drives. Given the relatively small number of independent hard disk drive manufacturers who require an independent source of thin film disks, as well as the consolidations and changes which have occurred and are continuing to occur in the industry, there can be no assurance that the Company's efforts to diversify its customer base will be successful. If they are not successful, the Company will continue to be dependent on a relatively limited number of customers, the loss of, or the reduction in orders by, any one of which could have a material adverse effect on the Company's business, results of operations and financial condition. 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 a manufacturing facility in Singapore dedicated to manufacturing disks for Seagate (the "Dedicated Facility"). The Company has expended significant financial and management resources to construct and operate at such facility. While Seagate continues to be required to purchase certain volumes of disks through March 31, 1999, Seagate and the Company recently amended and restated the Seagate Supply Agreement (the "Amended Agreement") to allow the Company to manufacture disks for Seagate at any one of its three facilities, subject to qualification. 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. To the extent that the Company's facilities do not become qualified in Seagate's programs, Seagate would have no commitment to purchase volumes of disks under the Amended Agreement. Any continued failure to qualify into Seagate's product programs or to qualify the Company's facilities with Seagate would have a material adverse effect on the Company's business, results of operating and financial condition. See "--Variability in Gross Margins and Operating Results." Uncertainties Associated with Agreement with Micropolis. In December 1996, the Company entered into a multi-year agreement with Micropolis, a manufacturer of digital audio/video disk drives (the "Micropolis Agreement"). Under the terms of the Micropolis Agreement, the Company will set up and operate a 15,000 square foot thin film manufacturing facility (the "Micropolis Facility") within Micropolis' 400,000 square foot disk drive manufacturing plant in Singapore. Micropolis has agreed to purchase all of the disks manufactured at the Micropolis Facility through December 31, 1999, provided that each product must still be qualified by Micropolis. In addition, the Company has agreed to supply Micropolis with specified volumes from its other facilities until the Micropolis Facility is completed, subject to prior qualification of such products. -12- 13 During the six months ended June 27, 1997, sales to Micropolis represented 19% of net sales. The Company believes that the Micropolis Agreement will result in savings for both companies in areas such as packaging, transport and response time. While the Company has set up two other manufacturing facilities in Singapore, this will be the first time in the industry and for the Company to build a manufacturing facility in a customer's manufacturing plant. The Company expects that the Micropolis Facility will begin furnishing Micropolis with a portion of its thin film requirements in the third quarter of 1997. The Company currently has manufacturing capacity located in Singapore that is under-utilized, a portion of which has been used to manufacture disks for Micropolis. Unless the Company is able to qualify additional customers to utilize this and other currently under-utilized capacity, the Company's gross profits and results of operations will continue to be adversely impacted by under-utilized capacity. Variability in Gross Margins and Operating Results. The Company's gross margins have fluctuated and will continue to fluctuate quarterly and annually based upon a variety of factors such 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 and engineering costs associated with initial production of new programs, changes in the cost of or limitations on availability of materials and labor shortages. During 1995, 1996, and the first half of 1997, the Company reported a gross margin of 27.0%, 17.3% and (20.4)%, respectively. The Company's gross margins in the first half of 1997 continued to be lower than the levels experienced in 1995 and 1996 primarily due to Maxtor's termination of the Maxtor Supply Agreement and the continued resulting under-utilization of production capacity. While the Company has taken and is continuing to take 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. Operating below capacity has had a significant impact on gross margins. If the Company continues to have excess production capacity, the Company's business, results in operations and financial condition will continue to be materially adversely affected. Generally, new products, which have been designed into its customers' products, have higher average selling prices than more mature products. Therefore, the Company's ability to introduce new products, and become designed into its customers' programs, in a timely fashion is an important factor in its ability to maintain gross and operating margins. Moreover, manufacturing yields and production capacity utilization impact the Company's gross margins. New products often initially have lower manufacturing yields, are produced in lower quantities and generally have lower gross margins than more mature products. The Company expects that a substantial portion of its shipments in the second half of 1997 will be of new products and will negatively impact the Company's overall yield at least for that period. 