-----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, CH15iwrELXK8CN6swh9Zgm6Pk4Uy/v6bxyuyVYPXYAMogst5sizEhqe1c1qQwqba nU6FT6DtRV6jILfu0Fpaqg== 0000813347-98-000002.txt : 19980326 0000813347-98-000002.hdr.sgml : 19980326 ACCESSION NUMBER: 0000813347-98-000002 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971228 FILED AS OF DATE: 19980325 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: KOMAG INC /DE/ CENTRAL INDEX KEY: 0000813347 STANDARD INDUSTRIAL CLASSIFICATION: MAGNETIC & OPTICAL RECORDING MEDIA [3695] IRS NUMBER: 942914864 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-16852 FILM NUMBER: 98573091 BUSINESS ADDRESS: STREET 1: 1704 AUTOMATION PWY CITY: SAN JOSE STATE: CA ZIP: 95131 BUSINESS PHONE: 4089462300 MAIL ADDRESS: STREET 1: 275 S HILLVIEW DR CITY: MILPITAS STATE: CA ZIP: 95035 10-K405 1 FORM 10-K FOR PERIOD ENDING 12/28/97 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED] For the fiscal year ended December 28, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period from to Commission file number 0-16852 KOMAG, INCORPORATED (Exact name of registrant as specified in its charter) Delaware 94-2914864 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1704 Automation Parkway, San Jose, California 95131 (Address of Principal Executive Offices, including Zip Code) Registrant's telephone number, including area code: (408) 576-2000 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- -------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- [Cover page 1 of 2 pages] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment of this Form 10-K. [X] The aggregate market value of voting stock held by non-affiliates of the Registrant as of February 20, 1998 was approximately $722,784,028 (based upon the closing sale price for shares of the Registrant's Common Stock as reported by the Nasdaq National Market for the last trading date prior to that date). Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. On February 20, 1998 approximately 52,806,139 shares of the Registrant's Common Stock, $0.01 par value, were outstanding. Documents Incorporated by Reference Designated portions of the following document are incorporated by reference into this Report on Form 10-K where indicated: Komag, Incorporated Proxy Statement for the Annual Meeting of Stockholders to be held on May 27, 1998, Part III. PART I ITEM 1. BUSINESS Komag, Incorporated ("Komag" or the "Company") designs, manufactures and markets thin-film media ("disks"), the primary storage medium for digital data used in computer hard disk drives. Komag believes it is the world's largest independent manufacturer of thin-film media and is well positioned as a broad-based strategic supplier of choice for the industry's leading disk drive manufacturers. The Company's business strategy relies on the combination of advanced technology and high-volume manufacturing. Komag's products address the high-end desktop and the high-capacity/high-performance enterprise segments of the disk drive market and are used in products such as personal computers, disk arrays, network file servers and engineering workstations. The Company manufactures leading-edge disk products primarily for 3 1/2-inch and 5 1/4-inch form factor hard disk drives. The Company was organized in 1983 and is incorporated in the State of Delaware. The Company's business is subject to risks and uncertainties, a number of which are discussed under "Risk Factors." Increasing demand for digital storage and low-cost, high-performance hard disk drives has resulted in strong unit demand for these products. International Data Corporation ("IDC") forecasts that worldwide disk drive unit shipments in 1998 through 2001 will grow at a 17% compound annual growth rate. Greater processing power, more sophisticated operating systems and application software, high-resolution graphics and larger data bases are among the developments that have required ever higher performance from disk drives. For example, the first 5 1/4-inch hard disk drive, introduced in 1980, offered a capacity of five megabytes (one million bytes is a megabyte or "MB") with a storage density of less than two megabits (one million bits is a megabit; eight bits is one byte) per square inch. Current-generation 3 1/2-inch drives typically have capacities of one to nine gigabytes (one billion bytes is a gigabyte or "GB") with densities of approximately 1.0 to 1.5 gigabits (one billion bits is a gigabit) per square inch. Advances in component technology have been critical to improving the performance and storage capacity of disk drives and lowering the cost per bit stored. The Company has capitalized on its technological strength in thin- film processes and its manufacturing capabilities to achieve and maintain its position as the leading independent supplier to the thin- film media market. The Company's technological strength stems from the depth of its understanding of materials science and the interplay between disks, heads and other drive components. Komag's manufacturing expertise in thin-film media is evidenced by its history of delivering reliable products in high volume. Current manufacturing operations are conducted by the Company in the U.S. and Malaysia as well as through Asahi Komag Co., Ltd. ("AKCL"), a joint venture with Asahi Glass Co., Ltd. ("Asahi Glass") and Vacuum Metallurgical Company, which manufactures thin-film media in Japan and Thailand. The Company manufactures disk substrates for internal use through its subsidiary, Komag Material Technology, Inc. ("KMT") located in Santa Rosa, California. A 20% minority interest in KMT is held by Kobe Steel USA Holdings Inc. ("Kobe USA"), together with Kobe Steel, Ltd. ("Kobe") and other affiliated companies. Technology Komag manufactures and sells thin-film magnetic media on rigid disk platters for use in hard disk drives. These drives are used in computer systems to record, store and retrieve digital information. Inside a disk drive, the media or disk rotates at speeds of up to 10,000 rpm. The head scans across the disk as it spins, magnetically recording or reading information. The domains where each bit of magnetic code is stored are extremely small and precisely placed. The tolerances of the disks and recording heads are extremely demanding and the interaction between these components is one of the most critical design aspects in an advanced disk drive. The primary factors governing the density of storage achievable on a disk's surface are (1) the minimum distance at which read/write heads can reliably pass over the surface of the disk to detect a change in magnetic polarity when reading from the disk, defined as glide height (measured in microinches or millionths of an inch); (2) the strength of the magnetic field required to change the polarity of a bit of data on the magnetic layer of a disk when writing, defined as coercivity (measured in oersteds-"Oe"), and (3) the ability of the head to discriminate a signal from background media noise (signal-to-noise ratio). As glide height is reduced, smaller bits can be read. The higher the coercivity of the media, the smaller the width of the bit that can be stored. The signal-to-noise ratio is determined by the choice of magnetic materials and the method for depositing those materials on the disk's surface. The Company's plating, polishing and texturing processes result in a uniform surface with relatively few defects, which permits the read/write heads to fly over the disk surface at glide heights of 0.8 to 1.0 microinches. The magnetic alloys deposited on the surfaces of Komag's disks have high coercivity, low noise and other desirable magnetic characteristics. The combination of these factors results in more data stored in a given area on the disk surface. The Company currently manufactures inductive and magnetoresistive ("MR") media. Inductive media is designed for use in conjunction with a conventional head that uses a single electromagnet to read and write data. The most advanced versions of inductive media are termed proximity media, describing the extremely low glide height necessary to achieve high recording density. An MR disk is optimized for use with MR heads that use separate read and write elements. The write element is made from conventional inductive materials, but the read element is made of a material whose electrical resistance changes when subjected to changes in a magnetic field. MR heads are more sensitive to magnetic fields enabling them to read more densely-packed, smaller-sized bits. The Company believes that MR disks will be the predominant media for disk drives in 1998. In 1997, MR media accounted for nearly half of the Company's net revenue. Products, Customers and Marketing Komag's thin-film disk products generally can be classified by size and type of media. The diameter of the disk corresponds roughly with the width of the disk drive. The Company sells primarily 95-mm and 130- mm disks for 3 1/2-inch and 5 1/4-inch drives, respectively. The Company currently sells inductive (including proximity) and MR media. Within each of these sizes and types of media, Komag offers a range of coercivities, glide height capabilities and other parameters to meet specific customer requirements. Komag primarily sells its media products to independent OEM disk drive manufacturers for incorporation into hard disk drives that are marketed under the manufacturers' own labels. The Company also currently sells its disks to computer system manufacturers who make disk drives for their own use or for sale in the open market. The Company works closely with customers as they design new high-performance disk drives and generally customizes its products according to customer specifications. Five customers accounted for approximately 96% of the Company's net sales in 1997. Net sales to major customers were as follows: Western Digital Corporation ("Western Digital")-38%; Maxtor Corporation, a subsidiary of Hyundai Electronics America, ("Maxtor")-19%; Quantum Corporation ("Quantum"), including its Japanese manufacturing partner, Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE")-15%; Seagate Technology, Inc. ("Seagate")-14%; and International Business Machines ("IBM")-10%. Sales are generally concentrated in a small number of customers due to the high volume requirements of the dominant disk drive manufacturers and their tendency to rely on a few suppliers because of the close interrelationship between media and other disk drive components. Further, industry consolidation continued among the Company's disk drive customers in 1997 with the bankruptcy and shutdown of Micropolis in November. Given the relatively small number of high- performance disk drive manufacturers, the Company expects that it will continue its dependence on a limited number of customers. Sales are made directly to disk drive manufacturers worldwide (except media sales into Japan) from the Company's U.S. and Malaysian operations. Sales of media for assembly into disk drives within Japan are made solely through AKCL. On a selective basis, the Company has used AKCL to distribute its products to Japanese drive manufacturers for assembly outside of Japan. During 1997, the Company sold product to MKE in Japan and to MKE's Singapore manufacturing facility through AKCL. Media sales to the Far East from the Company's U.S. and Malaysian operations represented 96%, 88% and 62% of Komag's net sales in 1997, 1996 and 1995, respectively. The Company's customers assemble a substantial portion of their disk drives in the Far East and subsequently sell these products throughout the world. Therefore, the Company's high concentration of Far East sales does not accurately reflect the eventual point of consumption of the assembled disk drives. All foreign sales are subject to certain risks common to all export activities, such as government regulation and the risk of imposition of tariffs or other trade barriers. Foreign sales must also be licensed by the Office of Export Administration of the U.S. Department of Commerce. The Company's sales are generally made pursuant to purchase orders rather than long-term contracts. At December 28, 1997, the Company's backlog of purchase orders scheduled for delivery within 90 days totaled approximately $23.7 million compared to $113.0 million at December 29, 1996. These purchase orders may be changed or canceled by customers on short notice without significant penalty. Accordingly, the backlog should not be relied upon as indicative of sales for any future period. Manufacturing Komag's manufacturing expertise in thin-film media is evidenced by its history of delivering reliable products in high volume. Through the utilization of proprietary processes and techniques, the Company has the capability to produce advanced disk products that generally exhibit uniform performance characteristics. Such uniform performance characteristics enhance the reliability of the drive products manufactured by the Company's customers. In addition, these characteristics raise production yields on the customers' manufacturing lines, which is an important cost consideration especially in high- performance disk drives with large component counts. Manufacturing costs are highly dependent upon the Company's ability to effectively utilize its installed physical capacity to produce large volumes of products at acceptable yields. To improve yields and capacity utilization, Komag has adopted formal continuous improvement programs at all of its worldwide operations. The process technologies employed by the Company require substantial capital investment. In addition, long lead times to install new increments of physical capacity complicate capacity planning. The manufacture of the Company's thin-film sputtered disks is a complex, multistep process that converts aluminum substrates into finished data storage media ready for use in a hard disk drive. The process requires the deposition of extremely thin, uniform layers of metallic film onto a disk substrate. To achieve this end, the Company uses a vacuum deposition, or sputtering, method similar to that used to coat semiconductor wafers. The basic process consists of many interrelated steps that can be grouped into five major categories: 1. Sizing and Grinding of the Substrate: A raw aluminum blank substrate is sized by precisely cutting the inner and outer diameter of the blank. A mechanical grinding process is then utilized to provide a relatively flat surface on the substrate prior to nickel alloy plating. 2. Nickel Alloy Plating and Polishing of the Substrate: Through a series of chemical baths aluminum substrates are plated with a uniform nickel phosphorus layer in order to provide support for the magnetic layer. Next, this layer is polished to achieve the required flatness. 3. Fine Polishing, Texturing and Cleaning: During these process steps, disks are smoothed and cleaned to remove surface defects to allow the read/write heads of the disk drives to fly at low and constant levels over the disks. 4. Sputtering and Lube: By a technically demanding vacuum deposition process, magnetic layers are successively deposited on the disk and a hard protective overcoat is applied. After sputtering, a microscopic layer of lubrication is applied to the disk's surfaces to improve durability and reduce surface friction. 5. Glide Test and Certification: In robotically controlled test cells, disks are first tested for a specified glide height and then certified for magnetic properties. Based on these test results, disks are graded against customers' specific performance requirements. Most of the critical process steps are conducted in Class 100 or better environments. Throughout the process, disks are generally handled by custom-designed and, in many cases, Company-built automated equipment to reduce contamination and enhance process precision. Minute impurities in materials used, particulate contamination or other production problems can reduce production yields and, in extreme cases, result in the prolonged suspension of production. Although no contamination problems have required prolonged suspension of the Company's production to date, no assurance can be given that the Company will not experience manufacturing problems from contamination or other causes in the future. To address increased areal density requirements of disk products that will be introduced in mid-1998 and beyond, the Company has decided to make certain modifications to its current production processes during 1998. While the major processing steps remain the same, the implementation of various steps will be different. For a discussion of the process changes and the risks associated with these changes, see "Risk Factors-Rapid Technology Change." Facilities and Production Capacity Due to a recent slowdown in the growth of demand for media, improvements in the capabilities of the Company's competitors (both captive and noncaptive) and deployment of significant amounts of new media manufacturing capacity by many media suppliers including Komag, the Company's capacity is materially underutilized for the first time since 1989. The Company is in the process of executing a restructuring plan to reduce its manufacturing floorspace in response to these current conditions. At December 28, 1997, the Company and its joint venture, AKCL, had facilities in the U.S., Japan, Malaysia and Thailand. The Company occupied four production factories in the U.S. comprising approximately 468,000 square feet of floorspace, an R&D facility of approximately 188,000 square feet and warehouse and administrative facilities with approximately 130,000 square feet. One factory, subject to closure under the Company's restructuring plan, and a warehouse are located in Milpitas, California. Two factories are located in San Jose, California. The fourth factory, the Company's majority-owned subsidiary (KMT), is located in Santa Rosa, California. The factories in Milpitas and San Jose primarily perform the process steps from fine polishing through test whereas the KMT facility manufactures aluminum substrates. At the end of the third quarter of 1997, the Company closed the first of the two Milpitas factories in accordance with the restructuring plan. This space has been subleased. Subsequent to year-end, the Company closed the second Milpitas factory. The Company owns three production facilities in Malaysia, two in Penang totaling approximately 615,000 square feet and one in Sarawak of approximately 275,000 square feet. One of the Penang factories performs all of the Company's process steps except aluminum substrate preparation and the other is equipped to perform the fine polish through test steps. The Sarawak factory is primarily dedicated to plating and polishing and has limited capacity to manufacture aluminum substrates. The Company has strategically located a large portion of its total worldwide front end and back end manufacturing capacity in Malaysia. These facilities are closer to the customers' disk drive assembly plants in Southeast Asia and enjoy certain cost and tax advantages. AKCL occupies approximately 495,000 square feet of building space. AKCL's Japanese facilities are primarily dedicated to fine polish through test and its Thailand facility is designed for plating and polishing. The Company expects to have installed equipment capacity at its U.S. and Malaysian facilities capable of producing 20 million units per quarter by the end of 1998, assuming full utilization with proper labor staffing and adequate yields. These facilities when fully equipped and staffed are expected to be capable of producing in excess of 25 million units per quarter. AKCL anticipates exiting 1998 with a quarterly capacity of approximately 7 million units. Beginning in 1998, the Company and AKCL will use a combination of in-line and static sputtering machines to manufacture their disk products. See "Risk Factors-Rapid Technology Change". Research, Development and Engineering Since its founding, Komag has focused on the development of advanced thin-film disk designs as well as the process technologies necessary to produce these designs. The Company's spending and capital investment for R&D are aimed at the investigation, design, development and testing of new products and processes as well as the development of more efficient processes that can be integrated into manufacturing in a commercially viable manner. Historically, the Company has utilized a full-scale in- line sputtering line for both development and pilot production. The new R&D facility is equipped with two in-line sputtering lines and two static sputtering systems. The Company believes this additional capacity will allow more rapid development of new products as well as expanded prototype and pilot production capability. In 1998, the Company plans to spend approximately $50 million for R&D, comparable to the amount spent in 1997. The Company's R&D team will focus on introduction of new product generations, on process changes to manufacture such products, and on improvements to increase yields of products currently in volume production. As areal density increases, recording heads are required to read and write smaller data bits packed more tightly together on the surface of a disk. To accomplish this, the read/write head must fly closer to the disks' surfaces and be able to discriminate smaller, weaker magnetic signals. Disk substrates must be smoother and flatter, with fewer, smaller defects. In addition, more uniform crystal growth and improved magnetic orientation on the surface of the disk is needed to facilitate increased density. The Company plans to migrate its sputtering process from the deposition of a magnetic layer over an amorphous underlayer to epitaxial deposition of the active magnetic layer upon a crystalline underlayer, to achieve these desired magnetic characteristics. Since epitaxial deposition requires higher temperatures and dryer process chambers than current processes, a number of changes must be made during 1998. First, the processes related to producing substrates, prior to sputtering, must be changed by adding new annealing steps to accommodate higher process temperatures. Next, to make substrates smoother and reduce defects a new polish step will be added. Further, the Company plans to upgrade its existing in-line sputtering lines to increase process temperatures and provide higher vacuum capability. While the Company believes the relatively slow deposition rate achieved in its in-line sputtering machines will provide a competitive advantage over time, the Company and AKCL will also purchase and use static sputtering lines. This will allow the Company to gain experience using static sputtering equipment, which runs at higher deposition rates and temperatures than the Company's in-line sputtering systems. Finally, the Company will have to continue reducing and eliminating sources of contamination throughout its process to reduce small surface defects on its disk products. See "Risk Factors-Rapid Technology Change." The Company's expenditures (and percentage of sales) on research, development and engineering, were $51.4 million (8.1%) in fiscal 1997, $29.4 million (5.1%) in fiscal 1996 and $23.8 million (4.6%) in fiscal 1995. Strategic Alliances The Company has established joint ventures with Asahi Glass and Kobe. Komag believes these alliances have enhanced the Company's competitive position by providing research, development, engineering and manufacturing expertise that reduce costs and technical risks and shorten product development cycles. Asahi Komag Co., Ltd. ("AKCL") In 1987, the Company formed a partnership (Komag Technology Partners) with the U.S. subsidiaries of two Japanese companies, Asahi Glass and Vacuum Metallurgical Company. The partners simultaneously formed a wholly owned subsidiary, AKCL, to manufacture and distribute thin-film disks in Yonezawa, Japan. Under the joint venture agreement, the Company contributed technology developed prior to January 1987 and licensed technology developed after January 1987, to the extent such technology relates to sputtered thin-film hard disk media, for a 50% interest in the partnership. The Japanese partners contributed equity capital aggregating 1.5 billion yen (equivalent to approximately $11 million at that time). AKCL began commercial production in 1988. The terms of the joint venture agreement provide that AKCL may only sell disks for incorporation into disk drives that are assembled in Japan, with no limitation on the territory in which AKCL's customers can sell such assembled disk drive products. During the term of the joint venture agreement and for five years thereafter, the Japanese partners and their affiliates have agreed not to develop, manufacture or sell sputtered media anywhere in the world other than through the joint venture, and the Company and its affiliates have agreed not to develop, manufacture or sell such media in Japan except through the joint venture. The Company has, however, periodically granted AKCL a limited right to sell its disks outside of Japan and has received royalties on such sales. Upon the occurrence of certain terminating events and the subsequent acquisition of AKCL by one or more of the joint venture partners, the restrictions related to activities of the acquiring joint venture partner(s) within Japan may lapse. Disk sales to AKCL represented 14% of the Company's net sales in 1997 compared to 6% in 1996 and less than 1% in 1995. Disk sales by the Company to AKCL for distribution are expected to decline in 1998. The Company purchased 11% of AKCL's unit output during 1997 compared to approximately 