-----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, HT01a28pIYusRlYBzxO5GvUy6//IOWKo47zxs6JIjJtnBZirYtwNhhNpD1LXO9AV khYANdJIXEAm8xv3au25HQ== 0000891618-01-502345.txt : 20020411 0000891618-01-502345.hdr.sgml : 20020411 ACCESSION NUMBER: 0000891618-01-502345 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011120 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: 0102 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-16852 FILM NUMBER: 1796849 BUSINESS ADDRESS: STREET 1: 1710 AUTOMATION PWY CITY: SAN JOSE STATE: CA ZIP: 95131 BUSINESS PHONE: 4085762000 MAIL ADDRESS: STREET 1: 1710 AUTOMATION PWY CITY: SAN JOSE STATE: CA ZIP: 95131 10-Q 1 f77201e10-q.txt FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended September 30, 2001 Commission File Number 0-16852 KOMAG, INCORPORATED (Debtor-in-Possession as of August 24, 2001) (Registrant) Incorporated in the State of Delaware I.R.S. Employer Identification Number 94-2914864 1710 Automation Parkway, San Jose, California 95131 Telephone: (408) 576-2000 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 . ------ ----- On September 30, 2001, 111,924,983 shares of the Registrant's common stock, $0.01 par value, were issued and outstanding. INDEX KOMAG, INCORPORATED
Page No. PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) Consolidated statements of operations - Three and nine months ended September 30, 2001 and October 1, 2000 3 Consolidated balance sheets - September 30, 2001 and December 31, 2000 4 Consolidated statements of cash flows - Nine months ended September 30, 2001 and October 1, 2000 5 Notes to consolidated financial statements - September 30, 2001 6-18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19-38 PART II. OTHER INFORMATION Item 1. Legal Proceedings 39 Item 2. Changes in Securities 39 Item 3. Defaults Upon Senior Securities 39 Item 4. Submission of Matters to a Vote of Security Holders 39 Item 5. Other Information 40 Item 6. Exhibits and Reports on Form 8-K 40 SIGNATURES 41
-2- PART I. FINANCIAL INFORMATION KOMAG, INCORPORATED (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited)
Three Months Ended Nine Months Ended -------------------------- -------------------------- SEPT 30 Oct 1 SEPT 30 Oct 1 2001 2000 2001 2000 ----------- ----------- ----------- ----------- Net sales to unrelated parties $ 18,380 $ 39,684 $ 107,888 $ 105,396 Net sales to related parties 41,011 44,485 116,710 141,874 ----------- ----------- ----------- ----------- NET SALES 59,391 84,169 224,598 247,270 Cost of sales 58,246 74,396 230,927 214,725 ----------- ----------- ----------- ----------- GROSS PROFIT (LOSS) 1,145 9,773 (6,329) 32,545 Operating expenses: Research, development, and engineering 9,690 8,276 30,184 25,168 Selling, general, and administrative 4,704 2,985 16,776 10,399 Amortization of intangibles 6,505 2,555 20,575 7,665 Impairment/restructuring charges (credits) -- -- 43,020 (2,661) ----------- ----------- ----------- ----------- 20,899 13,816 110,555 40,571 ----------- ----------- ----------- ----------- OPERATING LOSS (19,754) (4,043) (116,884) (8,026) Other income (expense): Interest income 181 734 1,437 2,884 Interest expense (contractual interest was $115.0 million and $158.7 million for the three- and nine-month periods ended September 30, 2001) (111,464) (8,906) (155,192) (22,814) Other, net 2,458 (285) 4,092 286 ----------- ----------- ----------- ----------- (108,825) (8,457) (149,663) (19,644) ----------- ----------- ----------- ----------- Loss before reorganization costs, income taxes, minority interest, equity in unconsolidated company loss, and extraordinary gain (128,579) (12,500) (266,547) (27,670) Reorganization costs, net 2,837 -- 2,837 -- Provision for (benefit from) income taxes (10,519) 366 (9,738) 1,192 ----------- ----------- ----------- ----------- Loss before minority interest, equity in unconsolidated company loss, and extraordinary gain (120,897) (12,866) (259,646) (28,862) Minority interest in net income (loss) of consolidated subsidiary 396 (291) (41) (747) Equity in net loss of unconsolidated company 999 -- 2,664 -- ----------- ----------- ----------- ----------- LOSS BEFORE EXTRAORDINARY GAIN (122,292) (12,575) (262,269) (28,115) Extraordinary gain -- -- -- 3,772 ----------- ----------- ----------- ----------- NET LOSS $ (122,292) $ (12,575) $ (262,269) $ (24,343) =========== =========== =========== =========== Basic and diluted loss before extraordinary gain per share $ (1.09) $ (0.19) $ (2.35) $ (0.42) Basic and diluted extraordinary gain per share -- -- -- 0.06 ----------- ----------- ----------- ----------- Basic and diluted net loss per share $ (1.09) $ (0.19) $ (2.35) $ (0.36) =========== =========== =========== =========== Number of shares used in basic and diluted computations 111,925 66,792 111,800 66,236 =========== =========== =========== ===========
See notes to consolidated financial statements. -3- KOMAG, INCORPORATED (DEBTOR-IN-POSSESSION) CONSOLIDATED BALANCE SHEETS (In thousands)
SEPT 30 Dec 31 2001 2000 ------------ ------------ (UNAUDITED) (note) ASSETS Current assets Cash and cash equivalents $ 10,813 $ 71,067 Short-term investments 1,323 9,597 Accounts receivable (including $25,737 and $19,498 due from related parties in 2001 and 2000, respectively) less allowances of $2,287 in 2001 and $5,348 in 2000 32,386 40,243 Inventories: Raw materials 6,402 8,883 Work-in-process 2,394 5,778 Finished goods 3,333 6,781 ------------ ------------ Total inventories 12,129 21,442 Prepaid expenses and deposits 3,308 6,299 ------------ ------------ Total current assets 59,959 148,648 Investment in unconsolidated company 5,336 12,000 Property, plant and equipment Land 7,785 7,785 Buildings 163,238 136,149 Equipment 480,159 497,233 Furniture 7,549 7,517 Leasehold improvements 30,478 31,931 ------------ ------------ 689,209 680,615 Less allowances for depreciation and amortization (438,577) (396,097) ------------ ------------ Net property, plant and equipment 250,632 284,518 Land and buildings held for sale 35,000 70,355 Goodwill and other net intangible assets (see Note 5) 95,556 116,131 Deposits and other assets 1,372 1,409 ------------ ------------ $ 447,855 $ 633,061 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Current portion of long-term debt $ -- $ 216,740 Trade accounts payable 10,148 29,014 Accounts payable to related parties 9,096 2,487 Accrued compensation and benefits 12,189 13,866 Other liabilities 589 18,704 Other liabilities to related party 6,756 12,000 Accrued costs to exit certain business activities 807 17,927 Income taxes payable 25 6 Restructuring liabilities 1,191 14,277 ------------ ------------ Total current liabilities 40,801 325,021 Note payable to related party -- 25,649 Convertible subordinated debt -- 111,896 Deferred income taxes 1,006 11,813 Other long-term liabilities 910 5,441 ------------ ------------ Total liabilities not subject to compromise 42,717 479,820 Liabilities subject to compromise (Note 3) 514,612 -- Minority interest in consolidated subsidiary 1,339 1,380 Stockholders' equity (deficit) Preferred stock -- -- Common stock 1,119 1,116 Additional paid-in capital 586,304 586,133 Accumulated deficit (698,236) (435,967) Accumulated other comprehensive income -- 579 ------------ ------------ Total stockholders' equity (deficit) (110,813) 151,861 ------------ ------------ $ 447,855 $ 633,061 ============ ============