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. Despite the Seagate Supply Agreement, as amended and restated, and the Micropolis Agreement, 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 "--Dependence on a Limited Number of Customers," "Uncertainties Associated with Supply Agreement with Seagate" and "Uncertainties Associated With Agreement With Micropolis." Dependence on Intensely Competitive Hard Disk Drive Industry; Risk of Excess Industry Capacity. The demand for the Company's thin film disks depends solely upon the demand for hard disk drives. This market is characterized by short product life cycles and rapid technological change and has experienced large fluctuations in product demand. 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 disk 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. The effect of these cycles may be magnified by increased disk production capacity. During 1995 and 1996, the Company's principal customers and -13- 14 many of its competitors and potential customers engaged in substantial efforts to increase disk manufacturing capacity in light of the then imbalance between previously existing levels of demand for disks and existing industry capacity. These efforts are resulting in significant excess capacity in the industry. To the extent industry capacity exceeds demand, resulting in significant excess capacity, there has been increased levels of competition in the industry which has negatively impacted prices of disks. Continuation of this trend would 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 such as the Company. 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 Akashic Memories Corporation, 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 is building a manufacturing facility for use in Maxtor disk drives supplementing 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" and "-- Consolidation Within the Disk Drive Industry." 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 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 New Substrate Facility. The Company has begun operations at its substrate manufacturing facility in Singapore and expects it to become fully operational during the third quarter of 1997. This facility continues to require the expenditure of significant management resources. In addition to the usual risks of establishing a new -14- 15 manufacturing facility, such as the completion of the buildings, installation of equipment, implementation of systems, procedures and controls and the hiring and training of qualified personnel, there are unique risks associated with this facility. First, 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. Second, the facility is being established in Singapore and will be the first facility of this type in Singapore. There can be no assurance that the Company will not continue to experience delays and other start-up difficulties or that once the facility is fully operational that it will produce high quality and low cost aluminum substrates. Manufacturing and other problems which occur in connection with the commencement and expansion of operations at this facility could materially adversely affect the Company's results of operations and financial condition. Future Capital Needs. The disk industry is capital intensive and the Company expects to require significant additional financial resources over the next several years for capital expenditures, working capital and research and development. The Company spent approximately $78.1 million on capital expenditures during 1996 for expansion of its facilities including investments in Singapore and other capital expenditures. Capital expenditures are expected to approximate no more than $35 million during 1997, primarily for the maintenance capital in Singapore and Santa Clara, California. In light of the Company's recent actions to reduce costs, expenses and capital expenditures, the Company believes it will be able to fund these expenditures from a combination of existing debt financing, cash balances and cash from operations. If these funds are insufficient to finance the Company's requirements, the Company would be required to seek additional debt or equity financing. There can be no assurance that such financing will be available to the Company or, if available, will be available on favorable terms to the Company and its Stockholders. 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 both in California and in Singapore. 