3% and 1% in 1996 and 1995, respectively. The Company anticipates that distribution sales of AKCL-produced disks to U.S. customers in 1998 will remain a relatively small percentage of the Company's net sales. As a result of product transition and qualification issues, AKCL operated substantially under capacity for the majority of 1997. While AKCL has obtained qualification on new product offerings, the Company anticipates that AKCL will continue to underutilize its capacity through at least the second quarter of 1998. In February 1998, AKCL decided to replace certain manufacturing equipment. The capacity underutilization, coupled with the equipment write-off, will most likely generate substantial quarterly losses at AKCL for at least the first half of 1998. AKCL plans to use a combination of static and in-line sputtering machines to manufacture its disk products. AKCL believes that the products produced by a static sputtering process will be technically similar to those produced by other Japanese media suppliers, thus improving AKCL's ability to meet specific requirements of certain Japanese customers on a timely basis. AKCL also plans to implement the new epitaxial process on certain in-line sputtering equipment. The successful implementation of the epitaxial process on AKCL's in-line sputtering equipment, and the Japanese market acceptance of products produced using in-line equipment, will determine AKCL's relative mix of in-line and static machines. Komag Material Technology, Inc. ("KMT") In 1988, Komag formed a wholly owned subsidiary, KMT, to secure an additional stable supply of aluminum substrates of satisfactory quality for the Company's products. In 1989, Kobe, a leading worldwide supplier of blank aluminum substrates, purchased a 45% interest in KMT for $1.4 million. In December 1995, the Company reacquired 25% of the outstanding Common Stock of KMT by purchasing shares from Kobe for $6.75 million. The Company's purchase raised its total ownership percentage of KMT to 80%. Under the recent stock purchase and related agreements, Kobe retained one seat on KMT's Board of Directors. Under these agreements, Kobe will continue to supply substrate blanks to KMT while the Company will continue to purchase KMT's entire output of finished substrates. Further, the Company has indicated its intention to purchase a substantial proportion of its future substrate requirements from Kobe, a continuation of a past procurement practice. In combination, KMT, Kobe, and the Company's Sarawak facility supply substantially all of the Company's substrate requirements. The Company's Sarawak facility began substrate production in 1997. Equity Positions Held by Asahi Glass and Kobe in Komag Asahi Glass and Kobe each purchased two million shares of newly issued Common Stock from the Company for $20 million in January 1989 and March 1990, respectively. In 1992, Asahi Glass transferred ownership of its shares to a U.S. subsidiary of Asahi Glass. Under their respective stock purchase agreements, Asahi Glass and Kobe each have the right to purchase additional shares of the Company's Common Stock on the open market to increase their respective equity interests in the Company to 20%, to maintain their percentage interest in the Company by purchasing their pro rata shares of any new equity issuance by the Company and to require the Company to register their shares for resale, either on a demand basis or concurrent with an offering by the Company. Each stock purchase agreement further provides that the Company shall use its best efforts to elect a representative of each investor to the Company's Board of Directors and to include such representatives on the Nominating Committee of the Board. There were no purchases or sales of the Company's stock by Asahi Glass or Kobe in 1997 and according to the Company's stock records at February 20, 1998, Asahi America and Kobe held 2,000,000 and 2,000,002 shares of Common Stock, respectively. Sales of significant amounts of the security holdings of Asahi Glass and/or Kobe in the future could adversely affect the market price of the Company's Common Stock. Any sales by either party, however, would relieve the Company of its obligation to nominate that party's representative for election to the Board of Directors. Competition Current thin-film disk competitors fall into three groups: U.S. noncaptive manufacturers, U.S. captive manufacturers, and Japanese/Asian manufacturers. Historically, each of these groups has supplied approximately 30% to 40% of the worldwide thin-film disk unit output. Based upon research conducted by an independent market research firm, the Company believes it is the leading independent supplier of thin-film disks. The Company's 1997 net sales were more than 90% greater than the next largest U.S. noncaptive manufacturer during the same period. U.S. noncaptive thin-film disk competitors include HMT Technology Corporation and StorMedia Inc. (including the former Akashic Memories Corporation, which was purchased by StorMedia as of December 31, 1997). Japan-based thin-film disk competitors include Fuji Electric Company, Ltd.; Mitsubishi Kasei Corp.; Showa Denko K.K.; and HOYA Corporation. The U.S. captive manufacturers include IBM and OEM disk drive manufacturers, such as Maxtor, Seagate and Western Digital, which manufacture disks as a part of their vertical integration programs. To date, IBM and these OEM disk drive manufacturers have sold nominal quantities of disks in the open market. Captive media suppliers, in particular Seagate, added significant capacity in 1997 and gained market share. The captive manufacturers supplied in the low-40% range of the disk drive industry's media requirements for 1997 and exited the year with a market share in the mid- to high-40% range. Continued success by the captive suppliers could heighten competition among the noncaptive media suppliers for the remaining available market. Such competition could adversely affect the financial results of noncaptive suppliers, such as Komag. See "Risk Factors-Competition." Environmental Regulation The Company is subject to a variety of regulations in connection with its operations and believes that it has obtained all necessary permits for its operations. The Company uses various industrial hazardous materials, including metal plating solutions, in its manufacturing processes. Wastes from the Company's manufacturing processes are either stored in areas with secondary containment before removal to a disposal site or processed on site and discharged to the industrial sewer system. The Company has made investments in upgrading its waste-water treatment facilities to improve the performance and consistency of its waste-water processing. Nonetheless, industrial waste-water discharges from the Company may, in the future, be subject to more stringent regulations. Failure to comply with present or future regulations could result in the suspension or cessation of part or all of the Company's operations. Such regulations could restrict the Company's ability to expand at its present locations or could require the Company to acquire costly equipment or incur other significant expenses. Patents and Proprietary Information Komag holds and has applied for U.S. and foreign patents and has entered into cross-licenses with certain of its customers. While possession of patents could present obstacles to the introduction of new products by competitors and possibly result in royalty-bearing licenses from third parties, the Company believes that its success does not depend on the ownership of intellectual property rights but rather on its innovative skills, technical competence and marketing abilities. Accordingly, the patents held and applied for will not constitute any assurance of the Company's future success. The Company regards elements of its equipment designs and processes as proprietary and confidential and relies upon employee and vendor nondisclosure agreements and a system of internal safeguards for protection. Despite these steps for protecting proprietary and confidential information, there is a risk that competitors may obtain and use such information. Furthermore, the laws of certain foreign countries in which the Company does business may provide a lesser degree of protection to the Company's proprietary and confidential information than provided by the laws of the U.S. In addition, the Company from time to time receives proprietary and confidential information from vendors, customers and partners, the use and disclosure of which are governed by nondisclosure agreements. Through internal communication and the monitoring of use and disclosure of such information, the Company complies with its obligations regarding use and nondisclosure. However, despite these efforts, there is a risk that such information may be used or disclosed in violation of the Company's obligations of nondisclosure. The Company has occasionally received, and may receive in the future, communications from third parties asserting violation of intellectual rights alleged to cover certain of the Company's products or manufacturing processes or equipment. In such cases, the Company evaluates whether it would be necessary to defend against the claims or to seek licenses to the rights referred to in such communications. However, no assurance can be given that the Company will be able to negotiate necessary licenses on terms that would not have a material adverse effect on the Company, or at all, or that any litigation resulting from such claims would not have a material adverse effect on the Company's business and financial results. Employees As of December 28, 1997, the Company and its consolidated subsidiaries had 4,738 employees (4,689 of which are regular employees and 49 of which were employed on a temporary basis), including 4,233 in manufacturing, 330 in research, development and engineering and 175 in sales, administrative and management positions. Of the total, 2,930 are employed at offshore facilities. The Company believes that its future success will depend in large part upon its ability to continue to attract, retain and motivate highly skilled and dedicated employees. None of the Company's employees is represented by a labor union and the Company has never experienced a work stoppage. Risks Factors The Company's business is subject to a number of risks and uncertainties. While this discussion represents the Company's current judgment on the risks and future direction of the business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. The discussion contained in Item 1-"Business" and Item 7-"Management's Discussion and Analysis of Financial Condition and Results of Operations" contains predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties. Among the factors that could cause actual results to differ are the following. The Company sells a single product into a market characterized by rapid technological change and sudden shifts in the balance between supply and demand. Further, the Company is dependent on a limited number of customers, some of whom also manufacture some or most of their own disks internally. Competition in the market, defined by both technology offerings and pricing, can be fierce, especially during times of excess available capacity. The Company has a high fixed-cost structure that can cause operating results to vary dramatically with changes in the yield, productivity and utilization of its factories. In addition, the business requires substantial investments for research and development activities and for physical assets such as equipment and facilities, that are dependent on the Company's access to financial resources. These and other risks are discussed more fully below. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Rapid Technology Change The thin-film disk industry has been characterized by rapid technological developments, increasingly shorter product life cycles and price erosion. The Company believes that its future success depends, in large measure, on its ability to develop and implement new process technologies in a timely manner and to continually improve these technologies. Such technologies must support cost-effective, high-volume production of thin-film disks that meet the ever-advancing customer requirements for enhanced magnetic recording performance. Although the Company has a significant, ongoing research and development effort to advance its process technologies and the resulting products, there can be no assurance that the Company will be able to develop and implement such technologies in a timely manner in order to compete effectively against competitors' products and/or entirely new data storage technologies. The Company's results of operations would be materially adversely affected if the Company's efforts to advance its process technologies were not successful or if the technologies that the Company had chosen not to develop were proven to be viable competitive alternatives. As areal density increases, recording heads are required to write and read smaller data bits packed more tightly together on the surface of the disk. To accomplish this, the read/write head must fly closer to the disks' surfaces and be able to discriminate smaller, weaker magnetic signals. Disk substrates must be smoother and flatter, with fewer, smaller defects. In addition, more uniform crystal growth and improved magnetic orientation on the disk surface is needed to facilitate increased density. The Company plans to migrate its sputtering process from the deposition of a magnetic layer over an amorphous underlayer to epitaxial deposition of the active magnetic layer upon a crystalline underlayer to achieve these desired magnetic characteristics. Since epitaxial deposition requires higher temperatures and dryer process chambers than current processes, a number of changes must be made during 1998. First, the processes related to producing substrates, prior to sputtering, must be changed by adding new annealing steps to accommodate higher process temperatures. Next, to make substrates smoother and reduce defects a new polish step will be added. Further, the Company plans to upgrade its existing in-line sputtering lines to increase process temperatures and provide higher vacuum capability. While the Company believes the relatively slow deposition rate achieved in its in- line sputtering machines will provide a competitive advantage over time, the Company and AKCL will also purchase and use static sputtering lines. This will allow the Company to gain experience using static sputtering equipment, which runs at higher deposition rates and temperatures than the Company's in-line sputtering systems. Finally, the Company will have to continue reducing and eliminating sources of contamination throughout its process to reduce small defects on the disks' surfaces. There can be no assurance that the Company and AKCL will succeed in modifying equipment or deploying these new processes into manufacturing in a timely or cost-effective manner. Failure to execute these process changes, or to execute them on time, or the inability to achieve expected improvements through these planned changes could result in products that would not meet industry needs. This would in turn lead to delay in, or failure of, new product qualification and resulting lower sales, which could have a material adverse effect on the Company's results of operations. Dependence on Hard Disk Drive Industry; Limited Number of Customers The demand for the Company's high-performance thin-film disks depends upon the demand for hard disk drives and the Company's ability to provide technically superior products at competitive prices. The hard disk drive market is characterized by short product life cycles and rapid technological change. Failure by the Company to qualify new products and/or successfully achieve volume production of new customer products could adversely affect the Company's results of operations. The market is also characterized by changes in the balance between supply and demand. During periods of excess supply, prices can drop rapidly, causing abrupt changes in the Company's financial performance. Prior to 1997, the Company's financial performance was partially insulated from this effect due to its focus on sales of enterprise-class disk products. The enterprise disk drive market segment experienced increased competitive pressures and an excess supply of disk drives in 1997 as new entrants vied for market share in this historically higher-margin segment. Additionally, the captive media operations of various disk drive manufacturers became stronger technically and supplied enterprise- class disks in volume during 1997. As a result, the Company's exposure to the more price-competitive desktop market increased significantly while the Company's sales volume and pricing of enterprise-class disk products declined sharply. In June 1997, a major customer made a sudden and material cut in the Company's orders due to the increased competition and oversupply in the enterprise segment of the data storage business. This customer reduced its disk drive production, utilized its own captive media operations and purchased limited quantities of disks from noncaptive suppliers, including Komag. Since June, the production of disk drives for the enterprise market segment has remained at low levels as excess inventories of enterprise-class disk drives were gradually reduced, thus limiting the Company's sales of enterprise disk products. The $45 million drop in sales from the second quarter of 1997 to the third quarter of 1997 was primarily attributable to reductions in enterprise disk sales to two major customers. These two customers comprised 43% of sales in the first half of 1997 compared to only 12% of sales in the second half of the year. In late December 1997, the Company experienced another unexpected and material reduction in disk orders for high-end desktop drives due to deteriorating conditions within this market segment. The weak market condition in both the enterprise and desktop market segments will adversely affect the Company's financial performance for at least the first half of 1998. Furthermore, the Company's sales are generally made pursuant to purchase orders that are subject to cancellation, modification or rescheduling without significant penalties. There can be no assurance that the Company's current customers will continue to place orders with the Company, that orders by existing customers will recover to the levels of earlier periods or that the Company will be able to obtain orders from new customers. In general, the Company's customers are moving towards fewer larger- volume programs, characterized by shorter product life cycles. Competition for this limited number of programs is increasing due to media capacity additions during 1997. Additionally, customer expectations of media suppliers are growing more demanding. Media must be more customized to each disk drive program and supply chain management, including just-in-time delivery, has assumed greater importance. Timely development of new products and technologies that assist customers in reducing their time-to-market performance and operational excellence that supports high-volume manufacturing ramps and tight inventory management throughout the supply chain will be keys to both the Company's profitability and the maintenance of constructive customer relationships. There can be no assurance that the Company will respond to this rapidly changing environment in a manner that will maximize utilization of its production facilities and minimize its inventory losses. Furthermore, the Company's sales are concentrated in a small number of customers due to the high-volume requirements of the dominant disk drive manufacturers and their tendency to rely on a few suppliers because of the close interrelationship between media performance and disk drive performance and the complexity of integrating components from a variety of suppliers. Net sales to major customers in 1997 were as follows: Western Digital Corporation ("Western Digital")-38%; Maxtor Corporation, a subsidiary of Hyundai Electronics America, ("Maxtor")- 19%; Quantum Corporation ("Quantum") including its Japanese manufacturing partner, Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE")-15%; Seagate Technology, Inc. ("Seagate")-14%; and International Business Machines ("IBM")-10%. Consolidation continued among the Company's disk drive customers in 1997 with the bankruptcy and shutdown of Micropolis in November 1997. Given the relatively small number of disk drive manufacturers, the Company expects that it will continue its dependence on a very limited number of customers. AKCL, the Company's Japanese joint venture, despite a long- established working relationship with MKE, suffered a dramatic drop in sales of AKCL-produced media to MKE due to difficulties with new product qualifications. Like the Company, AKCL is converting its processes to epitaxial deposition in order to improve its competitive position in the future. During 1997, all of the Company's product sales to MKE in Japan and to MKE's Singapore manufacturing facility were through AKCL. Competition The Company's thin-film disk products primarily serve the 3 1/2-inch and 5 1/4-inch hard disk drive market, where product performance, consistent quality and availability, taken together, are of great competitive importance. To succeed in an industry characterized by rapid technological developments, the Company must continuously advance its thin-film technology at a pace consistent with or faster than its competitors. However, if the Company is not able to keep pace with rapid advances, the Company may lose market share and face increased price competition from other manufacturers. Such competition could materially adversely affect its results of operations. Worldwide disk drive shipments grew approximately 23% in 1997 over 1996 and are projected to grow at a 17% compound annual growth rate in 1998 through 2001 according to International Data Corporation ("IDC"). In response to these historical and projected growth rates for the disk drive market, the Company and a majority of the Company's competitors (both independent disk manufacturers and captive disk manufacturers owned by vertically integrated disk drive customers) have substantially increased their disk manufacturing capacity to satisfy the anticipated demand for disk products. The Company believes that its manufacturing operations in Penang and Sarawak, Malaysia can provide a competitive cost advantage relative to most other thin-film disk manufacturers that operate exclusively in the U.S. and Japan. However, in order to remain cost competitive, many of the U.S.- and Japan-based competitors, including captive manufacturers, have or are currently expanding into lower-cost regions in the world such as Southeast Asia. These significant investments in capable new disk production capacity, combined with the recent slowdown in demand, have resulted in an oversupply of disk media and increased price competition in the media market. These supply-demand conditions have increased competition for the remaining market and have led to higher than historical price erosion and lower factory utilization. These conditions are expected to adversely affect the Company's results of operations for the first half of 1998, particularly in the first quarter. Such conditions, should they continue beyond the first half of 1998, would continue to adversely affect the Company's results of operations. Of the Company's U.S.