Note: The balance sheet at December 31, 2000 has been derived from the audited financial statements at that date. See notes to consolidated financial statements. -4- KOMAG, INCORPORATED (DEBTOR-IN-POSSESSION) CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
Nine Months Ended ------------------------------ SEPT 30 Oct 1 2001 2000 ------------ ------------ OPERATING ACTIVITIES Net loss $ (262,269) $ (24,343) Adjustments to reconcile net loss to net cash provided by (used in) operating activities, excluding reorganization items: Impairment charge related to property, plant, and equipment 43,020 -- Depreciation and amortization 53,339 56,644 Amortization of intangibles 20,575 7,665 Extraordinary gain -- (3,772) Provision for losses on accounts receivable (312) 200 Interest accrual on note payable to related party 3,196 3,190 Accretion and amortization of interest on debt 130,861 2,302 Equity in net loss of unconsolidated company 2,664 -- Realized gain on cumulative translation adjustment (579) -- Loss on disposal of property, plant and equipment 145 248 Deferred income taxes (10,807) -- Deferred rent -- 147 Minority interest in net loss of consolidated subsidiary (41) (747) Changes in operating assets and liabilities: Accounts receivable 14,408 (8,946) Accounts receivable from related parties (6,239) 8,144 Inventories 9,313 274 Prepaid expenses and deposits 22 (4,252) Trade accounts payable (6,456) 4,646 Accounts payable to related parties (147) 1,516 Accrued compensation and benefits (1,677) 15 Other liabilities 6,002 (10,718) Other liabilities to related party (7,827) -- Income taxes refundable 27 629 Costs to exit certain business activities (14,080) -- Restructuring liabilities (5,320) (16,793) ------------ ------------ (32,182) 16,049 Reorganization items: Accretion of discount on note payable to related party 2,270 -- Professional fees 600 -- ------------ ------------ Net cash provided by (used in) operating activities (29,312) 16,049 INVESTING ACTIVITIES Acquisition of property, plant and equipment (24,947) (13,875) Purchases of short-term investments (5,133) (5,382) Proceeds from short-term investments at maturity 13,407 7,091 Proceeds from disposal of property, plant and equipment 520 1,233 Deposits and other assets 37 2,307 ------------ ------------ Net cash used in investing activities (16,116) (8,626) FINANCING ACTIVITIES Repayment of debt (15,000) (22,500) Sale of common stock, net of issuance costs 174 1,776 ------------ ------------ Net cash used in financing activities (14,826) (20,724) Decrease in cash and cash equivalents (60,254) (13,301) Cash and cash equivalents at beginning of year 71,067 65,116 ------------ ------------ Cash and cash equivalents at end of period $ 10,813 $ 51,815 ============ ============
See notes to consolidated financial statements. -5- KOMAG, INCORPORATED (DEBTOR-IN-POSSESSION) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) SEPTEMBER 30, 2001 NOTE 1 - BASIS OF PRESENTATION AND POLICY The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation of the financial position, operating results, and cash flows for the periods presented, have been included. Operating results for the three and nine-month periods ended September 30, 2001 are not necessarily indicative of the results that may be expected for the year ending December 30, 2001. The accompanying condensed consolidated financial statements as of September 30, 2001 and the related condensed consolidated statements of operations and cash flows for the three- and nine-month periods ended September 30, 2001 have not been reviewed by an independent public accountant in accordance with Statement of Auditing Standards No. 71 as required by the Securities and Exchange Commission Rules and Regulations. On November 19, 2001, the Company engaged an independent public accountant to perform a review of said condensed consolidated financial statements. The Company intends to file an amended 10-Q with the Securities and Exchange Commission after completion of such review. As discussed in Note 2, Komag, Incorporated (KUS) filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code on August 24, 2001 (the "Petition Date"). The petition was filed with the United States Bankruptcy Court for the Northern District of California. The case has been assigned to the Honorable James R. Grube under case number 01-54143-JRG. The petition affects only the Company's U.S. corporate parent, KUS, and does not include any of its subsidiaries, including Komag Material Technology (KMT), or Komag USA (Malaysia) Sdn (KMS). The Company is operating its business as a debtor-in-possession. The financial statements have been prepared on a going-concern basis, which contemplates continuity of operations, realization of assets, and liquidation of liabilities in the normal course of business. As a result of the Company's recurring losses, as well as the Chapter 11 Bankruptcy and related circumstances (including the Company's substantial debt and current economic conditions), realization of assets and liquidation of liabilities are subject to significant uncertainty. These matters, among others, raise substantial doubt about the Company's ability to continue as a going concern. The Company's ability to continue as a going concern depends on, among other things, the ability to: 1) develop a Plan of Reorganization acceptable to the Bankruptcy Court; 2) achieve satisfactory levels of future profitable operations; 3) maintain adequate financing; and 4) generate adequate cash from operations to meet future obligations. In connection with the Chapter 11 Bankruptcy, the Company is required to prepare its financial statements as of September 30, 2001 in accordance with Statement of Position 90-7, "Financial Reporting by Entities in -6- Reorganization Under the Bankruptcy Code," issued by the American Institute of Certified Public Accountants (SOP 90-7). In accordance with SOP 90-7, all of the Company's pre-petition liabilities that are subject to compromise under the proposed Plan of Reorganization (as defined in Note 2) are segregated in the Company's consolidated balance sheet as liabilities subject to compromise. These liabilities are recorded at the amounts expected to be allowed as claims in the Chapter 11 case rather than as estimates of the amounts for which those allowed claims may be settled as a result of the approved Plan of Reorganization. As of the effective date of the Plan of Reorganization, the Company expects to adopt "fresh start" reporting as defined in SOP 90-7. In accordance with "fresh start" reporting, the reorganization value of the Company will be allocated to the emerging entity's specific tangible and identified intangible assets. Excess reorganization value, if any, will be reported as "reorganization value in excess of amounts allocable to identifiable assets." As a result of the adoption of such "fresh start" reporting, the Company's post-emergence financial statements ("successor") will not be comparable with its pre-emergence financial statements ("predecessor"), including the historical financial statements included in this quarterly report. The accompanying statements of operations reflect certain reorganization costs, including professional fees and accretion to full value of the note payable to a related party. Interest expense on the Company's senior bank debt, subordinated convertible notes, subordinated unsecured convertible debt, and note payable has been recorded to the petition date. Such interest expense was not recorded subsequent to that date because it will not be paid during the bankruptcy case (except from distributions otherwise