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 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 five U.S. patents issued to it, and has seventeen additional patent applications (three of which are provisional applications) pending in the United States. 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, -15- 16 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. 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 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 Santa Clara, California facility is 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 1995, 1996 and the first half of 1997, international sales (sales delivered to customers in the Far East and Ireland, including foreign subsidiaries of domestic companies) accounted for over 95% 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 facility, a portion of the Company's expenses must be paid in Singapore dollars. Future international sales may be denominated in foreign currencies. Gains and losses on the conversion to U.S. dollars of accounts receivable and accounts -16- 17 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, a significant portion of the Company's manufacturing operations are located in Singapore which requires the Company to continually implement and monitor new systems, procedures and controls. These risks are exacerbated by the distance of the Singapore facilities from the Company's California headquarters, the fact that the Company was the first thin film disk manufacturer and is the first substrate manufacturer with a facility in Singapore and the fact that Singapore has substantially full employment. These risks will increase as production in Singapore increases as a percentage of the Company's overall sales. Due to the anticipated concentration of the Company's manufacturing operations in Singapore, 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, volume purchase agreements, announcements of changes in capacity, new customers, consolidations in the industry, technological innovations or new products by the Company or its competitors, developments in patents or other intellectual property rights, general conditions in the disk drive or computer industry, 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. -17- 18 STORMEDIA INCORPORATED AND SUBSIDIARIES 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. Defendants Park and Yoo have answered the complaint, denying any wrongdoing. Defendants Hyundai and Chung have moved to dismiss for insufficient service of process. The court is scheduled to hear that motion on September 5, 1997. The Company intends to vigorously prosecute its claim. 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. WEREZBERGER, 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 "State Complaint"). The State 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 and, in particular, 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. The action is purportedly brought on behalf of all persons who purchased StorMedia stock during that period. The Complaint seeks an unspecified amount of damages. On March 21, 1997, the trial court overruled the Company's demurrer to plaintiff's state law securities claim. On June 24, 1997, the Court of Appeal denied the Company's petition for a writ of mandate with respect to the trial court's demurrer ruling. On June 19, 1997, a purported class action complaint, Werezberger, et al. v. StorMedia Inc., et al. No. C-97 20538, was filed in the United States District Court, Northern District of California (the "Federal Complaint"). The Federal Complaint alleges that StorMedia and certain of its officers violated federal securities laws by making false and misleading statements of material fact about StorMedia's prospects between November 27, 1995 and August 8, 1996. The substantive allegations of the Federal Complaint are nearly identical to those of the State Complaint. Defendants intend to defend both cases vigorously. ITEM 2. CHANGES IN SECURITIES None ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its 1996 Annual Meeting of Stockholders on April 24, 1997. The results of such meeting were reported in the Quarterly Report on Form 10-Q for the quarter ended March 28, 1997. -18- 19 ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Exhibits. 10.45* Supply Agreement between the Company and Seagate Technology, Inc. 11.1 Statement regarding computation of earnings (loss) per share 27.1 Financial Data Schedule * Confidential treatment has been requested. b. Reports on Form 8-K None -19- 20 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: August 11, 1997 By: /s/ Stephen M. Abely -------------------------------------- Stephen M. Abely, Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) -20- 21 INDEX TO EXHIBITS
EXHIBIT PAGE ------- -------- 10.45* Supply Agreement between the Company and Seagate Technology, Inc........................ 11.1 Statement regarding computation of earnings (loss) per share ........................... 27.1 Financial Data Schedule.................................................................