-based customers, IBM, Seagate and Western Digital produce significant portions of their media demand internally. During 1997 IBM and Seagate produced in excess of 75% of their media demand internally. Western Digital produced approximately one-third of its media requirement. For the longer term, IBM and Seagate are expected to maintain a similarly high proportion while Western Digital has announced its intention to produce more of its media needs internally. Another customer, Maxtor, recently commenced internal media production. Other customers and potential customers could adopt similar vertical-integration strategies. Depending on the overall growth in market demand for disk products, such actions could result in the reduction or cessation of purchases from the Company, thus materially adversely affecting the Company's results of operations. Fluctuation in Operating Results The Company believes that its future operating results will continue to be subject to quarterly variations based upon a wide variety of factors, including the cyclical nature of the hard disk drive industry; the ability to develop and implement new manufacturing process technologies; the ability to introduce new products and to achieve cost- effective, high-volume production in a timely manner; changes in product mix and average selling prices; the availability and the extent of utilization of the Company's production capacity; manufacturing yields; prolonged disruptions of operations at any of the Company's facilities for any reason; changes in the cost of or limitations on availability of labor; and increases in production and engineering costs associated with initial design and production of new product programs. Because thin-film disk manufacturing requires a high level of fixed costs, gross margins are also extremely sensitive to changes in volume. At constant average selling prices, reductions in manufacturing efficiency cause declines in gross margins. Additionally, decreasing market demand for the Company's products generally results in reduced average selling prices and/or low capacity utilization that, in turn, adversely affect gross margins and operating results. The Company's ability to maintain average selling prices is dependent on its ability to produce, in volume, products that are differentiated on the basis of technological superiority. During 1997, competitive technology had advanced to the point that the Company's current products did not provide a sufficient advantage, increasing the downward pressure on pricing. During 1997, the Company introduced new products to keep pace with the industry's 60% improvement in areal density. These products incorporate many new technologies including smoother substrates, laser textures and new magnetic alloys. Industry pricing for new products has typically decreased over a given product life cycle based on the assumption that as improvements in new product yield and other manufacturing efficiencies were realized, profit margins would be maintained. In light of increasingly complex production processes and shorter product cycles, accurately forecasting yields is a difficult task. The difficulty in maintaining cost competitiveness through improving yields will continue to be magnified by ever-increasing process complexity and by the compression of product life cycles. Lower- than-planned yields on new products, coupled with continued high usage of production equipment for product and process development activities, constrained unit output throughout 1997. In addition, weak demand for enterprise-class disks in the second half of 1997 resulted in a further reduction in utilization of the Company's factories. Further, in December 1997, the desktop segment of the market weakened; several customers have reduced their order volumes in the first quarter of 1998. The Company expects that net sales could be as much as 55% lower in the first quarter of 1998 than in the fourth quarter of 1997. Even with expected, improved industry conditions in the second quarter, the Company expects financial results will remain under pressure due to capacity utilization and pricing issues. In light of the capital- intensive, fixed-cost nature of the business, low unit output results in high unit costs and low gross margins. In the event that market demand does not improve, that yields of new products do not improve at the rate expected or that the Company is unable to introduce and ramp to volume production next-generation products in a timely manner, the Company's operating results would likely continue to be adversely affected. Financial Resources The thin-film disk industry is highly capital intensive. The Company must anticipate customer demand for both production volume and technological capability. Careful planning is essential since the lead time for deployment of new capacity and new process capabilities typically exceeds current product life cycles. The Company must make major commitments well in advance of anticipated need. The inaccurate estimation of capacity requirements or the failure to implement the proper technologies in a timely manner would have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that, in order to achieve its long-term growth objectives and maintain and enhance its competitive position, it will need significant additional financial resources over the next several years for capital expenditures, working capital and research and development. During 1996 and 1997, the Company spent approximately $403 million and $199 million, respectively, on property, plant and equipment. In 1998, the Company plans to spend $120 million, primarily to upgrade existing facilities and equipment in order to deploy new process technologies into manufacturing and to improve yield and productivity. There can be no assurance that net sales will increase sufficiently to absorb these additional costs. The Company borrowed $175 million during 1997 and $15 million subsequent to year-end, increasing overall debt to $260 million and leaving a balance of $85 million available for future borrowing under existing lines of credit. The Company's lines of credit are subject to certain covenants, including the number and size of consecutive quarterly losses. In anticipation of a violation of these profitability tests at the end of the first quarter of 1998, the Company renegotiated the terms and covenants of its $175 million syndicated loan facility to provide for continued access to these funds. Current borrowings under this facility totaled $100 million at December 28, 1997. The Company will most likely remain in compliance with its other credit facilities through at least the first half of 1998. There can be no assurance that these funds will remain available should the Company violate its loan covenants at any future date or that any available funds will be sufficient for the Company needs. The Company believes that it will be able to fund planned 1998 expenditures from a combination of cash flow from operations, funds available from existing bank lines of credit and existing cash balances. If the Company is unable to obtain sufficient capital, it could be required to reduce its capital equipment and research and development expenditures, which could have a material adverse affect on the Company's results of operations. Risk of Foreign Operations / Joint Venture In 1997, sales to customers in the Far East, including the foreign subsidiaries of domestic disk drive companies, accounted for approximately 96% of the Company's net sales from its U.S. and Malaysian facilities. The Company's customers assemble a substantial portion of their disk drives in the Far East and subsequently sell these products throughout the world. Therefore, the Company's high concentration of Far East sales does not accurately reflect the eventual point of consumption of the assembled disk drives. The Company anticipates that international sales will continue to represent the majority of its net sales. All of the Company's sales are currently priced in U.S. dollars worldwide. Certain costs at the Company's foreign manufacturing and marketing operations are incurred in the local currency. The Company also purchases certain operating supplies and production equipment from Japanese suppliers in yen-denominated transactions. Accordingly, the Company's operating results are subject to the risks inherent with international operations, including, but not limited to, compliance with or changes in the law and regulatory requirements of foreign jurisdictions, fluctuations in exchange rates, tariffs or other barriers, difficulties in staffing and managing foreign operations, exposure to taxes in multiple jurisdictions and transportation delays and interruptions. The Company's Malaysian operations accounted for a significant portion of the Company's 1997 consolidated net sales and generated profits that partially offset losses incurred in the U.S. Prolonged disruption of operations in Malaysia for any reason would cause delays in shipments of the Company's products, thus materially adversely affecting the Company's results of operations. Recently, there has been a substantial devaluation of the Malaysian ringgit, along with other Southeast Asian currencies. Changes in relative currency values can be swift and unpredictable. While the effect of the ringgit's devaluation has been to reduce the U.S. dollar equivalent of the ringgit-based operating expenses, future fluctuations may have the opposite effect. Fluctuations in the financial results of AKCL, the Company's unconsolidated Japanese disk manufacturing joint venture, also impact the Company's financial performance. Equity in the net loss of AKCL increased the Company's 1997 consolidated net loss by $4.9 million. AKCL operated substantially under capacity for the majority of 1997 and the Company anticipates that AKCL will continue to underutilize its capacity through at least the first half of 1998. This underutilization, coupled with the anticipated write-off of certain unutilized equipment, will most likely generate substantial quarterly losses at AKCL for at least the first half of 1998. AKCL is subject to many of the same risks facing the Company, including the risks associated with new product introduction. In addition, the equity income derived from AKCL fluctuates over time due to its dependence on a more limited customer base (MKE and Fujitsu Ltd. accounted for 76% and 17%, respectively, of AKCL's 1997 net sales) and yen/dollar exchange rate fluctuations. Volatility of Stock Price The Company's Common Stock has experienced and can be expected to experience substantial price volatility in response to actual or anticipated quarterly variations in operating results; announcements of technological innovations or new products by the Company or its competitors; the success or failure of new product qualifications (especially as new generations of product are introduced); developments related to patents or other intellectual property rights; developments in the Company's relationships with its customers or suppliers; announcements of alliances, mergers or other relationships by or between the Company's competitors and/or customers; and other events or factors. In addition, any shortfall or changes in revenue, gross margins, earnings or other financial results from analysts' expectations could cause the price of the Company's Common Stock to fluctuate significantly. In recent years, the stock market in general has experienced extreme price and volume fluctuations which have particularly affected the market price of many technology companies and which have often been unrelated to the operating performance of those companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. See "Price Range of Common Stock." Patents and Proprietary Information Protection of technology through patents and other forms of intellectual property rights in technically sophisticated fields is commonplace. In the disk drive industry, it is not uncommon for companies and individuals to initiate actions against others in the industry to enforce intellectual property rights. There can be no assurance that others have not or will not perfect intellectual property rights and either enforce those rights to prevent the Company from practicing certain technologies or demand royalty payments from the Company in return for practicing those technologies, both of which may have a material adverse affect on the Company's results of operations. As a measure of protection, the Company has entered into cross-license agreements with certain of its customers. In addition, the Company reviews, on a routine basis, patent issuances in the U.S. and patent applications that are published in Japan. Through these reviews, the Company occasionally becomes aware of a patent, or an application that may mature into a patent, which could give rise to a claim of infringement. When such patents are identified, the Company investigates the validity and possibility of actual infringement. The Company is presently involved in such an investigation of several recently issued patents. Other Risk Factors The Company relies on a limited number of suppliers, in some cases a sole supplier, for certain materials and equipment used in its manufacturing processes. These materials include aluminum substrates, nickel plating solutions, certain polishing and texturing supplies, and sputtering target materials. These suppliers work closely with the Company to optimize the Company's production processes. Although this reliance on a limited number of suppliers, or a sole supplier, entails some risk that the Company's production capacity would be limited if one or more of such materials were to become unavailable or available in reduced quantities, the Company believes that the advantages of working closely with these suppliers outweigh such risks. If such materials should be unavailable for a significant period of time, the Company's results of operations would be adversely affected. Given the Company's dependence on a few customers and a limited number of product programs for each customer, the magnitude of the inventory commitments the Company must make to support its customers' programs and the Company's limited remedies in the event of program cancellations, if a customer cancels or materially reduces one or more product programs, or should a customer experience financial difficulties, the Company may be required to take significant inventory charges, which, in turn, could materially and adversely affect the Company's results of operations. While the Company has taken certain charges including inventory write-downs, to address known issues, there can be no assurance that the Company will not be required to take additional inventory write-downs due to the Company's inability to obtain necessary product qualifications or due to further order cancellations by customers. Recently the Company was forced to reduce, for a short period of time, operations at its Malaysian factories due to smoke generated by wide-spread fires in the region. This curtailment did not have a material effect on the Company's operations. In addition, the Company's California manufacturing facilities, its Japanese joint venture (AKCL), its Japanese supplier of aluminum blanks for substrate production, other Japanese suppliers of key manufacturing supplies and its Japanese supplier of sputtering machines are each located in areas with seismic activity. The Company has incurred no significant disruptions to its business due to seismic activity; however, there can be no assurance that natural or man-made disasters will not result in a prolonged disruption of production in the future. Such disruptions could have a material adverse effect on the Company's results of operations. ITEM 2. PROPERTIES Worldwide (excluding AKCL), the Company currently occupies facilities totaling approximately 1.6 million square feet. The Company owns three disk-manufacturing facilities in Malaysia, two in Penang and one in Sarawak. The square footage of each of these facilities and acreage of the related land parcels are 340,000 square feet and 13 acres, 275,000 square feet and 18 acres, and 275,000 square feet and 89 acres. The Company leases five manufacturing facilities in Milpitas, San Jose and Santa Rosa, California. The Company's new headquarters facility and new R&D facility in San Jose, California were occupied in the first quarter of 1997. These facilities are leased for the following terms: Facility Size Current Lease (square feet) Term Expires Extension Options 225,000 September 2006 20 years 188,000 January 2007 20 years 103,000 July 1999 10 years 97,000 (1) February 2001 10 years 96,000 (2) February 2001 10 years 82,000 February 2007 20 years 48,000 December 1999 - 44,000 April 1999 10 years In addition to the facilities listed above, the Company leases other smaller facilities in California and Singapore. The Company owned approximately 6 acres of undeveloped land adjacent to its Milpitas manufacturing complex, which it sold in March 1998. (1) This facility was vacated in the third quarter of 1997 as part of the Company's restructuring plan and subleased in December 1997. (2) Subsequent to year-end, the Company closed this facility as part of the Company's restructuring plan. ITEM 3. LEGAL PROCEEDINGS There are no material legal proceedings to which either the Company or its subsidiaries is a party or to which any of its property is subject. ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS No matters were submitted to the stockholders of the Company during the Company's fourth quarter of 1997. Executive Officers of the Registrant As of February 23, 1998 the executive officers of the Company are as follows: Name Age Position - ------------------------- ---- --------------------------------------------- Tu Chen.................. 62 Chairman of the Board of Directors Stephen C. Johnson....... 55 President, Chief Executive Officer and Director Christopher H. Bajorek... 54 Senior Vice President and Chief Technical Officer Willard Kauffman......... 62 Senior Vice President and Chief Operating Officer William L. Potts, Jr. ... 51 Senior Vice President, Chief Financial Officer and Secretary Thian Hoo Tan............ 49 Senior Vice President - Worldwide Manufacturing Fred J. Wiele............ 59 Senior Vice President - Marketing and Sales Ronald Allen............. 49 Vice President - Equipment Technology and Automation Richard Austin........... 42 Vice President - U.S. Manufacturing Elizabeth A. Lamb........ 46 Vice President - Human Resources Ray Martin............... 54 Vice President - Product Assurance and Product Test Steven J. Miura.......... 45 Vice President - Advanced Products Sonny Wey................ 58 Vice President - Product Research and Development Tsutomu T. Yamashita..... 43 Vice President - Process Technology Research and Development Dr. Chen is a founder of the Company and has served as Chairman of the Board from its inception in June 1983. From 1971 to June 1983, he was a Member, Research Staff and principal scientist at Xerox Corporation's Palo Alto Research Center. From 1968 to 1971, Dr. Chen was employed as a research scientist for Northrop Corp. Dr. Chen received his Ph.D. and M.S. degrees in Metallurgical Engineering from the University of Minnesota and holds a B.S. degree in Metallurgical Engineering from Cheng Kung University in Taiwan. Dr. Chen is a director of Headway Technologies, Inc. Mr. Johnson has served as President and Chief Executive Officer of the Company since September 1983. From 1977 to 1983, Mr. Johnson was an officer of Boschert Incorporated, a manufacturer of switching power supplies, initially as Vice President, Marketing and subsequently as President and Chief Executive Officer. Mr. Johnson holds a B.S. degree in Engineering from Princeton University, a M.S. degree in Electrical Engineering from the University of New Mexico and an M.B.A. degree from the Harvard Graduate School of Business. Mr. Johnson is a director of Uniphase Corporation. Dr. Bajorek joined the Company and was elected to the newly created position of Senior Vice President-Chief Technical Officer in June 1996. Dr. Bajorek was most recently Vice President, Technology Development and Manufacturing for the Storage Systems Division of IBM in San Jose, California. During his 25-year career with IBM, Dr. Bajorek held various positions in research and management related to magnetic recording, magnetic bubble and optical storage applications. He holds a Ph.D. degree in Electrical Engineering and Business Economics from Caltech. Mr. Kauffman was appointed Senior Vice President and Chief Operating Officer in February 1990. For three years prior to joining the company, Mr. Kauffman was Executive Vice President and Chief Operating Officer of Vitelic Corporation. Prior to that, he was employed at Intel Corporation for 16 years in a variety of positions, including Vice President of Component Production and Vice President of Component Quality. Mr. Kauffman holds B.S. and M.S. degrees in Engineering Physics from Lehigh University. Mr. Potts joined the Company in 1987 and served as Vice President and Chief Financial Officer from January 1991 until his promotion to Senior Vice President and Chief Financial Officer in January 1996. In addition, Mr. Potts serves as Secretary. Prior to joining Komag, Mr. Potts held financial management positions at several high-technology manufacturing concerns. He has also served on the consulting staff of Arthur Andersen & Co. Mr. Potts holds a B.S. degree in Industrial Engineering from Lehigh University and an M.B.A. degree from the Stanford Graduate School of Business. Mr. Tan was appointed Vice President of Manufacturing in September 1993 and was promoted to Senior Vice President-Worldwide Manufacturing in February 1998. He previously served as Vice President- Manufacturing-Asia Operations in charge of the Company's operations in Penang and Sarawak, Malaysia. Prior to that, he served as the Managing Director of the Company's Penang, Malaysia operation. Mr. Tan joined Komag in 1989 and was in charge of operations at the Company's first San Jose, California manufacturing facility. Before joining Komag in 1989, Mr. Tan was Vice President of Operations at HMT Technology. Mr. Tan holds a M.S. degree in Physics from the University of Malaya at Kuala Lumpur. Mr. Wiele joined the Company as Senior Vice President-Marketing and Sales in June 1996. Most recently, he was General Manager, Worldwide Sales and Marketing for the Storage Systems Division of IBM in San Jose, California. During his 31 years with IBM, Mr. Wiele held various marketing and sales positions within the domestic and overseas operations of IBM. He headed product management for AS/400 hardware and software for IBM's U.S. Marketing and Services Division. He also directed marketing and product management for IBM Europe, Middle East and Africa. He holds a B.S. degree in Mechanical Engineering from Villanova University. Mr. Allen was promoted to Vice President-Equipment Technology and Automation in January 1997. Mr. Allen joined the Company in October 1983 to establish the Company's automation manufacturing program that he has since directed. Prior to joining Komag, Mr. Allen was employed with Xerox's Palo Alto Research Center as a member of the research staff. Mr. Allen holds a B.S. degree in Physics and a minor in Chemistry from Dillard University. Mr. Austin joined the Company in October 1988 as Facilities and Equipment Maintenance Manager. Prior to his promotion to Vice President-U.S. Manufacturing in August 1997, Mr. Austin served Komag as Vice President-Manufacturing and Corporate Facilities. Prior to joining Komag, Mr. Austin was an Equipment Maintenance and Facilities Manager at VLSI Technology Inc. Mr. Austin also worked at National Semiconductor and Rockwell International between 1975 and 1983. Ms. Lamb joined the Company as Vice President-Human Resources in October 1996. From 1995 to 1996 she was Director of Worldwide Staffing and Employee Relations at Adaptec. Prior to that, Ms. Lamb was Director of Compensation, Benefits and Executive programs at Tandem. Ms. Lamb holds a B.A. degree in Communications from San Jose State University. Mr. Martin joined the Company as Vice President-Product Assurance and Product Test in October 1997. From 1990 to 1997, he headed product engineering and head/media development as Director of Process and Technology at Quantum Corporation. Prior to working at Quantum, Mr. Martin held a number of management and engineering positions at several leading disk drive manufacturers, including Western Digital, Seagate, and IBM. Mr. Martin holds a B.S. degree in Mechanical Engineering from Kansas State University. Mr. Miura joined the Company in 1984 as Director of Test Engineering prior to his promotion to Vice President-Quality and Product Integration in November 1991. He currently serves as Vice President- Advanced Products. Before joining Komag, Mr. Miura held various engineering positions at IBM. Mr. Miura holds both B.S. and M.S. degrees in Electrical Engineering from the University of California, Davis. Dr. Wey was appointed Vice President-Engineering in April 1988. Dr. Wey currently serves as Vice President-Product Research and Development. Dr. Wey joined the Company in November 1983 and has held director positions in both engineering and manufacturing. For 10 years prior to joining the Company, Dr. Wey worked in various engineering and engineering management positions at IBM. Dr. Wey received his Ph.D. degree in Physical Chemistry from the Illinois Institute of Technology and holds a B.S. degree in Chemical Engineering from National Chen-Kung University in Taiwan. Mr. Yamashita joined the Company in 1984 and was Senior Director of Research prior to his promotion to Vice President-Research and Development in January 1995. Mr. Yamashita currently serves as Vice President-Process Technology Research and Development. Prior to joining the Company, Mr. Yamashita was a graduate research assistant in the Department of Material Science and Engineering at Stanford University. Mr. Yamashita holds a B.S. degree in Chemistry and an M.S. degree in Materials Science from Stanford University. PART II ITEMS 5, 6, 7 and 8. Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the Nasdaq National Market under the symbol KMAG. The following table sets forth the range of high and low closing sales prices, as reported on the Nasdaq National Market. At February 20, 1998 the Company had approximately 507 holders of record of its Common Stock and 52,806,139 shares outstanding. Price Range of Common Stock -------------------- HIGH LOW --------- --------- 1996 First Quarter 33 1/4 23 Second Quarter 36 9/16 24 Third Quarter 27 19 3/8 Fourth Quarter 36 21 1997 First Quarter 32 7/8 25 13/32 Second Quarter 35 1/8 16 7/16 Third Quarter 22 7/16 16 1/8 Fourth Quarter 21 3/8 14 1/2 1998 First Quarter (through February 20, 1998) 15 5/8 12 1/16 DIVIDEND POLICY The Company has never paid cash dividends on its Common Stock. The Company presently intends to retain all cash for use in the operation and expansion of the Company's business and does not anticipate paying any cash dividends in the near future. Certain of Komag's debt agreements limit the amount of dividend payments without the lenders' consent. Item 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected consolidated financial data and other operating information of Komag, Incorporated. The financial data and operating information is derived from the consolidated financial statements of Komag, Incorporated and should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.