allocable to subordinated creditors) and will not be an allowed claim under the Plan of Reorganization. The difference between recorded interest expense and stated contractual interest expense is approximately $3.5 million for the period from August 25 to September 30, 2001. In accordance with SOP 90-7, a significant portion of the Company's outstanding debt, related accrued interest, and pre-petition accounts payable is classified as "liabilities subject to compromise" at September 30, 2001. Comparable items in the prior year have not been reclassified to the presentation required by SOP 90-7. See Note 3 for a complete description of liabilities subject to compromise. The accompanying consolidated financial statements include the consolidated financial position and results of operations of all of the Company's entities, including KUS. The following condensed financial statements reflect the financial position and results of operations of KUS only, using the equity method of accounting for reporting the results of operations of all subsidiaries of the Company which are not debtors in the Chapter 11 case. -7- Komag, Incorporated (KUS) Debtor-In-Possession Condensed Statement of Operations (Unaudited) (In Thousands)
Three Months Ended Nine Months Ended ------------------------------ ------------------------------ Sept 30 Oct 1 Sept 30 Oct 1 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Net sales $ 1,776 $ 7,901 $ 30,848 $ 18,439 Cost of sales (6,935) (13,411) (65,535) (34,672) ------------ ------------ ------------ ------------ Gross loss (5,159) (5,510) (34,687) (16,233) Research, development, and engineering expenses 7,779 6,664 19,957 20,312 Selling, general, and administrative expenses 3,468 1,956 12,965 7,425 Amortization of intangible assets 3,950 -- 12,910 -- Impairment/restructuring charges (credits) -- -- 43,020 (2,661) ------------ ------------ ------------ ------------ Operating loss (20,356) (14,130) (123,539) (41,309) Interest income 89 667 1,158 2,686 Interest expense (111,464) (8,902) (155,192) (22,807) Intercompany income, net 17,329 16,338 70,606 38,539 Other income, net 2,769 369 3,541 1,759 Equity in net income (loss) of non-debtor subsidiaries (17,974) (6,567) (52,244) (8,133) ------------ ------------ ------------ ------------ Loss before reorganization costs, income taxes, minority interest and equity in unconsolidated company loss (129,607) (12,225) (255,670) (29,265) Reorganization costs, net 2,837 -- 2,837 -- Provision for (benefit from) income taxes (10,152) 350 (9,436) 1,150 ------------ ------------ ------------ ------------ Loss before extraordinary gain (122,292) (12,575) (262,269) (28,115) Extraordinary gain -- -- -- 3,772 ------------ ------------ ------------ ------------ Net loss $ (122,292) $ (12,575) $ (262,269) $ (24,343) ============ ============ ============ ============
-8- Komag, Incorporated (KUS) Debtor-In-Possession Condensed Balance Sheet (Unaudited) (In Thousands) SEPTEMBER 30, 2001 ------------ ASSETS Current Assets Cash and cash equivalents $ 3,551 Accounts receivable, net 2,707 Intercompany receivables with companies not debtors in bankruptcy 13,851 Inventories, net 726 Prepaid expenses and deposits 1,736 ------------ Total current assets 22,571 Investment in subsidiaries not debtors in bankruptcy 258,325 Investment in unconsolidated company 5,336 Net property, plant and equipment 63,006 Goodwill and other net intangible assets 90,445 Deposits and other assets 1,299 Long-term intercompany receivables with companies not debtors in bankruptcy 195,572 ------------ Total assets $ 636,553 ============ Liabilities and Stockholders' Equity Current liabilities Trade accounts payable $ 1,348 Intercompany payables with companies not debtors in bankruptcy 454 Accrued compensation and benefits 7,092 Other liabilities 97 Other liabilities to related parties 6,756 Costs to exit certain business activities 807 Restructuring liabilities ------------ Total current liabilities 16,554 Deferred income taxes 1,006 Other long-term liabilities 910 Minority interest in consolidated subsidiary 0 ------------ Total liabilities not subject to compromise 18,470 Liabilities subject to compromise 514,612 Stockholders' equity Common stock 1,119 Additional paid-in capital 586,205 Accumulated deficit (483,853) ------------ Total stockholders' equity 103,471 ------------ Total liabilities and stockholders' equity $ 636,553 ============ For further information, refer to the consolidated financial statements and related footnotes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000. The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. The three-month reporting periods included in this report are comprised of thirteen weeks. -9- Certain reclassifications have been made to the prior year balances in order to conform to the current year presentation. Long-lived assets and certain identifiable intangible assets are generally evaluated for impairment on an individual acquisition, market, or product basis whenever events or changes in circumstances indicate that such assets may be impaired or the estimated useful lives are no longer appropriate. The Company considers the primary indicators of impairment to include significant decreases in unit volumes, unit prices or significant increases in production costs. Periodically, the Company reviews its long-lived assets and certain identifiable intangible assets for impairment based on estimated future undiscounted cash flows attributable to the assets. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values utilizing discounted cash flows. The discount rate that will be used will be based on the estimated incremental borrowing rate at the date of the event that triggered the impairment. NOTE 2 -- REORGANIZATION UNDER CHAPTER 11 On August 24, 2001, Komag, Incorporated filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. The Company has continued operations since the petition date, and expects to continue its operations during the Chapter 11 process. The Company filed a proposed Plan of Reorganization on September 21, 2001, which it amended on November 9, 2001, and by which it intends to satisfy and discharge the claims underlying the liabilities discussed in Note 3 below. As amended, the proposed Plan of Reorganization, which must be confirmed by the Bankruptcy Court, currently has the support of creditors holding more than one-half, or $260 million, of the Company's estimated outstanding debt. On November 9, 2001, the Bankruptcy Court held a hearing regarding the adequacy of information in the amended Disclosure Statement that was previously filed with respect to the amended Plan of Reorganization. The Court preliminarily approved the amended Disclosure Statement, subject to some changes which are not substantive. After the Company makes the necessary modifications, it will send the Disclosure Statement and the proposed Plan of Reorganization to all of its creditors and shareholders shortly. The proposed Plan of Reorganization may be modified materially before it is confirmed. NOTE 3 -- LIABILITIES SUBJECT TO COMPROMISE Liabilities included in the accompanying consolidated balance sheet at September 30, 2001, which are subject to compromise under the terms of the Plan of Reorganization, are summarized as follows (in thousands):
Priority Tax Claims $ 1,861 Loan Restructure Agreement Claims 206,140 Western Digital Note Claim 33,783 Western Digital Rejection Claims 9,087 Convertible Notes Claims 10,193 Subordinated Notes Claims 238,258 General Unsecured Claims 15,290 ------------ Total liabilities subject to compromise $ 514,612 ============