*Confidential Treatment has been requsted -21- EX-10.45 2 SUPPLY AGREEMENT B/W THE CO. & SEAGATE TECH., INC. 1 EXHIBIT 10.45 SUPPLY AGREEMENT BETWEEN STORMEDIA INCORPORATED AND SEAGATE TECHNOLOGY, INC. This Supply Agreement ("Agreement") is entered into by and between StorMedia Incorporated, a Delaware corporation ("StorMedia") and Seagate Technology, Inc., a Delaware corporation ("Seagate"). This agreement is effective as of January 1, 1997. WHEREAS, Seagate makes and sells computer storage devices which utilize thin film disks, and WHEREAS, StorMedia is a manufacturer of thin film disks for hard disk drives and wishes to sell such thin film disks to Seagate. NOW, THEREFORE, for good and valuable consideration, the receipt of which is hereby acknowledged, the parties agree as follows: 1. DEFINITIONS 1.1 Products. 2.5 inch and 3.5 inch aluminum and glass/ceramic substrate thin film disks and such other disk products as the parties shall hereafter agree in writing manufactured by StorMedia. 1.2 Shipment Date. The date as of which Product is shipped by StorMedia for delivery to Seagate. 2. PURCHASE COMMITMENT 2.1 Purchase Commitment. StorMedia shall perform Product qualification in a timely manner to ensure that Product meets Seagate specifications. Seagate shall purchase, from any qualified StorMedia facility, [*] disks each fiscal month. The [*] disks per month is based on the assumption that Seagate purchases [*] 3.5 inch aluminum disks and [*] 2.5 inch aluminum disks each fiscal month and that StorMedia has qualified Product in a timely manner. The purchase commitment is, therefore, contingent upon timely Product qualification. 2.2 Supply Commitment. During the term of this Agreement, and for so long as Seagate is not in breach of this Agreement, StorMedia shall reserve for Seagate [*] disks per month capacity subject to Paragraphs 3.1 and 3.2. [*] Confidential treatment has been requested. 2 3. FORECASTS AND PURCHASE ORDERS 3.1 Forecasts. The parties shall periodically agree to a reasonable forecasting procedure. 3.2 Purchase Orders. Seagate shall order Products by issuing written purchase orders ("Purchase Orders"). StorMedia shall ship Products in accordance with such Purchase Orders. Purchase Orders must be placed thirty (30) days in advance of the Shipment Date set forth in the applicable Purchase Order. Seagate may request a Shipment Date with a shorter lead time and StorMedia shall use its best efforts to meet such date. 3.3 Terms of Purchase Orders. Purchase Orders shall include the Products being purchased, quantity requested, price to be paid under the invoice and destination address and requested Shipment Date(s). 3.4 General Terms and Conditions. Purchase Orders will be governed by the terms of this Agreement notwithstanding any contrary terms and conditions contained in the Purchase Order or Order Acknowledgment unless otherwise mutually agreed in writing. 3.5 Shipment. StorMedia shall deliver the Products to Seagate F.O.B., StorMedia's facility. Seagate shall bear all freight, insurance, duty and associated shipping and delivery charges from the Facility. 4. PRODUCT PRICE Price. Prices will be set [*], in U.S. dollars, once every [*] StorMedia represents that the prices charged will be the lowest price offered by StorMedia, with terms no less favorable than accorded to any other similarly situated customer. If StorMedia offers any customer lower prices and/or more favorable terms and conditions, it shall make those same prices, terms and conditions available to Seagate effective as of the date they were available to the other customer. 5. TERM AND TERMINATION 5.1 Term. This Agreement shall terminate on March 31, 1999. 5.2 Termination. This Agreement may be terminated prior to the end of its term by either party if the other party is in material default of this Agreement and such default is not corrected within thirty (30) days of receipt of written notice setting forth such default. Such termination shall be effected by delivery to the defaulting party of written notice of termination. - ------ *Confidential treatment requested. -2- 3 6. CONFIDENTIAL INFORMATION 6.1 Disclosure. The parties intend to disclose to each other certain Confidential Information (as defined below) in the course of the relationship established hereunder. 