Fiscal Year Ended --------------------------------------------------------------- 1997 1996 1995 1994 1993 ----------- ----------- ----------- ----------- ----------- (in thousands, except per share amounts and number of employees) Consolidated Statements of Operations Data: Net Sales $631,082 $577,791 $512,248 $392,391 $385,375 Gross Profit 93,546 175,567 197,486 125,386 91,439 Restructuring Charge 52,157 -- -- -- 38,956 Income (Loss) Before Minority Interests and Equity in Joint Venture Income (Loss) (16,838) 100,553 101,410 54,156 (33,738) Minority Interests in Net Income (Loss) of Consolidated Subsidiaries 400 695 1,957 1,091 (18,977) Equity in Net Income (Loss) of Unconsolidated Joint Venture (4,865) 10,116 7,362 5,457 4,860 Net Income (Loss) ($22,103) $109,974 $106,815 $58,522 ($9,901) Basic Income (Loss) Per Share ($0.42) $2.15 $2.24 $1.31 ($0.23) Diluted Income (Loss) Per Share ($0.42) $2.07 $2.14 $1.27 ($0.23) Consolidated Balance Sheet Data: Working Capital $296,099 $142,142 $252,218 $118,230 $97,265 Net Property, Plant & Equipment 678,596 643,706 329,174 228,883 187,267 Long-term Debt (less current portion) 245,000 70,000 -- 16,250 29,482 Stockholders' Equity 686,184 697,940 574,564 331,215 255,331 Total Assets $1,084,664 $938,357 $686,315 $424,095 $382,297 Number of Employees at Year-end 4,738 4,101 2,915 2,635 3,497 (1) Results of operations for 1997 included a $52.2 million restructuring charge related to the consolidation of the Company's U.S. manufacturing operations. (2) Results of operations for 1993 included the Company's thin-film head operations and a restructuring charge for the closure of the thin-film head operations. (3) The Company paid no cash dividends during the five-year period.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Overview The Company's business is both capital intensive and volume sensitive, making capacity planning and efficient capacity use imperative. Physical capacity, utilization of this physical capacity, yields and average unit sales price constitute the key determinants of the Company's profitability. Of these key determinants, price and utilization are the most sensitive to changes in product demand. If capacity and product price are fixed at a given level and demand is sufficient to support a higher level of output, then increased output attained through improved utilization rates and higher manufacturing yields will translate directly into increased sales and improved gross margins. Alternatively, if demand for the Company's products decreases, falling average selling prices and lower capacity utilization could adversely affect the results of the Company's operations. Risk Factors The following discussion contains predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties. While this discussion represents the Company's current judgment on the future direction of the business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. Factors that could cause actual results to differ include the following: industry supply-demand relationship and related pricing for enterprise and high-end desktop disk products; successful product qualification of next-generation products; successful deployment of new process technologies into manufacturing; utilization of manufacturing facilities; rate of improvement in manufacturing efficiencies; extensibility of process equipment to meet more stringent future product requirements; availability of sufficient cash resources; vertical integration and consolidation within the Company's limited customer base; increased competition; and availability of certain sole-sourced raw material supplies. See "Business-Risk Factors" for more detailed discussions of the Company's risk factors. 1997 vs. 1996 Operating results for 1997 were dramatically lower than 1996. Entering 1996, the Company was producing mature product offerings at high yields with full utilization of its capacity and strong demand for these products. Gross margins exceeding 40% in both the first and second quarters of 1996 were at near-record levels for the Company. In the third quarter of 1996, the Company began a rapid transition to MR and proximity-inductive thin-film media products. Manufacturing yields for these products were substantially below the high yields achieved during the first half of 1996. Additionally, the Company devoted significant portions of its manufacturing capacity to development efforts for the new products. As a result of these low yield and equipment utilization rates, the Company's sales in the second half of 1996 were production constrained and declined from the levels during the first half of the year. Furthermore, an increasing mix of the low yielding new products led to higher unit costs and sequential declines in the gross margin percentage in the second half of 1996. The gross margin percentages for the third and fourth quarters of 1996 were 24.0% and 11.7%, respectively. Net sales increased sequentially to $167.2 million and $175.1 million during the first and second quarters of 1997, respectively. The sequential increases were primarily due to manufacturing capacity additions. The gross margin percentages for the first and second quarters of 1997 were 23.5% and 20.4%, respectively. Demand for thin- film media products fell sharply at the end of the second quarter of 1997 as an excess supply of enterprise-class disk drives caused drive manufacturers to reduce their build plans for this class of drives. The resulting imbalance between media supply and demand caused a loss of sales and prevented the Company from fully utilizing its expanded capacity during the last half of 1997. Net sales and the gross margin percentage fell sharply to $129.7 million and 0.2%, respectively, in the third quarter of 1997. During the third quarter of 1997, the Company undertook an evaluation of the size and location of its existing production capacity relative to the short-term market demand outlook. Based upon this evaluation, the Company implemented a restructuring plan in August 1997. Under the restructuring plan, the Company consolidated its U.S. manufacturing operations into its San Jose, California facilities and closed two older factories in Milpitas, California. The first Milpitas factory was closed at the end of the third quarter of 1997 and the second factory was closed in January 1998. Over time, the Company expects that its Malaysian manufacturing operations will account for an increasing portion of the Company's production output. These facilities are closer to the customers' disk drive assembly plants in Southeast Asia and enjoy certain cost and tax advantages over the Company's U.S. manufacturing facilities. Net sales and the gross margin percentage at $159.0 million and 11.6%, respectively, for the fourth quarter of 1997 improved over the third quarter of 1997. In December 1997, several disk drive manufacturers initiated cutbacks in their high-end desktop product production plans for early 1998 in response to supply-demand imbalances within that industry segment. Weakened demand for desktop media products, combined with the continuing slow recovery of the enterprise- class market segment and the increased capacity of captive media suppliers, resulted in an excess supply of media and heightened price competition among independent media suppliers. While these conditions dampened the results for the fourth quarter of 1997, the most significant impact of lower unit volumes and average selling prices will be evident in the Company's results for the first quarter of 1998. The Company expects that net sales for the first quarter of 1998 could fall as much as 55% relative to the fourth quarter of 1997. Improving industry conditions and shipment of new, higher- density products could improve the Company's net sales in the second quarter of 1998 but financial results will likely remain under pressure due to low capacity utilization and continuing pricing issues. In response to this situation, the Company has implemented a hiring freeze and idled portions of its Malaysian production operations for approximately two weeks during the first quarter of 1998. The Company also accelerated the closure of its second Milpitas manufacturing facility, which it initially planned to close in June 1998. Additionally, the Company reduced its 1998 capital expenditure plan to $120 million, compared to nearly $200 million in 1997. Net Sales Net sales for 1997 increased to $631.1 million, up 9% from $577.8 million in 1996. The higher sales were primarily due to an increase in unit sales volume. The overall average selling price increased less than 1% in 1997 relative to 1996. The overall average selling price typically strengthens only as the result of product transitions to more technologically advanced, higher-priced product offerings. Price reductions for individual product offerings are characteristic of the thin-film media industry. Sales of the new MR and proximity-inductive products, which began in the third quarter of 1996, increased rapidly and accounted for nearly all unit sales in the last half of 1997. The effect of the sales mix shift to these new higher-priced, next- generation products more than offset the effect of price reductions on individual product offerings and resulted in the flat overall average selling price. In addition to sales of internally produced disk products, the Company has historically resold products manufactured by its Japanese joint venture, Asahi Komag Co., Ltd. ("AKCL"). Distribution sales of thin-film media manufactured by AKCL were $10.5 million in 1997 and $5.7 million in 1996. The Company expects that distribution sales of AKCL product will remain a relatively small percentage of the Company's net sales. During 1997, five customers accounted for over 95% of consolidated net sales: Western Digital Corporation ("Western Digital")-38%; Maxtor Corporation, a subsidiary of Hyundai Electronics America, ("Maxtor")-19%; Quantum Corporation ("Quantum"), together with its Japanese contract manufacturing partner, Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE")-15%; Seagate Technology, Inc. ("Seagate")-14%; and International Business Machines ("IBM")-10%. The distribution of sales among customers may vary from quarter to quarter based on the match of the Company's product capabilities with specific disk drive programs of the customers. The Company's customer mix shifted dramatically in the third quarter of 1997 as a result of the reduction in enterprise-class disk drive production by the Company's customers. In the third quarter of 1997, Quantum (together with MKE) and Seagate collectively accounted for less than 10% of the Company's net sales. The Company's disk sales to these customers were primarily incorporated into enterprise-class disk drives. These two customers accounted for 35% of net sales in the second quarter of 1997. Unit production increased 6% in 1997 relative to 1996. Increased production volume typically occurs due to increased capacity (additional sputtering lines and improvements in process cycle times) and/or improvements in manufacturing efficiencies (improved production throughput from higher yields and/or better equipment utilization). The Company increased capacity 25% in 1997 relative to 1996. Equipment utilization rates decreased significantly in 1997 compared to 1996 as the Company operated below capacity in the last half of 1997 due to weak market demand for enterprise-class disk products. Overall manufacturing yields declined as the Company experienced continuing yield losses on MR products. These losses were due in large measure to certain deficiencies in the Company's front end processing operations. Additionally, the overall manufacturing yield was substantially higher during the first half of 1996 prior to the transition to proximity-inductive and MR media. Gross Margin The gross margin percentage for 1997 decreased to 14.8% from 30.4% for 1996. The substantial decrease in the gross margin percentage between the years was primarily attributable to a combination of lower manufacturing yields, reduced equipment utilization rates and inherently higher material and processing costs for MR and advanced proximity disks. Additionally, the Company incurred inventory write-downs in 1997, which accounted for approximately one-fourth of the decrease in the gross margin percentage. Operating Expenses Research and development ("R&D") expenses increased 75% ($22.0 million) in 1997 relative to 1996. The Company moved into a newly constructed 188,000-square-foot R&D facility in the first quarter of 1997. Costs for the new facility and increased R&D staffing accounted for the increases between the years. In 1998, the Company plans to spend approximately $50 million for R&D, comparable to the amount spent in 1997. R&D spending will focus on the introduction of new product generations, on process changes to manufacture such products and on improvements to increase yields of products currently in volume production. Selling, general and administrative ("SG&A") expenses decreased $6.1 million in 1997 compared to 1996. The decrease was mainly due to a decrease of $10.2 million in provisions for bonus and profit sharing programs offset by increased provisions for bad debt of $2.4 million. Excluding provisions for bonus/profit sharing programs and provisions for bad debt, SG&A expenses increased $1.7 million due primarily to higher payroll and facility-related costs. The Company moved into a newly constructed administration facility in March 1997. In the third quarter of 1997, the Company implemented a restructuring plan involving the consolidation of its U.S. manufacturing operations and recorded a restructuring charge of $52.2 million. The restructuring charge included $3.9 million for severance costs associated with approximately 330 terminated employees, $33.0 million for the write-off of the net book value of equipment and leasehold improvements, $10.1 million related to equipment order cancellations and other equipment-related costs and $5.2 million for facility closure costs. Non-cash items included in the restructuring charge totaled approximately $33.0 million. The Company has made cash payments totaling approximately $7.9 million primarily for severance and equipment-related costs. The majority of the remaining $11.3 million restructuring liability, primarily related to equipment order cancellations and facility closure costs, is expected to be paid in 1998. Interest Income/Expense and Other Income Interest income decreased $1.7 million (26%) in 1997 relative to 1996 primarily due to a lower average investment balance in 1997. Interest expense increased $8.5 million in 1997 compared to 1996. The Company was debt free from late 1995 until November 1996. Between November 1996 and the end of 1997, the Company borrowed $245 million under its credit facilities. Other income increased $1.3 million in 1997 relative to 1996 mainly due to foreign currency gains generated by the weakening of the Malaysian ringgit. Income Taxes The tax provision benefit of 55% for 1997 represents tax loss carrybacks associated with the Company's U.S. operations. The effective income tax rate for 1996 of 17% was lower than the 1996 combined federal and state statutory rate of 41% primarily as a result of an initial five-year tax holiday granted to the Company's wholly owned thin-film media operation, Komag USA (Malaysia) Sdn. ("KMS"), which commenced in July 1993. Assuming the Company fulfills certain commitments under its license to operate within Malaysia, this initial tax holiday may be extended for an additional five-year period by the Malaysian government. The impact of this tax holiday was to reduce the Company's 1997 net loss by approximately $20.8 million ($0.40 per share under both the basic and diluted methods) and increase 1996 net income by approximately $21.8 million ($0.43 basic income per share and $0.41 diluted income per share). Losses incurred prior to the commencement of this initial tax holiday, approximately $6.2 million, are available for carryforward to years following the expiration of this tax holiday. The Company has also been granted an additional ten-year tax holiday for its second and third plant sites in Malaysia. This new tax holiday had not yet commenced at December 28, 1997. Minority Interest in Consolidated Subsidiary/Equity in Unconsolidated Joint Venture The minority interest in the net income of consolidated subsidiary during 1997 represented Kobe Steel USA Holdings Inc.'s ("Kobe USA") share of Komag Material Technology, Inc.'s ("KMT") net income. KMT recorded net income of $2.0 million and $3.5 million in 1997 and 1996, respectively. The Company records 50% of AKCL's net income (loss) as equity in net income (loss) of unconsolidated joint venture. AKCL reported a net loss of $9.7 million for 1997, compared to net income of $20.2 million for 1996. AKCL's results for 1997 included a gain on the sale of its investment in Headway Technologies, Inc. ("Headway") of $5.3 million (net of tax). AKCL's results for 1996 included write-downs of $4.5 million (net of tax) related to its investment in Headway. Excluding the Headway-related items, AKCL's net loss was $15.0 million in 1997 compared to net income of $24.7 million in 1996. AKCL was primarily producing mature inductive products with more stable, higher yields in 1996. Product transition issues related to AKCL's qualification and production of MR products adversely affected 1997 results. AKCL operated substantially under capacity for the majority of 1997. While AKCL has obtained qualification on new MR product offerings recently, the Company anticipates that AKCL will continue to underutilize its capacity through at least the first half of 1998. In February 1998, AKCL decided to replace certain manufacturing equipment. The capacity underutilization, coupled with the equipment write-off, will most likely generate substantial quarterly losses at AKCL for at least the first half of 1998. AKCL plans to use a combination of static and in-line sputtering machines to manufacture its disk products. AKCL believes that the products produced by a static sputtering process will be technically similar to those produced by other Japanese media suppliers, thus improving AKCL's ability to meet specific requirements of certain Japanese customers on a timely basis. AKCL also plans to implement the new epitaxial process on certain in-line sputtering equipment. The successful implementation of the epitaxial process on AKCL's in-line sputtering equipment, and the Japanese market acceptance of products produced using in-line equipment, will determine AKCL's relative mix of in-line and static sputtering capacity. The Company translates AKCL's yen-based statements of operations to U.S. dollars at the average exchange rate in effect for each quarterly period. The Japanese yen weakened approximately 11% in 1997 relative to 1996. AKCL's net loss would have been $11.5 million in 1997 had the yen-based statement of operations been translated at the average rate in effect for 1996. Impact of Year 2000 Many computer systems were not designed to handle any dates beyond the year 1999. Such systems were designed using two digits rather than four to define the applicable year. Any computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices or engage in similar normal business activities. The Company is currently evaluating the impact of the year 2000 on its operations, suppliers and customers. Nothing has come to the attention of the Company that would materially impact the results of the Company's operations. However, there can be no assurance that a year 2000 issue, if encountered, would not have a material impact on the Company's results of operations. 1996 vs. 1995 Product transitions were significant factors in both the 1995 and 1996 fiscal years. In 1995, the Company transitioned to its then- current leading-edge inductive disk product family. Quarterly sales and gross margins increased sequentially during 1995 from $105.1 million and 31.2%, respectively, in the first quarter of 1995 to $153.5 million and 42.6%, respectively, in the fourth quarter of 1995. The Company entered 1996 with continuing strong demand for its inductive media products. Quarterly sales in excess of $150 million and gross margins exceeding 40% in both the first and second quarters of 1996 were at near-record levels for the Company. During the third and fourth quarters of 1996, the Company began a rapid transition to MR and proximity-inductive media. Sales and gross margins decreased during the last half of 1996 as low manufacturing yields on these new products and high usage of production equipment for product and process development activities prevented the Company from fulfilling customer demand for the products. In the third quarter of 1996, net sales and gross profit decreased to $131.5 million and 24.0%. Net sales and gross profit were $141.2 million and 11.7% for the fourth quarter of 1996. During the fourth quarter of 1996, the Company achieved volume production of MR disk products and also increased the production volume for proximity- inductive products. These two new products accounted for 54% of unit shipments during the fourth quarter. Net Sales Net sales for 1996 increased to $577.8 million, up 13% from $512.2 million in 1995. The higher sales resulted from the net effect of a 21% increase in unit sales volume and an 8% decrease in the overall average selling price. The effects of price reductions on maturing inductive disk products were only partially offset by a product mix shift to higher-priced MR and proximity-inductive media. Distribution sales of product manufactured by AKCL increased to $5.7 million in 1996 from $0.9 million in 1995. The increase in unit production required to support the increase in unit sales volume for 1996 relative to 1995 was primarily achieved through the addition of production lines. Improvements in process cycle times only slightly outpaced decreases in manufacturing yields and equipment utilization between the years and resulted in a marginal improvement in manufacturing efficiencies. Manufacturing yields and equipment utilization decreased between the years mainly due to substantially lower yield and utilization rates in the last half of 1996 on the new MR and proximity-inductive product families. Development time for these new products, incurred on manufacturing lines, lowered the manufacturing equipment utilization rate in the last half of 1996. Gross Margin The gross margin percentage for 1996 decreased to 30.4% from 38.6% for 1995. The combination of an 8% decrease in the overall average selling price, lower yield and equipment utilization rates in the last half of 1996 and higher costs associated with the production of the new MR and advanced proximity disks resulted in the lower gross margin percentage. Operating Expenses Research and development ("R&D") expenses increased 24% ($5.6 million) in 1996 relative to 1995. The increase was primarily due to development costs associated with next-generation proximity and MR media products. Selling, general and administrative ("SG&A") expenses decreased $10.9 million in 1996 compared to 1995. The decrease was mainly due to a $12.0 million reduction in the provision for the Company's bonus and profit sharing programs. Lower provisions in 1996 were primarily due to the Company's 1996 operating profit performance relative to the Company's 1996 operating profit plan. Provisions for bad debt also decreased $2.5 million between the years. Excluding provisions for bad debt and the Company's bonus and profit sharing programs, SG&A expenses increased approximately $3.6 million. Increases in administrative costs required to support the growth in operations in both the U.S. and Malaysia accounted for the increase. Interest Income/Expense and Other Income Interest income increased $0.6 million (11%) in 1996 relative to 1995 primarily due to a higher average investment balance in 1996. Interest expense decreased $1.2 million in 1996 compared to 1995. The Company repaid all of its existing outstanding debt in September 1995 and remained debt free until November 1996. The Company borrowed $70.0 million under its credit facilities during November and December 1996. Other income increased $0.7 million in 1996 relative to 1995 mainly due to the commencement of a royalty from AKCL for sales AKCL made outside of Japan. The royalty began in the second half of 1996 and amounted to $1.3 million for the year. Income Taxes The effective income tax rate for 1996 of 17% was lower than the 1996 combined federal and state statutory rate of 41% and the effective income tax rate of 25% in 1995 primarily as a result of an initial five- year tax holiday granted to the Company's wholly owned thin-film media operation, Komag USA (Malaysia) Sdn. ("KMS"), which commenced in July 1993. The effective tax rate for 1996 was lower than the rate in effect for 1995 primarily due to growth in the percentage of consolidated income derived from the Company's Malaysian operations in 1996. The impact of the tax holiday was to increase net income by approximately $21.8 million ($0.43 basic income per share and $0.41 diluted income per share) and $11.5 million ($0.24 basic income per share and $0.23 diluted income per share) in 1996 and 1995, respectively. Minority Interest in Consolidated Subsidiary/Equity in Unconsolidated Joint Venture The minority interest in the net income of consolidated subsidiary during 1996 represented Kobe Steel USA Holdings Inc.'s ("Kobe USA") share of Komag Material Technology, Inc.'s ("KMT") net income. KMT was owned 55% by the Company and 45% by Kobe USA from November 1988 to December 1995. On December 28, 1995, the Company increased its ownership of KMT to 80% through the purchase of KMT Common Stock directly from Kobe USA. Kobe USA retained a 20% minority interest investment in KMT. KMT recorded net income of $3.5 million and $4.3 million in 1996 and 1995, respectively. The Company records 50% of AKCL's net income as equity in net income of unconsolidated joint venture. AKCL reported net income of $20.2 million for 1996, up from $14.7 million for 1995. Excluding losses related to Headway, AKCL recorded net income of $24.7 million in 1996, up from $16.9 million in 1995. AKCL's improved operating performance in 1996 was primarily due to the combination of an increase in the overall average selling price of its products and a reduction in the overall average unit production cost on a substantially higher unit sales volume. The Company translates AKCL's yen-based income statements to U.S. dollars at the average exchange rate in effect for each quarterly period. The Japanese yen weakened approximately 13% in 1996 relative to 1995. AKCL's net income would have been approximately $23.9 million in 1996 had the yen-based income statement been translated at the average rate in effect for 1995. Liquidity and Capital Resources Consolidated cash and short-term investments of $166.2 million at the end of 1997 increased from $93.2 million at the end of 1996. Operating activities generated $84.4 million in cash during 1997 and partially funded the Company's $199.1 million of capital spending during the year. The Company borrowed $175.0 million under its credit facilities. Sales of Common Stock under the Company's stock option and stock purchase programs during the year generated $11.8 million. Working capital increased to $296.1 million at the end of 1997 from $142.1 million at the end of 1996. Trade accounts payable and accounts payable to related parties decreased $36.2 million primarily due to reductions in capital spending at the end of 1997 relative to the end of 1996. Trade accounts receivable and accounts receivable from related parties were $17.8 million higher at the end of 1997 than at the end of 1996. The increase was due to a combination of higher net sales in the fourth quarter of 1997 and an increase in days of sales outstanding at the end of 1997 compared to the corresponding period of 1996. Total capital expenditures for 1998 are currently planned at approximately $120 million. The 1998 capital spending plan primarily includes costs to upgrade existing facilities and equipment to support the deployment of new process technologies into manufacturing and to improve yield and productivity. Current noncancellable capital commitments total approximately $75 million. At December 28, 1997, the Company had $100 million available under its $345 million unsecured, multiyear bank lines of credit. The Company's lines of credit are subject to certain covenants, including the number and size of consecutive quarterly losses. In anticipation of a violation of these profitability tests at the end of the first quarter of 1998, the Company renegotiated the terms and covenants of its $175 million syndicated loan facility to provide for continued access to these funds. Current borrowings under this facility totaled $100 million at December 28, 1997. The availability of the remaining $75 million under this facility is subject to maintenance of certain financial ratios. The Company currently expects to remain in compliance with its other credit facilities through at least the first half of 1998. There can be no assurance that these funds will remain available should the Company violate its loan covenants at any future date or that any available funds will be sufficient for the Company's needs. The Company believes that it will be able to fund planned 1998 expenditures from a combination of cash flow from operations, funds available from existing bank lines of credit and existing cash balances. If the Company is unable to obtain sufficient capital, it could be required to reduce its capital equipment and research and development expenditures, which could have a material adverse affect on the Company's results of operations. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS KOMAG, INCORPORATED INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors Consolidated Statements of Operations, 1997, 1996 and 1995 Consolidated Balance Sheets, 1997 and 1996 Consolidated Statements of Cash Flows, 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity, 1997, 1996 and 1995 Notes to Consolidated Financial Statements Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Stockholders Komag, Incorporated We have audited the accompanying consolidated balance sheets of Komag, Incorporated as of December 28, 1997 and December 29, 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 28, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We did not audit the financial statements of Asahi Komag Co., Ltd. (a corporation in which the Company has a 50% interest) as of December 28, 1997 and December 29, 1996, and for each of the three years in the period ended December 28, 1997. Those financial statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to data included for Asahi Komag Co., Ltd. as of December 28, 1997 and December 29, 1996, and for each of the three years in the period ended December 28, 1997, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Komag, Incorporated at December 28, 1997 and December 29, 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 28, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP San Jose, California February 27, 1998 KOMAG, INCORPORATED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
Fiscal Year Ended ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- Net sales (see Note 13) $631,082 $577,791 $512,248 Cost of sales (see Notes 12 and 13) 537,536 402,224 314,762 ---------- ---------- ---------- Gross profit 93,546 175,567 197,486 ---------- ---------- ---------- Operating expenses: Research, development and engineering 51,427 29,409 23,804 Selling, general and administrative 27,523 33,665 44,598 Restructuring charge 52,157 -- -- ---------- ---------- ---------- 131,107 63,074 68,402 ---------- ---------- ---------- Operating income (loss) (37,561) 112,493 129,084 ---------- ---------- ---------- Other income (expense): Interest income 4,753 6,437 5,802 Interest expense (9,116) (625) (1,856) Other, net 4,104 2,843 2,189 ---------- ---------- ---------- (259) 8,655 6,135 ---------- ---------- ---------- Income (loss) before income taxes, minority interest and equity in joint venture income (loss) (37,820) 121,148 135,219 Provision (benefit) for income taxes (20,982) 20,595 33,809 ---------- ---------- ---------- Income (loss) before minority interest and equity in joint venture income (loss) (16,838) 100,553 101,410 Minority interest in net income of consolidated subsidiary 400 695 1,957 Equity in net income (loss) of unconsolidated joint venture (4,865) 10,116 7,362 ---------- ---------- ---------- Net income (loss) ($22,103) $109,974 $106,815 ========== ========== ========== Basic income (loss) per share ($0.42) $2.15 $2.24 ========== ========== ========== Diluted income (loss) per share ($0.42) $2.07 $2.14 ========== ========== ========== Number of shares used in basic computation 52,217 51,179 47,589 ========== ========== ========== Number of shares used in diluted computation 52,217 53,132 49,905 ========== ========== ========== See notes to consolidated financial statements.