-10- The above balance sheet amounts may differ from the estimates included in the amended Disclosure Statement filed on November 9, 2001. The estimates in the amended Disclosure Statement reflect the Company's best estimate as of November 9, 2001, as to the claims that will be allowed in the bankruptcy case. Priority Tax Claims This reflects the liability for property, sales, and income taxes that were unpaid as of August 24, 2001. Loan Restructure Agreement Claims This reflects the outstanding $201.7 million principal balance of the senior unsecured bank debt. In June 2000, the Company entered into a senior unsecured loan restructure agreement with its senior lenders. Under the loan restructure agreement, the bank debt became due and payable on June 30, 2001. The amount includes accrued interest of $4.4 million through August 24, 2001. Western Digital Note Claim This reflects a note to Western Digital in the principal amount of $30.1 million in connection with the purchase of the assets of Western Digital's media operation in April 1999. The note is subordinate to the Company's senior bank debt. The note was originally due in April 2002 and was subordinated to the Company's senior bank debt. The amount includes $3.7 million in accrued interest through August 24, 2001. Western Digital Rejection Claims This reflects the liability for all unused equipment leases in connection with the closure of the media operation acquired from Western Digital in April 1999. Convertible Notes Claims This reflects the outstanding $9.3 million of subordinated unsecured convertible debt that was scheduled to mature in 2005. This convertible debt was issued in June 2000 as part of the restructuring of the senior bank debt. The convertible debt lenders have the right to purchase additional convertible notes in an aggregate principal amount of up to $35.7 million. The original $9.3 million in convertible notes is convertible into shares of the Company's common stock, at the lenders' option, at any time on or after the issuance date of the convertible notes, at a conversion price of $2.53. The convertible notes bear interest of 8%, payable on the maturity date of the convertible notes. At the Company's option, the convertible notes are convertible into the Company's common stock, with no forced conversion for two years, on any date on which the closing sale price of the common stock has been, for seven of ten consecutive trading days, greater than 200% of the conversion price in effect on the issuance date of the applicable convertible notes. This amount includes $0.9 million in accrued interest through August 24, 2001. -11- Subordinated Notes Claims This reflects the outstanding $230.0 million in subordinated convertible notes assumed in the merger with HMT Technology. The HMT notes originally bore interest at 5 3/4% payable semiannually on January 15 and July 15, were convertible into shares of common stock of the Company at a conversion price of $26.12, and were scheduled to mature in January 2004. The Company has not paid the interest on the HMT notes that was due on July 15, 2001. This amount includes $8.3 million in accrued interest through August 24, 2001. General Unsecured Claims This reflects the liability for: 1) all materials and services that were received by KUS but not yet paid as of August 24, 2001; 2) remaining lease payments for unused equipment leased by HMT Technology; and 3) unpaid severance costs as of August 24, 2001. NOTE 4 - INVESTMENT IN DEBT SECURITIES The Company invests its excess cash in high-quality, short-term debt instruments. None of the Company's investments in debt securities have maturities greater than one year. The following is a summary of the Company's investments by major security type at amortized cost, which approximates fair value: (in thousands) SEPTEMBER 30, December 31, 2001 2000 ------------ ------------ Municipal auction rate certificates $ -- $ 28,500 Corporate debt securities 3,149 17,153 Mortgage-backed securities -- 13,991 Government-backed securities 3,157 8,045 ------------ ------------ $ 6,306 $ 67,689 ============ ============ Amounts included in cash and cash equivalents $ 4,983 $ 58,092 Amounts included in short-term investments 1,323 9,597 ------------ ------------ $ 6,306 $ 67,689 ============ ============
The Company utilizes zero-balance accounts and other cash management tools to invest all available funds including bank balances in excess of book balances. -12- NOTE 5 - GOODWILL AND OTHER NET INTANGIBLE ASSETS The following table presents the details of the goodwill and other net intangible assets:
(in thousands) SEPT 30 Dec 31 2001 2000 ------------ ------------ Goodwill associated with purchase of assets and volume purchase agreement from Western Digital, net $ 5,111 $ 12,776 Goodwill associated with HMT merger, net 84,917 95,532 Other intangibles associated with HMT merger, net: Current technology 3,198 3,996 Patents 2,330 2,768 Other -- 1,059 ------------ ------------ 90,445 103,355 ------------ ------------ Net goodwill and other intangible assets $ 95,556 $ 116,131 ============ ============
The remaining goodwill will be amortized using the straight-line method through December 30, 2001. The other intangibles are being amortized using the straight-line method. Subsequent to December 30, 2001, the Company will follow the guidance prescribed by FAS 142. See Note 16. NOTE 6 - INCOME TAXES The Company derived income tax benefits of $10.5 million and $9.7 million for the three- and nine-month periods ended September 30, 2001, primarily related to the expiration of a statutory period to audit the Company's state tax returns, net of foreign withholding taxes on royalty and interest payments, and foreign taxes of subsidiaries. The Company's income tax provisions for the three- and nine-month periods ended October 1, 2000, were $0.4 and $1.2 million, respectively, and represented foreign withholding taxes on royalty and interest payments, and foreign taxes of subsidiaries. The Company's wholly-owned thin-film media operation, KMS, received a five-year extension of its initial tax holiday through June 2003, for its first plant site in Malaysia. KMS has also been granted an additional eight-year and ten-year tax holiday through December 2006 and 2008 for its second and third plant sites in Malaysia, respectively, based on achieving certain investment criteria. NOTE 7 - COMPREHENSIVE LOSS Comprehensive loss for the three- and nine-month periods ended September 30, 2001, and October 1, 2000, in the accompanying Consolidated Statements of Operations is the same as the Company's net loss. Accumulated other comprehensive income at December 31, 2000, in the accompanying Consolidated Balance Sheets consists entirely of accumulated foreign currency translation adjustments. These accumulated foreign currency translation adjustments were realized as a gain due to the liquidation of the Company's joint -13- venture in Japan in the three-month period ended April 1, 2001, resulting in a zero balance in accumulated other comprehensive income at September 30, 2001. NOTE 8 - RESTRUCTURING CHARGES In the third quarter of 1999, 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 and long-term market demand outlook. Under the 1999 restructuring plan, the Company decided to close its U.S. manufacturing operations in San Jose, California. The restructuring actions resulted in a charge of $139.3 million and included $98.5 million for leasehold improvements and equipment write-offs, $17.7 million for future liabilities under non-cancelable equipment leases associated with equipment no longer being used, $15.6 million for severance pay associated with approximately 980 terminated employees (all in the U.S. and predominately all from the manufacturing area), and $7.5 million in plant closure costs. Non-cash items included in the restructuring charge totaled $98.5 million for the write-off of leasehold improvements and equipment. The following table summarizes these 1999 restructuring activities during the first nine months of 2001:
Liabilities Under Non-Cancelable Equipment (in millions) Leases Total -------------- -------------- Balance at December 31, 2000 $ 6.3 $ 6.3 Charged to Reserve (2.4) (2.4) Reclassifications (3.9) (3.9) -------------- -------------- Balance at September 30, 2001 $ 0.0 $ 0.0 ============== ==============
In the third quarter of 2001, the remaining reserve balance of $3.9 million associated with certain Western Digital unused equipment leases was reclassified to Liabilities Subject to Compromise (see Note 3). In 2001, 2000, and 1999, the Company made cash payments totaling $39.2 million. In the first quarter of 2000, the 1999 restructuring reserves were reduced by a total of $2.0 million. The writedown of net book value of equipment and leasehold improvements was increased by $2.4 million during the first quarter of 2000 for additional equipment that was determined unusable due to the restructure. The facility closure liability was reduced by $3.7 million in the first quarter of 2000 due to successfully terminating the leases on manufacturing facilities and subleasing the administrative facility earlier than originally expected. The severance costs liability was reduced by $0.7 million due to lower than expected payments in the first quarter of 2000. In December 2000, the Company implemented a restructuring plan related to KMT's U.S. manufacturing operations in May 2001. This restructuring action resulted in a charge of $8.0 million, and included $2.6 million of severance pay associated with eliminating approximately 160 positions, primarily in manufacturing, $4.5 million associated with the write-down of equipment and leasehold improvements, and $0.9 million associated with related facility closing costs. Through the first nine months of 2001, charges to the reserve of $6.8 million had been made. The balance of the restructuring costs is expected to be paid through 2004, the remaining lease term of the facility. -14- The following table summarizes these 2000 restructuring activities:
Writedown Net Book Value of Equipment and Facility Leasehold Closure Severance (in millions) Improvements Costs Costs Total ------------- ------------ ------------ ------------ Balance at December 31, 2000 $ 4.5 $ 0.9 $ 2.6 $ 8.0 Charged to Reserve (4.5) (0.1) (2.2) (6.8) ------------- ------------ ------------ ------------ Balance at September 30, 2001 $ -- $ 0.8 $ 0.4 $ 1.2 ============= ============ ============ ============
NOTE 9 -- IMPAIRMENT CHARGES In the second quarter of 2001, the Company recorded impairment charges of $43.0 million. A charge of $35.4 million reflected the write-down of land and buildings held for sale in Eugene, Oregon, and Fremont, California. The write-down reflected currently depressed market conditions for commercial real estate and was based on estimated fair market value quotes received from local realtors, less estimated selling expenses. The remaining $7.6 million charge primarily reflected the recognition of lease obligations for equipment no longer in service due to the general slowdown in the economy and the related weak media market. NOTE 10 - LOSS PER SHARE The net loss per share was computed using only the weighted average number of shares of common stock outstanding during the period. Incremental common shares attributable to the exercise of outstanding options (assuming proceeds would be used to purchase treasury stock) of 84,672 and 120,559 for the three months ended September 30, 2001 and October 1, 2000, respectively, and 300,850 and 227,656 for the nine months ended September 30, 2001 and October 1, 2000, respectively, were not included in the net loss per share computation because the effect would be antidilutive. Incremental common shares attributable to the exercise of outstanding warrants (assuming proceeds would be used to purchase treasury stock) of zero and 200,693 for the three months ended September 30, 2001 and October 1, 2000, and of zero and 87,635 for the nine months ended September 30, 2001 and October 1, 2000, respectively, were not included in the net loss per share computation because the effect would be antidilutive. Incremental common shares attributable to convertible debt of 12,474,181 and 3,668,668 for the three months ended September 30, 2001, and October 1, 2000, respectively, and of 12,474,181 and 2,479,375 for the nine months ended September 30, 2001, and October 1, 2000, respectively, were not included in the net loss per share computation because the effect would be antidilutive. -15- NOTE 11 - 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 12 -- LIABILITIES ASSOCIATED WITH PURCHASE OF ASSETS In April 1999, the Company purchased the assets of Western Digital Corporation's (Western Digital) media operation. In conjunction with the purchase, under purchase accounting rules, the Company recorded liabilities that increased the amount of goodwill recognized. These liabilities included estimated costs of $5.6 million for the closure of the former Western Digital media operation as well as costs of $26.5 million related to the remaining lease obligations for equipment taken out of service due to the closure, and $4.7 million of costs for purchase order cancellations and other costs. During 1999, 2000 and the first nine months of 2001, liabilities arising from this transaction were reduced by $32.4 million, including equipment lease obligations ($23.3 million), rent ($1.9 million) and other liabilities ($7.1 million). In the third quarter of 2001, the remaining liability of $4.4 million, representing unused equipment lease payments, was reclassified to Liabilities subject to Compromise (see Note 3). NOTE 13 -- LIABILITIES ASSOCIATED WITH MERGER On October 2, 2000, the Company merged with HMT. HMT was headquartered in Fremont, California, and designed, developed, manufactured, and marketed high-performance thin-film disks. In connection with the merger, in the fourth quarter of 2000, the Company implemented a reorganization plan which included a reduction in the Company's U.S. workforce and the cessation of manufacturing operations in the U.S. This transition was completed in the second quarter of 2001. U.S. production ended at all U.S. facilities by the end of April 2001. Under purchase accounting rules, the Company recorded liabilities that included $12.2 million for estimated severance pay associated with the termination of approximately 980 employees and $5.7 million for estimated facility closure costs for the closure of certain former HMT U.S. manufacturing operations. Payments against these liabilities are expected to be paid by the fourth quarter of 2001. In 2000 and the first nine months of 2001, $15.5 million of payments were made against these liabilities. Certain of the remaining liabilities for severance and prior years' property taxes were reclassified to Liabilities Subject to Compromise (see Note 