6.2 Definition. As used herein, "Confidential Information" shall include all proprietary information, technical data, trade secrets or know-how disclosed by StorMedia or Seagate hereunder, (including without limitation, research results, product plans, products, services, software, inventions, processes, formulas, technology, designs, drawings, hardware configuration information, and marketing, finance or other business information), which will be marked or labeled clearly as "CONFIDENTIAL" or with a similar legend. Any proprietary or confidential disclosure that is made orally or by visual inspection of equipment or parts shall be promptly confirmed and summarized in writing within thirty (30) days of disclosure by the disclosing party if such disclosure is to be included within the Confidential Information under this Agreement. Confidential Information shall not include information which the receiving party demonstrates is: (a) already in the possession of the receiving party at or before the time of disclosure hereunder as shown by the receiving party's files existing at the time of disclosure; or (b) publicly known prior to or after the time of disclosure through no wrongful act of the receiving party; or (c) lawfully received by the receiving party from a third party without obligation of confidence; or (d) independently developed by the receiving party without use of the Confidential Information of the disclosing party; (e) approved for release by written authorization of the disclosing party; or (f) ordered disclosed by the valid legal process of a court or governmental agency having jurisdiction; provided, however, that the receiving party shall notify the disclosing party in advance of any such disclosure and shall use its reasonable best efforts to obtain confidential treatment of any such disclosure. 6.3 Use of Confidential Information. StorMedia and Seagate each agree that at all times, and notwithstanding any termination, expiration, or cancellation hereunder, it will hold in strict confidence and not disclose to any third party Confidential Information of the other, except as approved in writing by the other party to this Agreement, and it will use the Confidential Information for no purpose other than pursuing the transactions and relationship contemplated by this Agreement. The parties shall maintain reasonable procedures to prevent accidental or other loss of any Confidential Information of the other party and shall exert at least the same degree of care as it uses to protect its own Confidential Information. 6.4 Return of Materials. Upon termination, cancellation or expiration of this Agreement, or upon written request of the other party, each party shall promptly return to the other all documents or other tangible materials representing the other's Confidential Information and all copies thereof. 6.5 No License. The parties recognize and agree that nothing contained in this Agreement shall be construed as granting any property rights, by license or otherwise, to any Confidential Information of the other party disclosed pursuant to this Agreement, or to any invention or any patent right that has issued or that may issue, based on such Confidential Information. -3- 4 6.6 Term of Nondisclosure Obligation. Notwithstanding the term of this Agreement, the obligations of the Company and Recipient hereunder with respect to any Confidential Information shall continue for a period of three (3) years from the date such Confidential Information was disclosed to it hereunder. 7. NOTICES All notices and other communications required or permitted hereunder shall be in writing and shall be mailed by registered or certified mail, postage prepaid, or otherwise delivered by hand, by telecopy (with receipt confirmed), or by commercial express courier service, addressed as follows: To StorMedia: StorMedia Incorporated 390 Reed Street Santa Clara, CA 95050 Attn: Stephen M. Abely With a copy to: Wilson, Sonsini, Goodrich & Rosati 650 Page Mill Road Palo Alto, CA 94302 Attn: Judith M. O'Brien To Seagate: Seagate Technology, Inc. 920 Disc Drive Scotts Valley, CA 95066 Attn: Robert A. Sandie With a copy to: Seagate Technology, Inc. 920 Disc Drive Scotts Valley, CA 95066 Attn: Corporate Contracts Such notices shall be deemed to have been served when delivered or, if delivery is not accomplished by reason of some fault of the addressee, when tendered. 8. GENERAL PROVISIONS 8.1 Governing Law. The substantive laws of the State of California govern this Agreement. 8.2 Severability. If any section or subsection of this Agreement is found by competent judicial authority to be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of any such section or subsection in every other respect and the remainder of this Agreement shall continue in effect. -4- 5 8.3 Amendment. This written Agreement may be modified only by a written amendment signed by persons authorized to so bind Seagate and StorMedia. 8.4 Survival. The provisions of Section 7 and all other obligations and duties which by their nature survive the expiration or termination of this Agreement shall remain in effect beyond any expiration or termination. 8.5 Force Majeure. Neither party shall be responsible for failure to fulfill its obligations under this Agreement due to fire, flood, war or other such cause beyond its control and without its fault or negligence provided it promptly notifies the other party. 8.6 Assignment. Neither party shall assign this Agreement or any rights hereunder without the prior written consent of the other party, except that either may assign the Agreement to a wholly-owned subsidiary without the other's consent if the original party remains liable for such assignee's performance hereunder. 