KOMAG, INCORPORATED CONSOLIDATED BALANCE SHEETS (In thousands, except per share amounts)
Fiscal Year End ------------------------ 1997 1996 ----------- ----------- Assets Current Assets Cash and cash equivalents $133,897 $90,741 Short-term investments 32,300 2,500 Accounts receivable, less allowances of $4,424 in 1997 and $3,087 in 1996 77,792 55,676 Accounts receivable from related parties 4,106 8,449 Inventories: Raw materials 33,730 33,734 Work-in-process 17,490 21,774 Finished goods 15,558 6,452 ----------- ----------- Total inventories 66,778 61,960 Prepaid expenses and deposits 3,697 2,866 Refundable income taxes 24,524 13,326 Deferred income taxes 28,595 15,579 ----------- ----------- Total current assets 371,689 251,097 Investment in Unconsolidated Joint Venture 30,126 39,754 Property, Plant and Equipment Land 9,526 9,367 Building 126,405 110,991 Leasehold improvements 141,111 131,737 Furniture 11,791 7,754 Equipment 793,561 673,210 ----------- ----------- 1,082,394 933,059 Less allowances for depreciation and amortization (403,798) (289,353) ----------- ----------- Net property, plant and equipment 678,596 643,706 Deposits and Other Assets 4,253 3,800 ----------- ----------- $1,084,664 $938,357 =========== =========== Liabilities and Stockholders' Equity Current Liabilities Trade accounts payable $40,043 $80,089 Accounts payable to related parties 7,093 3,294 Accrued compensation and benefits 13,596 21,835 Other liabilities 3,596 1,913 Income taxes payable 9 1,824 Restructuring liability 11,253 -- ----------- ----------- Total current liabilities 75,590 108,955 Long-term Debt 245,000 70,000 Deferred Income Taxes 73,335 57,806 Other Long-term Liabilities 960 497 Minority Interest in Consolidated Subsidiary 3,595 3,159 Commitments Stockholders' Equity Preferred Stock, $0.01 par value per share: Authorized--1,000 shares No shares issued and outstanding -- -- Common Stock, $0.01 par value per share: Authorized--85,000 shares Issued and outstanding--52,794 shares in 1997 and 51,696 shares in 1996 528 517 Additional paid-in capital 401,869 388,305 Retained earnings 281,476 303,579 Accumulated translation adjustment 2,311 5,539 ----------- ----------- Total stockholders' equity 686,184 697,940 ----------- ----------- $1,084,664 $938,357 =========== =========== See notes to consolidated financial statements.
KOMAG, INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- Operating Activities Net cash provided by operating activities- see detail on following page $84,396 $200,892 $188,792 ----------- ----------- ----------- Investing Activities Acquisition of property, plant and equipment (199,112) (403,062) (166,450) Purchase of subsidiary shares from minority interest holder -- -- (6,750) Purchases of short-term investments (37,585) (163) (177,993) Proceeds from short-term investments at maturity 7,785 196,462 50,478 Proceeds from disposal of equipment 550 1,883 916 Deposits and other assets (1,190) (649) 113 Dividend distribution from unconsolidated joint venture 1,535 -- -- ----------- ----------- ----------- Net cash used in investing activities (228,017) (205,529) (299,686) ----------- ----------- ----------- Financing Activities Proceeds from long-term obligations 175,000 70,000 -- Payments of long-term obligations -- -- (29,482) Sale of Common Stock, net of issuance costs 11,777 10,778 132,871 Distribution to minority interest holder -- (279) (280) ----------- ----------- ----------- Net cash provided by financing activities 186,777 80,499 103,109 ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents 43,156 75,862 (7,785) Cash and cash equivalents at beginning of year 90,741 14,879 22,664 ----------- ----------- ----------- Cash and cash equivalents at end of year $133,897 $90,741 $14,879 =========== =========== ===========
Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- Net income (loss) ($22,103) $109,974 $106,815 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 128,542 86,928 65,483 Provision for losses on accounts receivable 1,315 (1,011) 1,519 Equity in net (income) of unconsolidated joint venture 4,865 (10,117) (7,362) Loss on disposal of equipment 2,854 445 508 Non-cash portion of restructing charge related to write-off of property, plant and equipment 33,013 -- -- Deferred income taxes 2,513 13,153 17,418 Deferred rent 463 23 (74) Minority interest in net income of consolidated subsidiary 400 695 1,957 Changes in operating assets and liabilities: Accounts receivable (23,431) 6,995 (18,615) Accounts receivable from related parties 4,343 (3,415) (4,820) Inventories (4,818) (32,939) (4,920) Prepaid expenses and deposits (831) 974 (2,811) Trade accounts payable (40,046) 51,372 10,875 Accounts payable to related parties 3,799 (4,467) 5,407 Accrued compensation and benefits (8,239) (10,131) 14,053 Other liabilities 1,683 (183) 431 Income taxes payable (receivable) (11,179) (7,404) 2,928 Restructuring liability 11,253 -- -- ----------- ----------- ----------- Net cash provided by operating activities $84,396 $200,892 $188,792 =========== =========== =========== Supplemental disclosure of cash flow information Cash paid for interest $8,148 $340 $2,204 Cash paid (refunded) for income taxes (12,305) 15,280 13,463 Income tax benefit from stock options exercised 1,834 3,138 3,582 See notes to consolidated financial statements.
KOMAG, INCORPORATED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands)
Common Stock Additional Accumulated ------------------ Paid-in Retained Translation Shares Amount Capital Earnings Adjustment ---------- ------- ------------ ------------- ------------- Balance at January 1, 1995 45,803 $458 $238,033 $86,790 $5,934 Common Stock issued under stock option and purchase plans, including related tax benefits 1,411 14 14,298 -- -- Sale of Common Stock, net of issuance costs 3,500 35 122,068 -- -- Net income -- -- -- 106,815 -- Accumulated translation adjustment -- -- -- -- 119 ---------- ------- ------------ ------------- ------------- Balance at December 31, 1995 50,714 507 374,399 193,605 6,053 Common Stock issued under stock option and purchase plans, including related tax benefits 982 10 13,906 -- -- Net income -- -- -- 109,974 -- Accumulated translation adjustment -- -- -- -- (514) ---------- ------- ------------ ------------- ------------- Balance at December 29, 1996 51,696 517 388,305 303,579 5,539 Common Stock issued under stock option and purchase plans, including related tax benefits 1,098 11 13,564 -- -- Net loss -- -- -- (22,103) -- Accumulated translation adjustment -- -- -- -- (3,228) ---------- ------- ------------ ------------- ------------- Balance at December 28, 1997 52,794 $528 $401,869 $281,476 $2,311 ========== ======= ============ ============= ============= See notes to consolidated financial statements.
KOMAG, INCORPORATED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation: The consolidated financial statements include the accounts of the Company, its wholly owned and majority-owned subsidiaries (see Note 12) and equity in its unconsolidated joint venture (see Note 13). All significant intercompany accounts and transactions have been eliminated in consolidation. Foreign Currency Translation: The functional currency of the Company's unconsolidated joint venture is the Japanese yen. Translation adjustments relating to the translation of these statements are included as a separate component of stockholders' equity and not included in net income. The functional currency for the Company's Malaysian operation is the U.S. dollar. Remeasurement gains and losses, resulting from the process of remeasuring these foreign currency financial statements into U.S. dollars, are included in operations. Foreign Exchange Gains and Losses: The Company enters into foreign currency forward exchange contracts to reduce the impact of currency fluctuations on firm purchase order commitments for equipment and construction-in-process. Gains and losses related to these contracts are included in the cost of the assets acquired. The Company had approximately $14,095,000 and $10,320,000 in foreign exchange forward purchase contracts outstanding at December 28, 1997 and December 29, 1996, respectively. These forward exchange contracts were comprised of Japanese yen, Malaysian ringgit and Singapore dollar foreign currencies. The fair market value of these foreign exchange contracts was approximately $1,200,000 lower than the contract value at December 28, 1997. There were no significant unhedged purchase commitments at December 28, 1997. Cash Equivalents: The Company considers as a cash equivalent any highly liquid investment that matures within three months of its purchase date. Short-Term Investments: The Company invests its excess cash in high- quality, short-term debt instruments. None of the Company's debt security investments have maturities greater than one year. At December 28, 1997, all short-term investments are designated as available for sale. Interest and dividends on the investments are included in interest income. The following is a summary of the Company's investments by major security type at amortized cost, which approximates fair value: Fiscal Year Ended ----------------------- 1997 1996 ----------- ----------- (in thousands) Municipal auction rate preferred stock $32,300 $2,500 Corporate debt securities 56,837 55,618 Mortgage-backed securities 79,419 35,699 ----------- ----------- $168,556 $93,817 =========== =========== Amounts included in cash and cash equivalents $136,256 $91,317 Amounts included in short-term investments 32,300 2,500 ----------- ----------- $168,556 $93,817 =========== =========== There were no realized gains or losses on the Company's investments during 1997 as all investments were held to maturity during the year. The Company utilizes zero-balance accounts and other cash management tools to invest all available funds, including bank balances in excess of book balances. Inventories: Inventories are stated at the lower of cost (first-in, first-out method) or market. Property, Plant and Equipment: Property, plant and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed by the straight-line method over the estimated useful lives of the assets. The estimated useful life of the Company's buildings is 30 years. Furniture and equipment are generally depreciated over 3 to 5 years and leasehold improvements are amortized over the shorter of the lease term or the useful life. Revenue Recognition: The Company records sales upon shipment and provides an allowance for estimated returns of defective products. Research and Development: Research and development costs are expensed as incurred. Stock Compensation: The Company has adopted Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). In accordance with the provisions of FAS 123, the Company applies APB Opinion 25 and related Interpretations in accounting for its stock-based compensation plans. Note 5 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported net income (loss) and income (loss) per share for 1997, 1996 and 1995 as if the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by FAS 123. Income Taxes: The provision (benefit) for income taxes is based on pretax financial accounting income (loss). Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax and book basis of assets and liabilities. Income (Loss) Per Share: In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is very similar to the previously reported primary earnings per share. Earnings per share amounts for all periods presented have been restated to conform to FAS 128 requirements. Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- (in thousands, except per share amounts) Numerator: Net income (loss) ($22,103) $109,974 $106,815 ----------- ----------- ----------- Denominator for basic income (loss) per share - weighted-average shares 52,217 51,179 47,589 ----------- ----------- ----------- Effect of dilutive securities: Employee stock options -- 1,953 2,316 ----------- ----------- ----------- Denominator for diluted income (loss) per share 52,217 53,132 49,905 ----------- ----------- ----------- Basic income (loss) per share ($0.42) $2.15 $2.24 =========== =========== =========== Diluted income (loss) per share ($0.42) $2.07 $2.14 =========== =========== =========== Fiscal Year: The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. The years ended December 28, 1997, December 29, 1996 and December 31, 1995 were each comprised of 52 weeks. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. NOTE 2. SEGMENT AND GEOGRAPHIC INFORMATION The Company operates in one business segment, which is the development, production and marketing of high-performance thin-film media for use in hard disk drives. The Company sells to original equipment manufacturers in the rigid disk drive market and computer system manufacturers that produce their own disk drives. Summary information for the Company's operations by geographic location is as follows:
Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- (in thousands) Net sales To customers from U.S. operations $290,986 $316,658 $344,218 To customers from Far East operations 340,096 261,133 168,030 Intercompany from Far East operations 121,945 75,608 25,123 Intercompany from U.S. operations 38,310 22,232 6,683 ----------- ----------- ----------- 791,337 675,631 544,054 Eliminations (160,255) (97,840) (31,806) ----------- ----------- ----------- Total net sales $631,082 $577,791 $512,248 =========== =========== =========== Operating income (loss) U.S. operations ($112,022) $9,108 $63,755 Far East operations 70,821 107,774 67,930 ----------- ----------- ----------- (41,201) 116,882 131,685 Eliminations 3,640 (4,389) (2,601) ----------- ----------- ----------- Total operating income (loss) ($37,561) $112,493 $129,084 =========== =========== =========== Identifiable assets U.S. operations $768,395 $708,436 $573,006 Far East operations 467,990 381,015 201,915 ----------- ----------- ----------- 1,236,385 1,089,451 774,921 Eliminations (151,721) (151,094) (88,606) ----------- ----------- ----------- Total identifiable assets $1,084,664 $938,357 $686,315 =========== =========== =========== Export sales by domestic operations included the following: Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- (in thousands) Far East (see Note 13) $268,117 $249,130 $151,000 Europe 11,896 -- --
NOTE 3. CONCENTRATION OF CUSTOMER AND SUPPLIER RISK The Company performs ongoing credit evaluations of its customers' financial conditions and generally requires no collateral. Significant customers accounted for the following percentages of net sales in 1997, 1996 and 1995: Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- Western Digital Corporation 38% 22% 12% Maxtor Corporation 19% <10% <10% Quantum Corporation/MKE 15% 18% 23% Seagate Technology, Inc. 14% 52% 44% International Business Machines 10% <10% <10% Hewlett-Packard Company -- <10% 15% In early 1996, Seagate merged with Conner Peripherals, Inc. In addition, Quantum ceased disk drive production in Milpitas, California and Penang, Malaysia and contracted with its Japanese manufacturing partner, Matsushita-Kotobuki Electronics Industries, Ltd. ("MKE"), to manufacture all of its disk drives. Percentages for 1997, 1996 and 1995 represent the combined sales to Seagate/Conner and Quantum/MKE. Hewlett-Packard exited the disk drive manufacturing business in 1996. Kobe Steel, Ltd. ("Kobe") supplies aluminum substrate blanks to Komag Material Technology, Inc. ("KMT"), and the Company in turn purchases KMT's entire output of finished substrates. The Company also purchases substantial quantities of finished substrates from Kobe in addition to the substrates purchased from KMT. The Company also relies on a limited number of other suppliers, in some cases a sole supplier, for certain other materials used in its manufacturing processes. These materials include nickel plating solutions, certain polishing and texturing supplies and sputtering target materials. These suppliers work closely with the Company to optimize the Company's production processes. Although this reliance on a limited number of suppliers, or a sole supplier, entails some risk that the Company's production capacity would be limited if one or more of such materials were to become unavailable or available in reduced quantities, the Company believes that the advantages of working closely with these suppliers outweigh such risks. If such materials should be unavailable for a significant period of time, the Company's results of operations could be adversely affected. NOTE 4. STOCKHOLDER'S EQUITY In 1995, the Company raised $122,100,000 from the sale of 3,500,000 shares of Common Stock in a follow-on public stock offering. NOTE 5. STOCK OPTION PLANS AND STOCK PURCHASE PLAN At December 28, 1997, the Company has stock-based compensation plans, which are described below. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recorded in the financial statements for its stock option and stock purchase plans. Had compensation cost for the stock-based compensation plans been determined consistent with Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation," the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: Fiscal Year Ended ----------------------------------- 1997 1996 1995 ----------- ----------- ----------- (in thousands, except per share amounts) Net income: As reported ($22,103) $109,974 $106,815 Pro forma (36,833) 102,355 103,584 Basic EPS: As reported ($0.42) $2.15 $2.24 Pro forma (0.71) 2.00 2.18 Diluted EPS: As reported ($0.42) $2.07 $2.14 Pro forma (0.71) 1.93 2.08 Since FAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1999. In September 1997, the Company's Board of Directors approved the 1997 Supplemental Stock Option Plan ("Supplemental Plan"). Under the Supplemental Plan, the Company may grant nonqualified stock options to purchase up to 3,600,000 shares of Common Stock. In January 1998, the Company's Board of Directors approved a 1,000,000 share increase in the total number of shares that may be issued under the Supplemental Plan. Under the Company's stock option plans ("Plans"), including the Supplemental Plan, the Company may grant options to purchase up to 21,860,000 shares of Common Stock. Options may be granted to employees, directors, independent contractors and consultants. Options under the Supplemental Plan may not, however, be granted to the Company's executive officers or nonemployee members of the Company's Board of Directors. The Plans provide for issuing both incentive stock options and nonqualified stock options, both of which must be granted at fair market value at the date of grant. Outstanding options generally vest over four years and expire no later than ten years from the date of grant. Options may be exercised in exchange for cash or outstanding shares of the Company's Common Stock. Approximately 16,000, 5,000 and 17,000 shares of the Company's Common Stock were received in exchange for option exercises in 1997, 1996 and 1995, respectively. In October 1997, the Company's Board of Directors approved an option exchange program, subject to election by the option holders, whereby options to purchase 1,806,000 shares of the Company's Common Stock at prices ranging from $19.75 to $36.00 per share were canceled and reissued at $19.44 per share, which was the fair market value of the Company's Common Stock at that time. The new options generally vest over two to four years. The option exchange program was not available to the Company's executive officers or nonemployee members of the Company's Board of Directors. At December 28, 1997, approximately 6,473,000 shares of Common Stock were reserved for future option grants and 6,894,000 shares of Common Stock were reserved for the exercise of outstanding options. Approximately 2,297,000, 1,917,000 and 1,487,000 of the outstanding options were exercisable at December 28, 1997, December 29, 1996 and December 31, 1995, respectively. For purposes of the pro forma disclosure, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rates of 6.3%, 6.1% and 6.4%; volatility factors of the expected market price of the Company's Common Stock of 61.9%, 60.0% and 59.3%; and a weighted-average expected life of the options of 6.5, 5.9 and 6.2 years. There was no dividend yield included in the calculation as the Company does not pay dividends. The weighted-average fair value of options granted during 1997, 1996 and 1995 was $11.06, $12.88 and $8.58, respectively. A summary of stock option transactions is as follows: Weighted- average Exercise Shares Price --------- ------------ (in thousands, except per share amounts) Outstanding at January 1, 1995 4,699 $8.55 Granted 1,479 16.58 Exercised (997) 7.20 Cancelled (153) 10.24 --------- ------- Outstanding at December 31, 1995 5,028 11.13 Granted 1,651 25.65 Exercised (635) 9.00 Cancelled (299) 16.43 --------- ------- Outstanding at December 29, 1996 5,745 15.26 Granted 4,141 22.38 Exercised (678) 9.66 Cancelled (2,314) 25.42 --------- ------- Outstanding at December 28, 1997 6,894 $16.68 ========= ======= The following table summarizes information concerning currently outstanding and exercisable options (option shares in thousands):