3). NOTE 14 -- EQUITY IN UNCONSOLIDATED COMPANY In November 2000, the Company formed Chahaya Optronics, Inc. (Chahaya) with two venture capital firms. The Company contributed key personnel, design and tooling, manufacturing systems, equipment, facilities, and support services in exchange for a 45% interest in Chahaya. Chahaya currently occupies facilities located in Fremont, California, and was formed to provide manufacturing services, primarily in the field of optical components and subsystems. -16- The Company recorded an investment in Chahaya for $12.0 million in the fourth quarter of 2000. The investment included $4.0 million for future cash payments and $8.0 million for facilities, facility services, and equipment. In June 2001, the Company's investment was reduced by $4.0 million due to cancellation of the shares related to the future $4 million cash contribution. This reduced the Company's ownership percentage to 35%. As of September 30, 2001, the Company's remaining liability for facilities and facility services is $6.8 million. In the third quarter and first nine months of 2001, the Company recorded losses of $1.0 million and $2.7 million as its 35% equity share of Chahaya's net loss. The Company uses the equity method to account for its investment in Chahaya. NOTE 15 -- LEGAL PROCEEDINGS Komag, Incorporated (KUS) filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code on August 24, 2001 (the "Petition Date"). The petition was filed with the United States Bankruptcy Court for the Northern District of California. The case has been assigned to the Honorable James R. Grube under case number 01-54143-JRG. The petition affects only the Company's U.S. corporate parent, KUS, and does not include any of its subsidiaries, including Komag Material Technology (KMT), or Komag USA (Malaysia) Sdn (KMS). The Company is operating its business as a debtor-in-possession. See Notes 1, 2, and 3 for additional information. Asahi Glass Company, Ltd. (Asahi) has asserted that a technology cooperation agreement (the agreement) between the Company and Asahi gives Asahi exclusive rights, even as to Komag, to certain low-cost glass substrate-related intellectual property developed by the Company. In connection with the Chapter 11 Bankruptcy filing, the Bankruptcy Court, on October 19, 2001, ordered that the agreement be rejected, effective as of the petition date. The Company suspended the development of its low-cost glass substrate program on October 17, 2001. The Company currently has entered into a settlement Stipulation with Asahi to resolve the dispute regarding ownership of intellectual property and "know-how" developed by the Company prior to June 29, 2001, the agreed date of termination of the agreement. As part of that Stipulation, Asahi waived claims against the Company relating to the agreement. The Company believes that the resolution of the dispute will not have a significant financial impact on the Company's financial results. NOTE 16 -- NEW ACCOUNTING PRONOUNCEMENTS On June 29, 2001, the Financial Accounting Standards Board (FASB) approved the final standards resulting from its deliberations on the business combinations project. The FASB issued two statements in July 2001, Statement of Financial Accounting Standards No. 141, or FAS 141, on Business Combinations and FAS 142 on Goodwill and Other Intangible Assets. FAS 141 is effective for any business combinations initiated after June 30, 2001, and also includes the criteria for the recognition of intangible assets separately from goodwill. FAS 142 is effective for fiscal years beginning after December 15, 2001, and will require that goodwill not be amortized, but rather be subject to an impairment test at least annually. Separately identified and recognized intangible assets resulting from business combinations completed before July 1, 2001 that do not meet the new criteria for separate recognition of intangible assets will be subsumed into goodwill upon adoption. In addition, the useful lives of recognized intangible assets acquired in transactions completed before July 1, 2001 will be reassessed and the remaining amortization periods adjusted accordingly. -17- In June 2001, the FASB issued SFAS 143 "Accounting for Asset Retirement Obligations." SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. As used in this Statement, a legal obligation results from existing law, statute, ordinance, written or oral contract, or by legal construction of a contract under the doctrine of promissory estoppel. SFAS 143 is effective for fiscal years beginning after June 15, 2002. We do not expect the adoption of SFAS 143 to have a material impact on our financial position or results of operations. In October 2001, the FASB issued SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," and also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business. SFAS 144 is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The Company is in the process of determining the impact of this new accounting standard. NOTE 17 -- NASDAQ DELISTINGS On September 17, 2001, the Company withdrew its appeal to the Nasdaq Listing Qualifications Panel, and voluntarily delisted its common stock from the Nasdaq National Market. The Company's stock is currently trading on the OTC Bulletin Board under the symbol KMAGQ. On October 19, 2001, Nasdaq delisted the 5 3/4% subordinated convertible bonds due in January, 2004, that were originally issued by HMT Technology Corporation. -18- KOMAG, INCORPORATED MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The following discussion contains predictions, estimates, and other forward-looking statements that involve a number of risks and uncertainties about our business. These statements may be identified by the use of words such as "expects," "anticipates," "intends," "plans," and similar expressions. Komag's business is subject to a number of risks and uncertainties. While this discussion represents our current judgment on the future direction of our business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. Some of the important factors that may influence possible differences are continued competitive factors, pricing pressures, changes in customer demand, developments in and the outcome of the Chapter 11 proceedings described below, and general economic conditions. OVERVIEW Our business is characterized by high fixed costs, and is therefore volume-sensitive, making it imperative that we plan for the efficient use of capacity. The key factors in determining our profitability are physical capacity, utilization of this physical capacity, yields, input material costs, and average unit sales price. If we fix capacity and product price at a given level, and demand is sufficient to support a higher level of output, then the increased output achieved by improved utilization rates and higher manufacturing yields will directly increase sales and improve gross margins. Alternatively, if demand decreases, falling average selling prices and lower capacity utilization will adversely affect our operating results. Demand for disk drives grew rapidly during the mid-1990s, and industry forecasts were for continued strong growth. Along with many of our competitors (both independent disk manufacturers and captive disk manufacturers owned by vertically- integrated disk drive customers), in 1996 we committed to expansion programs and substantially increased media manufacturing capacity in 1997. In addition, the disk drive industry transitioned to and widely adopted