8.7 Waiver. The waiver by either party of any instance of the other party's noncompliance with any obligation or responsibility herein shall not be deemed a waiver of subsequent instances or of either party's remedies for such noncompliance. 8.8 Compliance with Laws. Each party will comply with all applicable federal, state and local laws, regulations and ordinances including, but not limited to, the regulations of the U.S. Government relating to the export or re-export of machines, commodities, software and technical data insofar as they relate to the activities under this Agreement. Seagate agrees that Products provided under this Agreement are subject to restrictions under the export control laws and regulations of the United States of America, including but not limited to the U.S. Export Administration Act and the U.S. Export Administration Regulations and Seagate agrees to comply with all applicable laws and regulations. 8.9 Entire Agreement. This Agreement constitutes the entire and exclusive Agreement between the parties hereto with respect to the subject matter hereof and supersedes and cancels all previous registrations, agreements, commitments and writings in respect thereof including but not limited to the supply agreement effective as of June 29, 1995. 8.10 Arbitration. (a) All disputes which may arise hereunder shall be resolved by binding arbitration, and without resort to the courts (except to compel arbitration or to enter judgment in accordance therewith). The arbitrators shall be appointed as follows: each party shall appoint one arbitrator; the two arbitrators thus appointed shall choose the third arbitrator who shall act as the presiding arbitrator of the tribunal. The parties agree that all arbitrators shall be governed by the Rules of the American Arbitration Association; that such arbitration proceedings -5- 6 shall be conducted in Santa Clara County, California, and that the result of such arbitration shall be binding upon the parties, and may be entered as a judgment in any court or tribunal with jurisdiction over any party with the same force and effect as a judgment rendered by such a court or tribunal. (b) The arbitration proceedings and all pleadings and written evidence shall be in the English language. Any written evidence originally in a language other than English shall be submitted in English translation accompanied by the original or a true copy thereof. (c) The prevailing party in such proceeding shall be entitled to collect reasonable attorneys fees from the other party. STORMEDIA INCORPORATED SEAGATE TECHNOLOGY, INC. By: /s/ William J. Almon By: /s/ Donald L. Waite --------------------------------- ------------------------------- William J. Almon Donald L. Waite Title: Chief Executive Officer Title: Executive VP, CAO and CFO ------------------------------- ----------------------------- Dated: May 30, 1997 Date: June 4, 1997 ------------------------------ ----------------------------- -6- EX-11.1 3 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS 1 EXHIBIT 11.1 STORMEDIA INCORPORATED AND SUBSIDIARIES STATEMENT REGARDING COMPUTATION OF EARNINGS (LOSS) PER SHARE (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED ------------------------------------------------------- JUNE 27, JUNE 28, JUNE 27, JUNE 28, 1997 1996 1997 1996 ------------------------------------------------------- (UNAUDITED) (UNAUDITED) PRIMARY: Statement of operations data: Net earnings (loss) $(20,903) $7,795 (30,222) $17,264 ======== ======= ======== ======== Weighted average number of common and dilutive equivalent shares used in computations: Common Stock 17,708 17,196 17,708 17,122 Stock options and other common stock equivalents 127 1,230 127 1,243 ======== ======= ======== ======== Shares used in computing net earnings (loss) per share 17,882 18,426 17,835 18,365 ======== ======= ======== ======== Net earnings (loss) per share ($1.17) $0.42 ($1.70) $0.94 ======== ======= ======== ======== FULLY DILUTED: Statement of operations data: Net earnings (loss) $(20,903) $7,795 $(30,222) $17,264 ======== ======= ======== ======== Weighted average number of common and dilutive equivalent shares used in computations: Common Stock 17,708 17,196 17,708 17,124 Stock options and other common stock equivalents 127 1,230 127 1,244 -------- ------- -------- -------- Shares used in computing net earnings (loss) per share 17,882 18,426 17,835 18,368 ======== ======= ======== ======== Net earnings (loss) per share (1.17) $0.42 $(1.70) $0.94 ======== ======= ======== ========
EX-27.1 4 FINANCIAL DATA SCHEDULE
5 1,000 6-MOS DEC-31-1997 JAN-01-1997 JAN-27-1997 23,402 0 27,376 8,750 21,737 72,920 177,839 36,854 215,041 52,520 50,114 0 0 237 128,837 215,041 66,653 66,653 80,228 80,228 11,490 5,438 1,366 (31,869) (1,647) (30,222) 0 0 0 (30,222) (1.70) (1.70)
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