Options Oustanding Options Exercisable ------------------------------------ ------------------------ Remaining Range of Number Contractual Exercise Number Exercise Exercise Prices* Outstanding Life (yrs)* Price* Exercisable Price* - ----------------- ------------ ----------- ----------- ------------ ----------- $ 7.06 - $ 10.00 1,535 5.9 $8.41 1,444 $8.39 10.01 - 14.00 1,412 7.5 11.76 594 10.67 14.01 - 21.00 2,615 9.1 19.05 100 19.93 21.01 - 28.00 901 8.2 25.32 103 25.19 28.01 - 34.13 431 8.1 29.84 56 33.94 ------------ ------------ Enter 6,894 2,297 ============ ============ * Weighted-average
Under the terms of the Employee Stock Purchase Plan ("ESPP Plan"), employees may elect to contribute up to 10% of their compensation toward the purchase of shares of the Company's Common Stock. The purchase price per share will be the lesser of 85% of the fair market value of the stock on the first day of enrollment in a twenty-four-month offering period or the last day of each semi-annual period within the twenty- four-month offering period. The total number of shares of stock that may be issued under the Plan cannot exceed 3,550,000 shares. Shares issued under the ESPP Plan approximated 436,000, 352,000 and 431,000 in 1997, 1996 and 1995, respectively. At December 28, 1997, approximately 360,000 shares of Common Stock were reserved for future issuance under the ESPP Plan. In January 1998, the Company's Board of Directors approved a 1,300,000 share increase in the total number of shares that may be issued under the ESPP Plan. The increase is subject to shareholder approval. For purposes of the pro forma disclosure, the fair value of the employees' purchase rights has been estimated using the Black-Scholes model assuming risk-free interest rates of 6.5%, 5.6% and 6.4% in 1997, 1996 and 1995, respectively. Volatility factors of the expected market price were 60%, 60% and 59% for 1997, 1996 and 1995, respectively. The weighted-average expected life of the purchase rights was six months for 1997, 1996 and 1995. The weighted-average fair value of those purchase rights granted in 1997, 1996 and 1995 was $6.37, $5.09 and $6.36, respectively. NOTE 6. BONUS AND PROFIT SHARING PLANS Under the terms of the Company's cash profit sharing plan, a percentage of consolidated semi-annual operating profit, as defined in the plan, is allocated among all employees who meet certain criteria. In 1997 and 1996, under the terms of the Company's bonus plans, a percentage of consolidated annual operating profit, as defined in the respective bonus plans, was paid to eligible employees. In 1995, various percentages of an operating unit's annual operating profit, as defined in the respective bonus plans, was paid to eligible employees. The Company expensed $1,966,000, $9,078,000 and $19,990,000 under these bonus and cash profit sharing plans in 1997, 1996 and 1995, respectively. The Company and its subsidiaries maintain savings and deferred profit sharing plans. Employees who meet certain criteria are eligible to participate. In addition to voluntary employee contributions to these plans, the Company contributes four percent of semi-annual consolidated operating profit, as defined in the plans. These contributions are allocated to all eligible employees. Furthermore, the Company matches a portion of each employee's contributions to the plans up to a maximum amount. The Company contributed $2,534,000, $5,573,000 and $6,653,000 to the plans in 1997, 1996 and 1995, respectively. Expenses for the Company's bonus and profit sharing plans are included in selling, general and administrative expenses. NOTE 7. INCOME TAXES The provision (benefit) for income taxes consists of the following: Fiscal Year Ended ----------------------------- 1997 1996 1995 --------- --------- --------- (in thousands) Federal: Current ($24,036) $3,988 $16,496 Deferred 2,192 10,265 14,830 --------- --------- --------- (21,844) 14,253 31,326 State: Current (490) 496 (1,284) Deferred 321 2,888 2,588 --------- --------- --------- (169) 3,384 1,304 Foreign: Current 1,031 2,958 1,179 --------- --------- --------- ($20,982) $20,595 $33,809 ========= ========= ========= The foreign provision above consists of withholding taxes on royalty and interest payments and foreign taxes of subsidiaries. Deferred tax assets (liabilities) are comprised of the following: Fiscal Year End ------------------- 1997 1996 --------- --------- (in thousands) Depreciation ($22,118) ($9,656) State income taxes (10,299) (11,988) Deferred income (34,023) (25,764) Other (6,895) (10,398) --------- --------- Gross deferred tax liabilities (73,335) (57,806) --------- --------- Inventory valuation adjustments 8,971 3,448 Accrued compensation and benefits 3,175 2,956 State income taxes 2,484 5,123 Other 13,965 4,052 Tax benefit of net operating losses 35,046 35,046 --------- --------- Gross deferred tax assets 63,641 50,625 --------- --------- Deferred tax asset valuation allowance (35,046) (35,046) --------- --------- ($44,740) ($42,227) ========= ========= As of December 28, 1997, a 60%-owned subsidiary of the Company, Dastek Holding Company, has a federal tax net operating loss carryforward of approximately $100,000,000. The Company has fully reserved for the potential future federal tax benefit of this net operating loss in the deferred tax asset valuation allowance due to the fact that its utilization is limited to the subsidiary's separately computed future taxable income and that the subsidiary has no history of operating profits. The deferred tax asset valuation allowance was unchanged in 1997 and increased $257,000 and $1,189,000 in 1996 and 1995, respectively. The $100,000,000 net operating loss carryforward expires at various dates through 2010. A reconciliation of the income tax provision at the 35% federal statutory rate to the income tax provision at the effective tax rate is as follows: Fiscal Year Ended ----------------------------- 1997 1996 1995 --------- --------- --------- (in thousands) Income taxes computed at federal statutory rate ($13,237) $42,402 $47,327 State and foreign income taxes, net of federal benefit 907 5,021 868 Tax-exempt interest income -- (1,193) (1,434) Permanently reinvested foreign earnings (25,597) (26,050) (12,634) Losses for which no current year benefit available 16,561 -- -- Other 384 415 (318) --------- --------- --------- ($20,982) $20,595 $33,809 ========= ========= ========= Foreign pretax income was $74,400,000, $104,300,000 and $65,903,000 in 1997, 1996 and 1995, respectively. Komag USA (Malaysia) Sdn. ("KMS"), the Company's wholly owned thin- film media operation in Malaysia, was granted its initial tax holiday for a period of five years commencing in July 1993. Assuming KMS fulfills certain commitments under its license to operate within Malaysia, this initial tax holiday may be extended for an additional five-year period by the Malaysian government. The impact of this tax holiday was to reduce the Company's 1997 net loss by approximately $20,826,000 ($0.40 per share under both the basic and diluted methods) and increase 1996 net income by approximately $21,800,000 ($0.43 basic income per share and $0.41 diluted income per share). Losses incurred prior to the commencement of this initial tax holiday, approximately $6,237,000, are available for carryforward to years following the expiration of the tax holiday. The Company has also been granted an additional ten-year tax holiday for its second and third plant sites in Malaysia. This new tax holiday had not yet commenced at December 28, 1997. The Company has generated $230,681,000 of earnings for which no U.S. tax has been provided as of December 28, 1997. These earnings are considered to be permanently invested outside the United States. NOTE 8. TERM DEBT AND LINES OF CREDIT The Company has borrowed $245,000,000 and $70,000,000 under its term debt and line of credit facilities at December 28, 1997 and December 29, 1996, respectively. At December 28, 1997, these borrowings incurred interest at 6.5% to 7.4%, with interest-only payments due quarterly. Principal payments under the line of credit agreements are due six and twelve months after the borrowing date but may be extended by the Company for additional one- to twelve-month periods through 1999 and 2002. The Company intends to extend the principal repayment under these lines of credit and has classified the principal as long-term debt. Interest rates in effect for the extension periods will be based upon prevailing Eurodollar, Federal Funds and/or LIBOR rates plus 0.375% to 1.875% at the time of principal extension. The Company's credit facilities total $345,000,000 and are comprised of five agreements: a five-year term loan that expires in 2002, two separate revolving line of credit agreements that expire in 2002 and two separate four-year revolving line of credit agreements that expire in 1999 and 2000. These agreements may be extended, subject to bank approvals, annually for an additional year, thus perpetuating their multiyear tenors. At December 28, 1997, $100,000,000 was available under these unsecured credit facilities. Subsequent to year-end, the Company borrowed an additional $15,000,000 under these unsecured credit facilities. The Company's credit facilities require maintenance of certain financial ratios and compliance with covenants, including limitations on both the size and number of sequential quarterly losses. Additionally, these covenants limit the amount of dividend payments without the lenders' consents. At December 28, 1997, the Company was in compliance with its debt covenants. NOTE 9. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values of cash and short-term investments, accounts receivable and certain other liabilities on the Consolidated Balance Sheets approximate fair value at December 28, 1997 and December 29, 1996 due to the relatively short period to maturity of the instruments. Fair value of long-term debt was based on quoted market prices or pricing models using current market rates. The carrying value on the Consolidated Balance Sheets approximates fair value at December 28, 1997 and December 29, 1996. See Note 1 for fair value of foreign currency hedge contracts. NOTE 10. LEASES AND COMMITMENTS The Company leases certain production, research and administrative facilities under operating leases that expire at various dates between 1999 and 2007. Certain of these leases include renewal options varying from five to twenty years. At December 28, 1997, the future minimum commitments for all noncancellable operating leases are as follows (in thousands): 1998 $6,879 1999 5,944 2000 5,222 2001 4,900 2002 4,818 Thereafter 21,290 --------- Total minimum lease payments $49,053 ========= Rental expense for all operating leases amounted to $8,047,000, $4,838,000 and $4,212,000 in 1997, 1996 and 1995, respectively. The Company has current noncancellable capital commitments of approximately $75,000,000. NOTE 11. RESTRUCTURING CHARGE In August 1997, the Company implemented a restructuring plan based on an evaluation of the size and location of its existing production capacity relative to the short-term market demand outlook. Under the restructuring plan, the Company consolidated its U.S. manufacturing operations into its San Jose, California facilities and closed two older factories in Milpitas, California. The first Milpitas factory was closed at the end of the third quarter of 1997 and the second factory, originally scheduled for closure by the end of the second quarter of 1998, was closed in January 1998. Over time the Company expects that its Malaysian manufacturing operations will account for an increasing portion of the Company's production output. These facilities are closer to customers' disk drive assembly plants in Southeast Asia and enjoy certain cost and tax advantages over the Company's U.S. manufacturing facilities. The planned restructuring actions resulted in a charge of $52,200,000 and included reducing headcount, vacating leased facilities, consolidating operations and disposing of assets. The restructuring charge included $3,900,000 for severance costs associated with approximately 330 terminated employees, $33,000,000 for the write-off of the net book value of equipment and leasehold improvements, $10,100,000 related to equipment order cancellations and other equipment-related costs and $5,200,000 for facility closure costs. Non-cash items included in the restructuring charge totaled approximately $33,000,000. At December 28, 1997, $11,300,000 related to the restructuring activities remained in current liabilities. The Company has made cash payments totaling approximately $7,900,000 primarily for severance costs and equipment-related costs. The majority of the remaining restructuring liability, primarily related to equipment order cancellations and facility closure costs, is expected to be paid in 1998. NOTE 12. KOMAG MATERIAL TECHNOLOGY, INC. The Company's financial statements include the consolidation of the financial results of Komag Material Technology, Inc. ("KMT"), which manufactures and sells aluminum disk substrate products for high- performance magnetic storage media. KMT is owned 80% by the Company and 20% by Kobe Steel USA Holdings Inc. ("Kobe USA"), a U.S. subsidiary of Kobe Steel, Ltd. ("Kobe"). Other transactions between Kobe or its distributors and the Company were as follows: Fiscal Year Ended ----------------------------- 1997 1996 1995 --------- --------- --------- (in thousands) Accounts payable to Kobe or its distributors: Beginning of year $2,430 $3,302 $2,234 Purchases 52,308 53,554 34,478 Payments (49,908) (54,426) (33,410) --------- --------- --------- End of year $4,830 $2,430 $3,302 ========= ========= ========= NOTE 13. UNCONSOLIDATED JOINT VENTURE In 1987, the Company formed a partnership, Komag Technology Partners ("Partnership"), with the U.S. subsidiaries of two Japanese companies and simultaneously formed a subsidiary, Asahi Komag Co., Ltd. ("AKCL"). The Company contributed technology in exchange for a 50% interest in the Partnership. The Partnership and its subsidiary (joint venture) established a facility in Japan to manufacture and sell the Company's thin-film media products in Japan. AKCL also sells its products to the Company for resale outside of Japan. In 1996, the Company granted AKCL various licenses to sell its products to specified customers outside of Japan in exchange for a 5% royalty on these sales. The Company recorded approximately $1,388,000 and $1,305,000 of royalty in other income in 1997 and 1996, respectively. The Company's share of the joint venture's net income (loss) was ($4,865,000), $10,116,000 and $7,362,000 in 1997, 1996 and 1995, respectively. Other transactions between the joint venture and the Company were as follows: Fiscal Year Ended ----------------------------- 1997 1996 1995 --------- --------- --------- (in thousands) Accounts receivable from joint venture: Beginning of year $8,316 $4,906 $96 Sales 95,302 69,311 21,224 Cash receipts (99,565) (65,901) (16,414) --------- --------- --------- End of year $4,053 $8,316 $4,906 ========= ========= ========= Accounts payable to joint venture: Beginning of year $549 $355 $46 Purchases 14,686 12,145 5,460 Payments (12,979) (11,951) (5,151) --------- --------- --------- End of year $2,256 $549 $355 ========= ========= ========= Equipment purchases by the Company from its joint venture partners were $17,836,000, $20,655,000 and $18,195,000 in 1997, 1996 and 1995, respectively. Summary combined financial information for the Partnership and AKCL for the years ended December 31, 1997, 1996 and 1995, and as of December 31, 1997 and 1996 is as follows. The subsidiary's total assets, liabilities, revenues, costs and expenses approximate 100% of the combined totals. Fiscal Year Ended ----------------------------- 1997 1996 1995 --------- --------- --------- (in thousands) Summarized Statements of Operations: Net sales $186,474 $230,904 $173,177 Costs and expenses 200,305 188,707 143,766 Income tax provision (benefit) (4,101) 21,965 14,687 Net income (loss) ($9,730) $20,232 $14,724 Fiscal Year End ------------------- 1997 1996 --------- --------- (in thousands) Summarized Balance Sheets: Current assets $63,512 $79,619 Noncurrent assets 151,540 129,068 --------- --------- Total Assets $215,052 $208,687 ========= ========= Current liabilities $115,106 $110,239 Long-term obligations 41,975 19,902 Partners' capital 57,971 78,546 --------- --------- Total Liabilities and Partners' Capital $215,052 $208,687 ========= ========= NOTE 14. PARTICIPATION IN HEADWAY TECHNOLOGIES, INC. Headway Technologies, Inc. ("Headway") was formed in 1994 to research, develop and manufacture advanced magnetoresistive ("MR") heads for the data storage industry. Hewlett-Packard Company ("HP") and AKCL (see Note 13) provided the initial cash funding to Headway in exchange for equity interests. The Company and Asahi America licensed to Headway MR technology developed through a prior joint venture and contributed certain research and production equipment in exchange for equity. As a result of these transactions, the Company held a direct voting interest in Headway of less than 20% and had no cost basis in its investment in Headway. In 1997, the Company sold its interest in Headway. AKCL invested in Headway in 1994 and recorded partial write-downs of its investment through 1995 based upon net losses incurred at Headway. During the third quarter of 1996, Headway's major customer, HP, announced the closure of its disk drive manufacturing operations. Based upon anticipated future operating losses at Headway arising from the loss of HP's business, AKCL wrote off its remaining Headway investment at the end of the third quarter of 1996. In 1997, AKCL sold its entire interest in Headway for $10,800,000 to a group of new investors as part of a recapitalization and AKCL recorded the proceeds from this sale as a gain ($5,300,000, net of tax). NOTE 15. QUARTERLY SUMMARIES (in thousands, except per share amounts, unaudited) 1997 --------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter(1)4th Quarter ----------- ----------- ----------- ----------- Net sales $167,242 $175,121 $129,694 $159,025 Gross profit 39,315 35,661 202 18,368 Net income (loss) 17,799 11,677 (52,748) 1,169 Basic income (loss) per share $0.34 $0.22 ($1.01) $0.02 Diluted income (loss) per share $0.33 $0.22 ($1.01) $0.02 1996 --------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter ----------- ----------- ----------- ----------- Net sales $152,839 $152,208 $131,533 $141,211 Gross profit 64,489 62,956 31,585 16,537 Net income 42,504 42,560 16,498 8,412 Basic income per share $0.84 $0.83 $0.32 $0.16 Diluted income per share $0.80 $0.80 $0.31 $0.16 (1) Results for the third quarter of 1997 included a $52,157,000 restructuring charge to consolidate the Company's U.S. manufacturing operations. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE. Not Applicable. PART III ITEMS 10, 11, 12 and 13. Items 10 through 13 of Part III will be contained in the Komag, Incorporated Proxy Statement for the Annual Meeting of Stockholders to be held May 27, 1998 (the "1998 Proxy Statement"), which will be filed with the Securities and Exchange Commission no later than May 7, 1998. The cross- reference table below sets forth the captions under which the responses to these items are found:
10-K Item Description Caption in 1998 Proxy Statement - ---------- ----------- ------------------------------ 10 Directors and Executive Officers "Item No. 1--Election of Directors: Nominees; Business Experience of Directors and Nominees" and "Additional Information: Certain Relationships and Related Transactions; Other Matters" 11 Executive Compensation "Additional Information: Executive Compensation and Related Information" 12 Security Ownership of Certain Beneficial "Additional Information: Principal Owners and Management Stockholders" 13 Certain Relationships and Related "Additional Information: Certain Transactions Relationships and Related Transactions"
The information set forth under the captions listed above, contained in the 1998 Proxy Statement, are hereby incorporated herein by reference in response to Items 10 through 13 of this Report on Form 10-K. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) List of Documents filed as part of this Report. 1. Financial Statements. The following consolidated financial statements of Komag, Incorporated are filed in Part II, Item 8 of this Report on Form 10-K: Consolidated Statements of Operations-Fiscal Years 1997, 1996 and 1995 Consolidated Balance Sheets-December 28, 1997 and December 29, 1996 Consolidated Statements of Cash Flows-Fiscal Years 1997, 1996 and 1995 Consolidated Statements of Stockholders' Equity-Fiscal Years 1997, 1996 and 1995 Notes to Consolidated Financial Statements 2. Financial Statement Schedules. The following financial statement schedule of Komag, Incorporated is filed in Part IV, Item 14(d) of this report on Form 10-K: Schedule II-Valuation and Qualifying Accounts Report of Other Auditor --Report of Chuo Audit Corporation on Asahi Komag Co., Ltd. All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. 3. Exhibits. 3.1 Amended and Restated Certificate of Incorporation (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1995). 3.2 Bylaws (incorporated by reference from Exhibit 3.3 filed with the Company's Report on Form 10-K for the year ended December 30, 1990). 4.2 Specimen Stock Certificate (incorporated by reference from a similarly numbered exhibit filed with Amendment No. 1 to the Registration Statement). 10.1.1 Lease Agreement dated May 24, 1991 between Milpitas-Hillview and Komag, Incorporated (incorporated by reference from Exhibit 10.1.2 filed with the Company's report on Form 10-K for the year ended December 29, 1991). 10.1.2 Lease Agreement dated May 24, 1991, between Milpitas-Hillview II and Komag, Incorporated (incorporated by reference from Exhibit 10.1.3 filed with the Company's report on Form 10-K for the year ended December 29, 1991). 10.1.3 Lease Agreement dated July 29, 1988 by and between Brokaw Interests and Komag Corporation (incorporated by reference from Exhibit 10.1.6 filed with the Company's Report on Form 10-K for the year ended January 1, 1989). 10.1.4 Lease Agreement dated May 2, 1989 by and between Stony Point Associates I and Komag Material Technology, Inc. (incorporated by reference from Exhibit 10.1.6 filed with the Company's Report on Form 10-K for the year ended December 31, 1989). 10.1.5 Amendment to Lease Agreement dated December 28, 1990 by and between Milpitas- Hillview II and Komag, Incorporated (incorporated by reference from Exhibit 10.1.11 filed with the Company's Report on Form 10-K for the year ended December 30, 1990). 10.1.6 Second Amendment to Lease dated December 28, 1990 by and between Milpitas-Hillview and Komag, Incorporated (incorporated by reference from Exhibit 10.1.12 filed with the Company's Report on Form 10-K for the year ended December 30, 1990). 10.1.7 First Amendment to Lease dated November 1, 1993 by and between Wells Fargo Bank et al and Komag Material Technology, Inc. (incorporated by reference from Exhibit 10.1.14 filed with the Company's Report on Form 10-K for the year ended January 2, 1994). 10.1.8 Lease Agreement dated May 27, 1994 by and between Hillview I Partners and Komag, Incorporated (incorporated by reference from Exhibit 10.1.16 filed with the Company's Report on Form 10-Q for the quarter ended July 3, 1994). 10.1.9 Lease Agreement dated August 4, 1995 by and between Great Oaks Interests and Komag, Incorporated (incorporated by reference from Exhibit 10.1.12 filed with Form 10-Q for the quarter ended October 1, 1995). 10.1.10 First Amendment to Lease dated November 3, 1995 by and between Great Oaks Interests and Komag, Incorporated (incorporated by reference from Exhibit 10.1.10 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.1.11 Lease Agreement (B10) dated May 24, 1996 between Sobrato Development Companies #871 and Komag, Incorporated (incorporated by reference from Exhibit 10.1.11 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.1.12 Lease Agreement (B11) dated May 24, 1996 between Sobrato Development Companies #871 and Komag, Incorporated (incorporated by reference from Exhibit 10.1.12 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.2 Form of Directors' Indemnification Agreement (incorporated by reference from Exhibit 10.9 filed with the Company's Report on Form 10-K for the year ended December 30, 1990). 10.3.1 Joint Venture Agreement by and among Komag, Inc., Asahi Glass Co., Ltd., and Vacuum Metallurgical Company dated November 9, 1986, as amended January 7, 1987 and January 27, 1987 (incorporated by reference from Exhibit 10.10.1 filed with the Registration Statement on Form S-1--File No. 33-13663) (confidential treatment obtained as to certain portions). 10.3.2 General Partnership Agreement for Komag Technology Partners dated January 7, 1987 (incorporated by reference from Exhibit 10.10.2 filed with the Registration Statement on Form S-1--File No. 33-13663). 10.3.3 Technology Contribution Agreement dated January 7, 1987 by and between Komag, Incorporated and Komag Technology Partners (incorporated by reference from Exhibit 10.10.3 filed with the Registration Statement on Form S-1--File No. 33-13663) (confidential treatment obtained as to certain portions). 10.3.4 Technical Cooperation Agreement dated January 7, 1986 by and between Asahi Glass Company, Ltd. and Komag, Incorporated (incorporated by reference from Exhibit 10.10.4 filed with the Registration Statement on Form S-1--File No. 33-13663). 10.3.5 Third Amendment to Joint Venture Agreement by and among Komag, Inc., Asahi Glass Co., Ltd., Vacuum Metallurgical Company, et al dated March 21, 1990 (incorporated by reference from Exhibit 10.10.5 filed with the Company's Report on Form 10-K for the year ended December 31, 1989). 10.3.6 Fourth Amendment to Joint Venture Agreement by and among Komag, Inc., Asahi Glass Co., Ltd., Vacuum Metallurgical Company, et al dated May 24, 1990 (incorporated by reference from Exhibit 10.10.11 filed with the Company's Report on Form 10-K for the year ended January 1, 1995). 10.3.7 Fifth Amendment to Joint Venture Agreement by and among Komag, Inc., Asahi Glass Co., Ltd., Vacuum Metallurgical Company, et al dated November 4, 1994 (incorporated by reference from Exhibit 10.10.12 filed with the Company's Report on Form 10-K for the year ended January 1, 1995). 10.3.8 Joint Venture Agreement dated March 6, 1989 by and between Komag, Incorporated, Komag Material Technology, Inc. and Kobe Steel USA Holdings Inc. (incorporated by reference from Exhibit 10.10.6 filed with the Company's Report on Form 10-K for the year ended December 31, 1989) (confidential treatment obtained as to certain portions). 10.3.9 Joint Development and Cross-License Agreement dated March 10, 1989 by and between Komag, Incorporated, Kobe Steel, Ltd., and Komag Material Technology, Inc. (incorporated by reference from Exhibit 10.10.7 filed with the Company's Report on Form 10-K for the year ended December 31, 1989). 10.3.10 Blank Sales Agreement dated March 10, 1989 by and between Komag, Incorporated, Kobe Steel, Ltd., and Komag Material Technology, Inc. (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1989). 10.3.11 Finished Substrate Agreement dated March 10, 1989 by and between Komag, Incorporated, Kobe Steel, Ltd., and Komag Material Technology, Inc. (incorporated by reference from Exhibit 10.10.9 filed with the Company's Report on Form 10-K for the year ended December 31, 1989) (confidential treatment obtained as to certain portions). 10.3.12 Stock Purchase Agreement between Komag, Incorporated and Kobe Steel USA Holdings Inc. dated November 17, 1995 (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1995). 10.3.13 Substrate Agreement by and between Kobe Steel, Ltd. and Komag, Incorporated dated November 17, 1995 (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1995) (confidential treatment obtained as to certain portions). 10.3.14 License Amendment Agreement among Komag, Incorporated, Komag Material Technology, Inc. and Kobe Steel, Ltd. dated November 17, 1995 (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1995). 10.3.15 Substrate Sales Amendment Agreement among Komag, Incorporated, Komag Material Technology, Inc. and Kobe Steel, Ltd. dated November 17, 1995 (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1995). 10.3.16 Joint Venture Amendment Agreement among Komag, Incorporated, Komag Material Technology, Inc. and Kobe Steel USA Holdings Inc. dated November 17, 1995 (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended December 31, 1995) (confidential treatment obtained as to certain portions). 10.4.1 Restated 1987 Stock Option Plan, effective January 31, 1996 and forms of agreement thereunder (incorporated by reference from a similarly numbered exhibit filed with the Company's report on Form 10-Q for the quarter ended June 30, 1996). 10.4.2 Komag, Incorporated 1996 Management Bonus Plan (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-Q for the quarter ended June 30, 1996). 10.4.3 1988 Employee Stock Purchase Plan Joinder Agreement dated July 1, 1993 between Komag, Incorporated and Komag USA (Malaysia) Sdn. (incorporated by reference from Exhibit 10.11.11 filed with the Company's Report on Form 10-K for the year ended January 2, 1994). 10.4.4 Komag, Incorporated Discretionary Bonus Plan. (incorporated by reference from Exhibit 10.4.4 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.4.5 Komag, Incorporated 1997 Supplemental Stock Option Plan. 10.5.1 Komag, Incorporated Deferred Compensation Plan (incorporated by reference from a similarly numbered exhibit filed with the Company's Report on Form 10-K for the year ended January 1, 1995). 10.5.2 Amendment No. 1 to Komag, Incorporated Deferred Compensation Plan dated January 1, 1997. (incorporated by reference from Exhibit 10.5.2 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.5.3 Komag Material Technology, Inc. 1995 Stock Option Plan (incorporated by reference from Exhibit 10.11.12 filed with Form 10-Q for the Quarter ended October 1, 1995). 10.6 Common Stock Purchase Agreement dated December 9, 1988 by and between Komag, Incorporated and Asahi Glass Co., Ltd. (incorporated by reference from Exhibit 1 filed with the Company's Report on Form 8-K filed with the Securities and Exchange Commission on December 20, 1988). 10.7 Common Stock Purchase Agreement dated February 6, 1990 by and between Komag, Incorporated and Kobe Steel USA Holdings Inc. (incorporated by reference from Exhibit 10.17 filed with the Company's Report on Form 10-K for the year ended December 31, 1989). 10.8 Registration Rights Agreement dated March 21, 1990 by and between Komag, Incorporated and Kobe Steel USA Holdings Inc. (incorporated by reference from Exhibit 10.18 filed with the Company's Report on Form 10-K for the year ended December 31, 1989). 10.9 Amendment No. 1 to Common Stock Purchase Agreement dated March 21, 1990 by and between Komag, Incorporated and Asahi Glass Co., Ltd. (incorporated by reference from Exhibit 10.19 filed with Amendment No. 1 to the Registration Statement filed with the Securities and Exchange Commission on May 26, 1987). 10.10 Amended and Restated Registration Rights Agreement dated March 21, 1990 by and between Komag, Incorporated and Asahi Glass Co., Ltd. (incorporated by reference from Exhibit 10.20 filed with Amendment No. 1 to the Registration Statement filed with the Securities and Exchange Commission on May 26, 1987). 10.11 Letter dated February 10, 1992 from the Malaysian Industrial Development Authority addressed to Komag, Incorporated approving the "Pioneer Status" of the Company's thin- film media venture in Malaysia (incorporated by reference from Exhibit 10.28 filed with the Company's report on Form 10-K for the year ended January 3, 1993). 10.12 Credit Agreement between Komag, Incorporated and Wells Fargo Bank, N.A. (formerly First Interstate Bank of California)--Three Year Facility--dated December 15, 1994 (incorporated by reference from Exhibit 10.24 filed with the Company's report on Form 10-K for the year ended January 1, 1995). 10.13 First Amendment to Credit Agreement by and between Komag, Incorporated and The Industrial Bank of Japan, Limited, San Francisco Agency dated November 19, 1996 (incorporated by reference to Exhibit 10.17 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.14 Second Amendment to Credit Agreement by and between Komag, Incorporated and The Industrial Bank of Japan, Limited, San Francisco Agency dated January 31, 1997 (incorporated by reference to Exhibit 10.18 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.15 Credit Agreement between Komag, Incorporated and The Dai-Ichi Kangyo Bank, Limited, San Francisco Agency dated October 7, 1996 (incorporated by reference to Exhibit 10.19 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.16 First Amendment to Credit Agreement between Komag, Incorporated and The Dai-Ichi Kangyo Bank, Limited, San Francisco Agency dated November 25, 1996 (incorporated by reference to Exhibit 10.20 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.17 Credit Agreement dated as of February 7, 1997 among Komag, Incorporated, institutional lenders and The Industrial Bank of Japan, Limited, San Francisco Agency, as agent for the lenders(incorporated by reference to Exhibit 10.22 filed with the Company's report on Form 10-K for the year ended December 28, 1996). 10.18 Amended and Restated Credit Agreement Among Komag, Incorporated and BankBoston, N.A. as agent (incorporated by reference from Exhibit 10.23 filed with the Company's report on Form 10-Q for the quarter ended June 29, 1997). 10.19 First Amendment to Amended and Restated Credit Agreement dated October 9, 1997 among Komag, Incorporated and BankBoston, N.A. as agent (incorporated by reference from Exhibit 10.24 filed with the Company's report on Form 10-Q for the quarter ended September 28, 1997). 21 List of Subsidiaries. 23.1 Consent of Ernst & Young LLP. 23.2 Consent of Chuo Audit Corporation. 24 Power of Attorney. Reference is made to the signature pages of this Report. 27 Financial Data Schedule. - ----------------- The Company agrees to furnish to the Commission upon request a copy of any instrument with respect to long-term debt where the total amount of securities authorized thereunder does not exceed 10% of the total assets of the Company. (b) Reports on Form 8-K. Not Applicable Undertaking For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows: Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered on the Form S-8 identified below, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1933 Act and will be governed by the final adjudication of such issue. The preceding undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 33-16625 (filed August 19, 1987), 33-19851 (filed January 28, 1988), 33-25230 (filed October 28, 1988), 33-41945 (filed July 29, 1991), 33-45469 (filed February 3, 1992), 33-53432 (filed October 16, 1992), 33-80594 (filed June 22, 1994), 33-62543 (filed September 12, 1995), 333-06081 (filed June 14, 1996), 333-23095 (filed March 11, 1997) and 333-31297 (filed July 16, 1997). SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Milpitas, California on this 24th day of March, 1998. Komag, Incorporated By Stephen C. Johnson ---------------------------------- Stephen C. Johnson President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears herein constitutes and appoints Stephen C. Johnson and William L. Potts, Jr., and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated:
Signature Title Date - ---------------------------- ------------------------------------ ------------- /s/ TU CHEN Chairman of the Board March 24, 1998 - ------------------------ and Director (Tu Chen) /s/ STEPHEN C. JOHNSON President and Chief Executive March 24, 1998 - ----------------------- Officer (Stephen C. Johnson) /s/ WILLIAM L. POTTS, JR. Senior Vice President, Chief March 24, 1998 - ------------------------- Financial Officer and Secretary (William L. Potts, Jr.) (Principal Financial and Accounting Officer) /s/ CRAIG R. BARRETT Director March 24, 1998 - ----------------------- (Craig R. Barrett) /s/ CHRIS A. EYRE Director March 24, 1998 - ----------------------- (Chris A. Eyre) /s/ IRWIN FEDERMAN Director March 24, 1998 - ----------------------- (Irwin Federman) /s/ GEORGE A. NEIL Director March 24, 1998 - ----------------------- (George A. Neil) /s/ MAX PALEVSKY Director March 24, 1998 - ----------------------- (Max Palevsky) /s/ ANTHONY SUN Director March 24, 1998 - ----------------------- (Anthony Sun) /s/ MASAYOSHI TAKEBAYASHI Director March 24, 1998 - ----------------------- (Masayoshi Takebayashi) *By WILLIAM L. POTTS, JR. ---------------------- (William L. Potts, Jr., Attorney-in-Fact)
ITEM 14(d) FINANCIAL STATEMENT SCHEDULES KOMAG, INCORPORATED Schedule II VALUATION AND QUALIFYING ACCOUNTS (in thousands)
Additions Balance at Charged to Balance Beginning Costs and at End of Period Expenses Deductions of Period ----------- ----------- ----------- ----------- Year ended December 31, 1995 Allowance for doubtful accounts $1,487 $1,519 $ -- $3,006 Allowance for sales returns 736 2,351 (1) 1,814 (2) 1,273 ----------- ----------- ----------- ----------- $2,223 $3,870 $1,814 $4,279 =========== =========== =========== =========== Year ended December 29, 1996 Allowance for doubtful accounts $3,006 ($1,011) $11 $1,984 Allowance for sales returns 1,273 3,528 (1) 3,698 (2) 1,103 ----------- ----------- ----------- ----------- $4,279 $2,517 $3,709 $3,087 =========== =========== =========== =========== Year ended December 28, 1997 Allowance for doubtful accounts $1,984 $1,286 ($28) $3,298 Allowance for sales returns 1,103 7,145 (1) 7,122 (2) 1,126 ----------- ----------- ----------- ----------- Sub total 3,087 8,431 7,094 4,424 Restructuring liability -- 52,157 (3) 40,904 (4) 11,253 ----------- ----------- ----------- ----------- $3,087 $60,588 $47,998 $15,677 =========== =========== =========== =========== (1) Additions to the allowance for sales returns are netted against sales. (2) Actual sales returns of subsequently scrapped product were charged against the allowance for sales returns. Actual sales returns of product that was subsequently tested and shipped to another customer were netted directly against sales. (3) The Company recorded a restructuring charge of $52,157,000 to consolidate its U.S. manufacturing operations. (4) Charges against the restructuring liability included non-cash charges of $33,000,000 for the write-off of the net book value of equipment and leaseholds, and cash charges of approximately $7,900,000 for severance and equipment related costs.
REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors Asahi Komag Co., Ltd. We have audited the accompanying consolidated balance sheets of Asahi Komag Co., Ltd. and subsidiary (the "Company") as of December 31, 1997 and 1996, and the consolidated statements of income, cash flows, and stockholder's equity for the years ended December 31, 1997, 1996 and 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. These standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audit, the financial statements referred to above present fairly, in all material respects the consolidated financial position of Asahi Komag Co., Ltd. and subsidiary as of December 31, 1997 and 1996, and the consolidated results of its operations and its cash flows for the years ended December 31, 1997, 1996 and 1995 in conformity with generally accepted accounting principles applicable in the United States of America. As discussed in Note 2b of the notes to the consolidated financial statements, the Company reporting entity changed in 1995 as a result of the establishment of a wholly owned subsidiary. As discussed in Note 14 of the notes to consolidated financial statements, on February 9, 1998 the Company's board of directors approved a plan to replace certain operating equipment with a net book value of Y398,555 thousand (Japanese Yen). The consolidated financial statements as of and for the year ended December 31, 1997 have been translated into United States Dollars solely for the convenience of the reader. Our audit included the translation, and in our opinion such translation has been made in accordance with the basis stated in note 2h to the financial statements. CHUO AUDIT CORPORATION Tokyo, Japan February 27, 1998 EX-10.4.5 2 1997 SUPPLEMENTAL STOCK OPTION PLAN EXHIBIT 10.4.5 KOMAG, INCORPORATED 1997 SUPPLEMENTAL STOCK OPTION PLAN ARTICLE ONE GENERAL PROVISIONS I. PURPOSES OF THE PLAN This 1997 Supplemental Stock Option Plan (the "Plan") is intended to promote the interests of Komag, Incorporated, a Delaware corporation (the "Corporation"), by providing a method whereby eligible individuals may be offered incentives and rewards which will encourage them to acquire a proprietary interest, or otherwise increase their proprietary interest, in the Corporation and continue to render services to the Corporation (or its parent or subsidiary corporations). II. ADMINISTRATION OF THE PLAN A. The Plan shall be administered by one or more committees comprised of Board members (the "Committee") or the Board may retain the power to administer the Plan. The members of the Committee shall each serve for such period of time as the Board may determine and shall be subject to removal by the Board at any time. B. The Committee (or the Board if no Committee has been designated) shall serve as the Plan Administrator and shall have full power and authority (subject to the express provisions of the Plan) to establish such rules and regulations as it may deem appropriate for the proper administration of such program and to make such determinations under the program and any outstanding option as it may deem necessary or advisable. Decisions of the Plan Administrator shall be final and binding on all parties with an interest in the Plan or any options or shares issued hereunder. III. ELIGIBILITY FOR OPTION GRANTS A. The persons eligible to participate in the Plan shall be - employees (excluding officers and directors) of the Corporation (or its parent or subsidiary corporations), - independent contractors and consultants of the Corporation (or its parent or subsidiary corporations). B. The Plan Administrator shall have full authority to select the eligible individuals who are to receive option grants under the Plan, the number of shares to be covered by each granted option, the time or times at which such option is to become exercisable and the maximum term for which the option is to be outstanding. C. For purposes of the Plan, the following provisions shall be applicable in determining the parent and subsidiary corporations of the Corporation: Any corporation (other than the Corporation) in an unbroken chain of corporations ending with the Corporation shall be considered to be a parent corporation of the Corporation, provided each such corporation in the unbroken chain (other than the Corporation) owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. Each corporation (other than the Corporation) in an unbroken chain of corporations beginning with the Corporation shall be considered to be a subsidiary of the Corporation, provided each such corporation (other than the last corporation) in the unbroken chain owns, at the time of the determination, stock possessing fifty percent (50%) or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. IV. STOCK SUBJECT TO THE PLAN A. The stock issuable under the Plan shall be shares of the Corporation's authorized but unissued or reacquired Common Stock. The aggregate number of shares which may be issued over the term of the Plan shall not exceed Three Million Six Hundred Thousand (3,600,000) shares (subject to adjustment from time to time in accordance with paragraph IV.C of this Article One). B. Should an option be terminated for any reason prior to exercise in whole or in part, the shares subject to the portion of the option not so exercised shall be available for subsequent option grants under this Plan. In addition, unvested shares issued under the Plan and subsequently repurchased by the Corporation at the original exercise price paid per share, pursuant to the Corporation's repurchase rights under the Plan shall be added back to the number of shares of Common Stock reserved for issuance under the Plan and shall accordingly be available for reissuance through one or more subsequent option grants under the Plan. C. In the event any change is made to the Common Stock issuable under the Plan (whether by reason of (i) merger, consolidation or reorganization or (ii) recapitalization, stock dividend, stock split, combination of shares, exchange of shares or other similar change affecting the outstanding Common Stock as a class without the Corporation's receipt of consideration), then unless such change results in the termination of all outstanding options pursuant to the provisions of paragraph II of Article Two of the Plan, appropriate adjustments shall be made to (i) the aggregate number and/or class of shares issuable under the Plan, and (ii) the number and/or class of shares and price per share in effect under each outstanding option under the Plan. The purpose of such adjustments to the outstanding options shall be to preclude the enlargement or dilution of rights and benefits under such options. ARTICLE TWO OPTION GRANT PROGRAM I. TERMS AND CONDITIONS OF OPTIONS Options granted pursuant to this Article Two shall be auth- orized by action of the Plan Administrator and shall be Non-Statutory Options. The granted options shall be evidenced by instruments in such form as the Plan Administrator shall from time to time approve; provided, however, that each such instrument shall comply with and incorporate the terms and conditions specified below. A. Option Price. 1. The option price per share shall be fixed by the Plan Administrator. In no event, however, shall the option price per share be less than one hundred percent (100%) of the fair market value per share of Common Stock on the date of the option grant. 2. The option price shall become immediately due upon exercise of the option and shall be payable as follows: (i) full payment in cash or check drawn to the Corporation's order; (ii) full payment in shares of Common Stock held by the optionee for the requisite period necessary to avoid a charge to the Corporation's earnings for financial reporting purposes and valued at fair market value on the Exercise Date (as such term is defined below) equal to the option price; or (iii) full payment through a combination of shares of Common Stock held by the optionee for the requisite period necessary to avoid a charge to the Corporation's earnings for financial reporting purposes and valued at fair market value on the Exercise Date and cash or check, equal in the aggregate to the option price. (iv) to the extent the option is exercised for vested shares, the option price may also be paid through a broker-dealer sale and remittance procedure pursuant to which the optionee shall provide irrevocable instructions to (I) a Corporation-designated brokerage firm to effect the immediate sale of the purchased shares and remit to the Corporation, out of the sale proceeds available on the settlement date, an amount equal to the aggregate option price payable for the purchased shares plus all applicable Federal and State income and employment taxes required to be withheld by the Corporation by reason of such purchase and (II) the Corporation to deliver the certificates for the purchased shares directly to such brokerage firm. For purposes of this subparagraph 2, the Exercise Date shall be the date on which notice of the exercise of the option is delivered to the Corporation. Except to the extent the sale and remittance procedure is utilized in connection with the exercise of the option, payment of the option price for the purchased shares must accompany such notice. 3. The fair market value of a share of Common Stock on any relevant date under subparagraph 1 or 2 above (and for all other valuation purposes under the Plan) shall be determined in accordance with the following provisions: (i) If the Common Stock is at the time traded on the Nasdaq National Market, then the fair market value shall be the closing selling price per share of Common Stock on the day prior to the date in question, as such price is reported by the National Association of Securities Dealers on the Nasdaq National Market or any successor system. If there is no closing selling price for the Common Stock on the day prior to the date in question, then the fair market value shall be the closing selling price on the last preceding date for which such quotation exists. (ii) If the Common Stock is at the time listed on either the New York Stock Exchange or the American Stock Exchange, then the fair market value shall be the closing selling price per share of Common Stock on the day prior to the date in question on such exchange, as such price is officially quoted in the composite tape of transactions on that exchange. If there is no closing selling price for the Common Stock on the day prior to the date in question, then the fair market value shall be the closing selling price on the last preceding date for which such quotation exists. B. Term and Exercise of Options. Each option granted under this Article Two shall be exercisable at such time or times, during such period, and for such number of shares as shall be determined by the Plan Administrator and set forth in the instrument evidencing such option; provided, however, that no option granted under this Article Two shall have a maximum term in excess of ten (10) years from the grant date. C. Limited Transferability of Options. During the lifetime of the optionee, the option shall be exercisable only by the optionee and shall not be assignable or transferable by the optionee otherwise than by will or by the laws of descent and distribution following the optionee's death. However, the Plan Administrator may grant one or more options under this Article Two which may, in connection with the optionee's estate plan, be assigned in whole or in part during the optionee's lifetime to one or more members of the optionee's immediate family or to a trust established exclusively for one or more such family members. The assigned portion may only be exercised by the person or persons who acquire a proprietary interest in the option pursuant to the assignment. The terms applicable to the assigned portion shall be the same as those in effect for the option immediately prior to such assignment and shall be set forth in such documents issued to the assignee as the Plan Administrator may deem appropriate. D. Termination of Service. 1. Should an optionee cease to remain in Service for any reason (including death, permanent disability or retirement at or after age 65) while the holder of one or more outstanding options granted to such optionee under the Plan, then such option or options shall not (except to the extent otherwise provided pursuant to paragraph VII below) remain exercisable for more than a twelve (12)-month period (or such shorter period as is determined by the Plan Administrator and set forth in the option agreement) following the date of cessation of Service; provided, however, that under no circumstances shall any such option be exercisable after the specified expiration date of the option term. Except to the extent otherwise provided pursuant to subparagraph I.D.4 below, each such option shall, during such twelve (12)-month or shorter period, be exercisable for any or all vested shares for which that option is exercisable on the date of such cessation of Service. Upon the expiration of such twelve (12)-month or shorter period or (if earlier) upon the expiration of the option term, the option shall terminate and cease to be exercisable for any such vested shares for which the option has not been exercised. However, the option shall, immediately upon the optionee's cessation of Service, terminate and cease to be outstanding with respect to any option shares in which the optionee is not otherwise at that time vested or for which the option is not otherwise at that time exercisable. 2. Should the optionee die while in Service, or cease to remain in Service and thereafter die while the holder of one or more outstanding options under the Plan, each such option may be exercised by the personal representative of the optionee's estate or by the person or persons to whom the option is transferred pursuant to the optionee's will or in accordance with the laws of descent and distribution but, except to the extent otherwise provided pursuant to subparagraph I.D.4 below, only to the extent of the number of vested shares (if any) for which the option is exercisable on the date of the optionee's death. Such exercise must be effected prior to the earlier of (i) the first anniversary of the date of the optionee's death or (ii) the specified expiration date of the option term. Upon the occurrence of the earlier event, the option shall terminate and cease to be exercisable. 3. If (i) the optionee's Service is terminated for cause (including, but not limited to, any act of dishonesty, willful misconduct, fraud or embezzlement or any unauthorized disclosure or use of confidential information or trade secrets) or (ii) the optionee makes or attempts to make any unauthorized use or disclosure of confidential information or trade secrets of the Corporation or its parent or subsidiary corporations, then in any such event all outstanding options granted the optionee under the Plan shall terminate and cease to be exercisable immediately upon such cessation of Service or (if earlier) upon such unauthorized use or disclosure of confidential or secret information or attempt thereat. 4. The Plan Administrator shall have complete discretion, exercisable either at the time the option is granted or at the time the optionee dies, retires at or after age 65, or ceases to remain in Service, to establish as a provision applicable to the exercise of one or more options granted under the Plan that during the limited period of exercisability following death, retirement at or after age 65, or cessation of Employee status as provided in subparagraph I.D.1 or I.D.2 above, the option may be exercised not only with respect to the number of vested shares for which it is exercisable at the time of the optionee's cessation of Service, but also with respect to one or more subsequent installments in which the optionee would have otherwise vested had such cessation of Service not occurred. 5. For purposes of the foregoing provisions of this paragraph I.D (and all other provisions of the Plan), - The optionee shall be deemed to remain in the Service of the Corporation for so long as such individual renders services on a periodic basis to the Corporation (or any parent or subsidiary corporation) in the capacity of an Employee, a non-employee member of the Board or an independent consultant or advisor. - The optionee shall be considered to be an Employee for so long as such individual remains in the employ of the Corporation or one or more of its parent or subsidiary corporations, subject to the control and direction of the employer not only as to the work to be performed but also as to the manner and method of performance. D. Stockholder Rights. An option holder shall have none of the rights of a stockholder with respect to any shares covered by the option until such individual shall have exercised the option, paid the option price and been issued a stock certificate for the purchased shares. No adjustment shall be made for dividends or distributions (whether paid in cash, securities or other property) for which the record date is prior to the date the stock certificate is issued. E. Repurchase Rights. The shares of Common Stock acquired upon the exercise of options granted under this Article Two may be subject to repurchase by the Corporation in accordance with the following provisions: The Plan Administrator shall have the discretion to authorize the issuance of unvested shares of Common Stock under this Article Two. Should the Optionee cease Service while holding such unvested shares, the Corporation shall have the right to repurchase any or all of those unvested shares at the option price paid per share. The terms and conditions upon which such repurchase right shall be exercisable (including the period and procedure for exercise and the appropriate vesting schedule for the purchased shares) shall be established by the Plan Administrator and set forth in the instrument evidencing such repurchase right. All of the Corporation's outstanding repurchase rights shall automatically terminate, and all shares subject to such terminated rights shall immediately vest in full, upon the occurrence of any Corporate Transaction under paragraph II of this Article Two, except to the extent: (i) any such repurchase right is to be assigned to the successor corporation (or parent thereof) in connection with the Corporate Transaction or (ii) such termination is precluded by other limitations imposed by the Plan Administrator at the time the repurchase right is issued. The Plan Administrator shall have the discretionary authority, exercisable either before or after the optionee's cessation of Service, to cancel the Corporation's outstanding repurchase rights with respect to one or more shares purchased or purchasable by the optionee under this Article Two and thereby accelerate the vesting of such shares in connection with the optionee's cessation of Service. II. CORPORATE TRANSACTIONS A. In the event of any of the following stockholder- approved transactions (a "Corporate Transaction"): (i) a merger or acquisition in which the Corporation is not the surviving entity, except for a transaction the principal purpose of which is to change the State of the Corporation's incorporation, (ii) the sale, transfer or other disposition of all or substantially all of the assets of the Corporation, or (iii) any reverse merger in which the Corporation is the surviving entity, then each option outstanding under this Article Two shall automatically become exercisable, during the five (5) business day period immediately prior to the specified effective date for the Corporate Transaction, with respect to the full number of shares of Common Stock purchasable under such option and may be exercised for all or any portion of such shares as fully vested shares of Common Stock. An outstanding option under the Plan shall not be so accelerated, however, if and to the extent (i) such option is, in connection with the Corporate Transaction, either to be assumed by the successor corporation or parent thereof or be replaced with a comparable option to purchase shares of the capital stock of the successor corporation or parent thereof or (ii) the acceleration of such option is subject to other limitations imposed by the Plan Administrator at the time of grant. B. Immediately following the consummation of the Corporate Transaction, all outstanding options under the Plan shall, to the extent not previously exercised or assumed by the successor corporation or its parent company, terminate and cease to be exercisable. C. Each outstanding option under this Article Two which is assumed in connection with the Corporate Transaction or is otherwise to continue in effect shall be appropriately adjusted, immediately after such Corporate Transaction, to apply and pertain to the number and class of securities which would have been issuable, in consummation of such Corporate Transaction, to an actual holder of the same number of shares of Common Stock as are subject to such option immediately prior to such Corporate Transaction. Appropriate adjustments shall also be made to the option price payable per share, provided the aggregate option price payable for such securities shall remain the same. In addition, the class and number of securities available for issuance under the Plan following the consummation of the Corporate Transaction shall be appropriately adjusted. D. Option grants under this Article Two shall in no way affect the right of the Corporation to adjust, reclassify, reorganize or otherwise change its capital or business structure or to merge, consolidate, dissolve, liquidate or sell or transfer all or any part of its business or assets. III. CANCELLATION AND REGRANT The Plan Administrator shall have the authority to effect, at any time and from time to time, with consent of the affected option holders, the cancellation of any or all outstanding options under the Plan and to grant in substitution therefor new options covering the same or different numbers of shares of Common Stock but having an exercise price per share equal to one hundred percent (100%) of the fair market value of the Common Stock on the new grant date. IV. EXTENSION OF EXERCISE PERIOD The Plan Administrator shall have full power and authority, exercisable from time to time in its sole discretion, to extend, either at the time the option is granted or at any time while such option remains outstanding, the period of time for which the option is to remain exercisable following the optionee's cessation of Service or death from the twelve (12)-month or shorter period set forth in the option agreement to such greater period of time as the Plan Administrator shall deem appropriate; provided, however, that in no event shall such option be exercisable after the specified expiration date of the option term. ARTICLE THREE MISCELLANEOUS I. AMENDMENT OF THE PLAN The Board shall have complete and exclusive power and authority to amend or modify the Plan in any or all respects whatsoever. However, no such amendment or modification shall, without the consent of the holders, adversely affect rights and obligations with respect to options at the time outstanding under the Plan. II. EFFECTIVE DATE AND TERM OF PLAN The Plan shall become effective upon its adoption by the Board. Unless sooner terminated in accordance with paragraph II of Article Two, the Plan shall terminate upon the earlier of (i) August ____, 2007 or (ii) the date on which all shares available for issuance under the Plan shall have been issued or cancelled pursuant to the exercise or surrender of options granted hereunder. If the date of termination is determined under clause (i) above, then options outstanding on such date shall not be affected by the termination of the Plan and shall continue to have force and effect in accordance with the provisions of the instruments evidencing such options. III. USE OF PROCEEDS Any cash proceeds received by the Corporation from the sale of shares pursuant to options granted under the Plan shall be used for general corporate purposes. IV. TAX WITHHOLDING The Corporation's obligation to deliver shares or cash upon the exercise or surrender of any option granted under the Plan shall be subject to the satisfaction of all applicable federal, state and local income and employment tax withholding requirements. V. NO EMPLOYMENT/SERVICE RIGHTS Neither the action of the Corporation in establishing or restating the Plan, nor any action taken by the Plan Administrator hereunder, nor any provision of the restated Plan shall be construed so as to grant any individual the right to remain in the employ or service of the Corporation (or any parent or subsidiary corporation) for any period of specific duration, and the Corporation (or any parent or subsidiary corporation retaining the services of such individual) may terminate such individual's employment or service at any time and for any reason, with or without cause. VI. REGULATORY APPROVALS A. The implementation of the Plan, the granting of any option hereunder, and the issuance of stock upon the exercise or surrender of any such option shall be subject to the Corporation's procurement of all approvals and permits required by regulatory authorities having jurisdiction over the Plan, the options granted under it and the stock issued pursuant to it. B. No shares of Common Stock or other assets shall be issued or delivered under the Plan unless and until there shall have been compliance with all applicable requirements of Federal and state securities laws, including the filing and effectiveness of the Form S-8 registration statement for the shares of Common Stock issuable under the Plan, and all applicable listing requirements of any stock exchange (or the Nasdaq National Market, if applicable) on which Common Stock is then listed for trading. EX-21 3 LIST OF SUBSIDIARIES KOMAG, INCORPORATED Exhibit 21 List of Subsidiaries Asahi Komag Co., Ltd., a Japanese corporation Komag USA (Malaysia) Sdn., a Malaysian corporation EX-23.1 4 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-31297, 333-23095, 333-06081, 33-62453, 33-80594, 33-53432, 33- 45469, 33-41945, 33-25230, 33-19851 and 33-16625) pertaining to the Komag, Incorporated Deferred Compensation Plan, the Komag, Incorporated Restated 1987 Stock Option Plan, the Komag Material Technology, Inc. 1995 Stock Option Plan, the Komag, Incorporated Employee Stock Purchase Plan, the Komag, Incorporated Restated 1987 Stock Option Plan, the Dastek International Stock Option Plan and the Dastek, Inc. 1992 Stock Option Plan and in the Registration Statement (Form S-3 No. 33-61161) of Komag, Incorporated and in the related Prospectus of our report dated January 19, 1998, with respect to the consolidated financial statements and schedule of Komag, Incorporated included in this Annual Report (Form 10-K) for the year ended December 28, 1997. ERNST & YOUNG LLP San Jose, California March 24, 1998 EX-23.2 5 CONSENT OF CHUO AUDIT CORPORATION EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the inclusion in this annual report on Form 10-K of our report dated February 27, 1998 on our audit of the consolidated financial statements of Asahi Komag Co., Ltd. and subsidiary as of December 31, 1997 and 1996 and for the three years in the period ended December 31, 1997. CHUO AUDIT CORPORATION Tokyo, Japan March 23, 1998 EX-27.1 6 ARTICLE 5 FIN. DATA SCHEDULE FOR 10-K
5 This schedule contains summary financial information extracted from the Balance Sheet and Statement of Operations included in the Company's Form 10-K for the year ended December 28, 1997 and is qualified in its entirety by reference to such Financial Statements. 1,000 Dec-28-1997 Dec-30-1996 Dec-28-1997 12-MOS 133,897 32,300 81,090 3,298 66,778 371,689 1,082,394 403,798 1,084,664 75,590 245,000 0 0 528 685,656 1,084,664 631,082 631,082 537,536 537,536 78,950 0 9,116 (37,820) (20,982) (22,103) 0 0 0 (22,103) ($0.42) ($0.42)
-----END PRIVACY-ENHANCED MESSAGE-----