magneto-resistive, or MR, media and recording head technology. This transition to MR components led to unprecedented increases in areal density and, therefore, the amount of data that could be stored on a single disk platter. The rate of increased storage per disk platter increased from 30% to 40% per year to over 100% per year. Increased storage capacity per disk allows drive manufacturers to offer lower-priced disk drives by incorporating fewer disk and head components into their disk drives. Because of this lower disk-per-drive ratio, demand for disks was relatively flat during the period from 1997 to 2001, resulting in substantial excess disk production capacity and sharp declines in average selling prices. The significant amount of captive capacity employed by certain disk drive manufacturers also continued to reduce the market opportunities for independent disk suppliers such as our company. In response to continuing excess industry capacity and the sharp decline in average selling prices, we ended volume production of finished disks in the U.S. by the end of 1999, and consolidated finished disk production in our low-cost plants in Malaysia. -19- In October 2000, we merged with HMT. The merger was accounted for under purchase accounting rules. The Company's consolidated financial statements include the operating results of HMT since the fourth quarter of 2000. In the fourth quarter of 2000, in connection with the merger, we implemented a reorganization plan to end volume production at the HMT U.S. facilities, and cease substrate manufacturing operations in Santa Rosa, California. Volume production ended at all of these U.S. sites in April 2001. Our California sites in San Jose and Santa Rosa are now focused solely on activities related to research, process development, and product prototyping. Our selling, general, and administrative functions also remain in California. We believe that completion of the shift of high-volume production to our cost-advantaged Malaysian manufacturing plants will improve our overall cost structure, result in lower unit production costs, and improve our ability to respond to the continuing price pressures in the disk industry. Net Sales Net sales decreased to $59.4 million in the third quarter of 2001, down 29.4% compared to $84.2 million in the third quarter of 2000. The year-over-year decrease was primarily due to the net effect of a 20.5% decrease in unit sales volume (from 12.2 million disks in the third quarter of 2000 to 9.7 million disks in the third quarter of 2001), and an 8.1% decrease in the finished disk average selling price (from $6.53 in the third quarter of 2000 to $6.00 in the third quarter of 2001). Net sales in the first nine months of 2001 decreased by $22.7 million to $224.6 million, a 9.2% decrease from $247.3 million in the first nine months of 2000. Unit sales volume decreased by 4.0%, to 33.4 million units from 34.8 million units. Additionally, the finished disk average selling price declined by 6.2% during this period, to $6.25 from $6.66. Net sales of substrate and single-sided disks were $1.0 million in the third quarter of 2001, and $4.6 million in the third quarter of 2000. Net sales of substrate and single-sided disks in the first nine months of 2001 were $16.2 million, and $15.7 million in the first nine months of 2000. The moderate year-over-year price decline is an indication that pricing has somewhat stabilized, compared to the trend over the past few years. Also, because industry capacity decreased during the last year, pricing pressure is moderating, and we expect average selling prices to remain flat during the remainder of 2001. During the third quarter of 2001, 69% of our consolidated net sales were to Western Digital and 24% were to Maxtor Corporation. Net sales to each of our other customers were less than 10% during the third quarter of 2001. We expect that we will continue to derive more than 90% of our sales from Western Digital and Maxtor. The distribution of sales among customers may vary from quarter to quarter based on the relative success of customer programs for which we are qualified and shipping. However, as a result of the April 1999, acquisition of Western Digital's media operation and related volume purchase agreement, we expect our sales to remain highly dependent on Western Digital's performance in the disk drive industry. Gross Margin Our overall gross profit percentage of 1.9% in the third quarter of 2001 declined from a gross margin -20- percentage of 11.6% in the third quarter of 2000, an overall decline of 9.7 percentage points. The reduction in the finished disk average selling price accounted for 7.8 percentage points of the decline. Higher per-unit costs resulting from lower production volume (9.2 million units in the third quarter of 2001 versus 11.4 million units in the third quarter of 2000) accounted for the remaining 1.9 percentage points of the decline. The decrease in unit production corresponds with the decreased sales volume compared to the same quarter in the prior year. For the first nine months of 2001, we sustained a gross loss percentage of 2.8%, compared to a gross margin percentage of 13.2% for the first nine months of 2000. The overall 16.0 point decrease was the result of a lower finished disk average selling price (5.7 percentage points) and higher per unit fixed costs associated with lower unit production and production at our U.S. production facilities prior to their closure (10.3 points). Operating Expenses Research, development, and engineering (R&D) expenses increased to $9.7 million in the third quarter of 2001 from $8.3 million in the third quarter of 2000, and increased to $30.2 million in the first nine months of 2001 from $25.2 million in the first nine months of 2000. The increases were the result of increased U.S. R&D headcount subsequent to the HMT merger. The combined R&D team has increased its focus on advanced technologies and new production processes for the multiple manufacturing equipment types of the combined company. Selling, general and administrative (SG&A) expenses increased to $4.7 million in the third quarter of 2001, from $3.0 million in the third quarter of 2000, and increased to $16.8 million in the first nine months of 2001 from $10.4 million in the first nine months of 2000. The year-over-year quarterly increase was primarily due to higher payroll and related expenses due to increased U.S. headcount from the HMT merger. The year-over-year nine-month increase was primarily due to higher payroll and related expenses due to increased U.S. headcount from the HMT merger, as well as higher discretionary bonus expenses and higher professional fees associated with the withdrawn financial restructuring plan. Amortization of intangible assets increased to $6.5 million in the third quarter of 2001 from $2.6 million in the third quarter of 2000, and increased to $20.6 million in the first nine months of 2001 from $7.7 million in the first nine months of 2000. The increases reflect amortization of goodwill associated with the HMT merger. Restructuring Charges In the third quarter of 1999, 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 and long-term market demand outlook. Under the 1999 restructuring plan, the Company decided to close its U.S. manufacturing operations in San Jose, California. The restructuring actions resulted in a charge of $139.3 million and included $98.5 million for leasehold improvements and equipment write-offs, $17.7 million for future liabilities under non-cancelable equipment leases associated with equipment no longer being used, $15.6 million for severance pay associated with approximately 980 terminated employees (all in the U.S. and predominately all from the manufacturing area), and $7.5 million in plant closure costs. Non-cash items included in the restructuring charge totaled $98.5 million for the write-off of leasehold improvements and equipment. -21- The following table summarizes these 1999 restructuring activities during the first nine months of 2001:
Liabilities Under Non-Cancelable Equipment (in millions) Leases Total -------------- -------------- Balance at December 31, 2000 $ 6.3 $ 6.3 Charged to Reserve (2.4) (2.4) Reclassifications (3.9) (3.9) -------------- -------------- Balance at September 30, 2001 $ 0.0 $ 0.0 ============== ==============
In the third quarter of 2001, the remaining reserve balance of $3.9 million associated with certain Western Digital unused equipment leases was reclassified to Liabilities Subject to Compromise (see Note 3). In 2001, 2000, and 1999, the Company made cash payments totaling $39.2 million. In the first quarter of 2000, the 1999 restructuring reserves were reduced by a total of $2.0 million. The writedown of net book value of equipment and leasehold improvements was increased by $2.4 million during the first quarter of 2000 for additional equipment that was determined unusable due to the restructure. The facility closure liability was reduced by $3.7 million in the first quarter of 2000 due to successfully terminating the leases on manufacturing facilities and subleasing the administrative facility earlier than originally expected. The severance costs liability was reduced by $0.7 million due to lower than expected payments in the first quarter of 2000. In December 2000, the Company implemented a restructuring plan related to KMT's U.S. manufacturing operations in May 2001. This restructuring action resulted in a charge of $8.0 million, and included $2.6 million of severance pay associated with eliminating approximately 160 positions, primarily in manufacturing, $4.5 million associated with the write-down of equipment and leasehold improvements, and $0.9 million associated with related facility closing costs. Through the first nine months of 2001, charges to the reserve of $6.8 million had been made. The balance of the restructuring costs is expected to be paid through 2004, the remaining lease term of the facility. The following table summarizes these 2000 restructuring activities: 2000 Restructuring Reserve
Writedown Net Book Value of Equipment and Facility Leasehold Closure Severance (in millions) Improvements Costs Costs Total ------------- ------------ ------------ ------------ Balance at December 31, 2000 $ 4.5 $ 0.9 $ 2.6 $ 8.0 Charged to Reserve (4.5) (0.1) (2.2) (6.8) ------------- ------------ ------------ ------------ Balance at September 30, 2001 $ -- $ 0.8 $ 0.4 $ 1.2 ============= ============ ============ ============
-22- Impairment Charges In the second quarter of 2001, the Company recorded impairment charges of $43.0 million. A charge of $35.4 million reflected the write-down of land and buildings held for sale in Eugene, Oregon, and Fremont, California. The write-down reflected currently depressed market conditions for commercial real estate and was based on estimated fair market value quotes received from local realtors. The remaining $7.6 million charge primarily reflected the recognition of lease obligations for equipment no longer in service due to the general slowdown in the economy and the related weak media market. We review and evaluate our long-lived assets and certain identifiable intangible assets for impairment on an individual acquisition, market, or product basis whenever events or changes in circumstances indicate that such assets may be impaired or the estimated useful lives are no longer appropriate. We consider the primary indicators of impairment to include significant decreases in unit volumes, unit prices, or significant increases in production costs. Periodically, we review our long-lived assets and certain identifiable intangible assets for impairment based on estimated future undiscounted cash flows attributable to the assets. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values utilizing discounted cash flows. At September 30, 2001, we had approximately $95.6 million of goodwill and other net intangible assets which were primarily related to the merger in October 2000. During 2001, we have periodically reviewed our long-lived assets as described in Note 1. Due to the continuing market weakness for products, we expect to perform further impairment review of our long-lived assets prior to the end of the fiscal year. If, as a result of this analysis, we determine that there has been an impairment of our goodwill, intangible assets, and/or property and equipment, asset impairment charges will be recognized. Asset impairment charges of this nature could be large, and could have a material adverse effect on our financial position and results of operations. Interest and Other Income/Expense Interest income decreased by $0.6 million and $1.4 million in the three and nine-month periods ended September 30, 2001, versus the same periods ended October 1, 2000 due to lower average cash and short-term investment balances. Interest expense increased by $102.6 million and $132.4 million in the three and nine-month periods ended September 30, 2001, versus the same periods ended October 1, 2000. The increases primarily reflect accretion on the value of the subordinated convertible notes to face value of $230 million in the third quarter of 2001 (due to the default on such notes prior to the application for bankruptcy), interest on the subordinated convertible notes, and amortization of loan fees and warrant expense associated with the completion of the loan restructure agreement with our senior lenders in the second quarter of 2000. Other income increased by $2.7 million and $3.8 million in the three and nine-month periods ended September 30, 2001, versus the same periods ended October 1, 2000. The quarter-over-quarter increase resulted primarily from a one-time $1.8 million refund for certain R&D manufacturing equipment work which was not completed by a vendor. The year-over-year increase also included $0.6 million in realized gain on cumulative translation adjustments. -23- Income Taxes We derived income tax benefits of $10.5 million and $9.7 million for the three- and nine-month periods ended September 30, 2001, primarily related to the expiration of a statutory period to audit our state tax returns, net of foreign withholding taxes on royalty and interest payments, and foreign taxes of subsidiaries. Our income tax provisions for the three- and nine-month periods ended October 1, 2000, were $0.4 and $1.2 million, respectively, and represented foreign withholding taxes on royalty and interest payments, and foreign taxes of subsidiaries. Our wholly-owned thin-film media operation, KMS, received a five-year extension of its initial tax holiday through June, 2003, for its first plant site. KMS has also been granted an additional eight-year and ten-year tax holiday through December 2006 and 2008 for its second and third plant sites in Malaysia, respectively, based on achieving certain investment criteria. Minority Interest in KMT The minority interest in the net income (loss) of consolidated subsidiary represented Kobe Steel USA Holdings Inc.'s (Kobe USA) 20% share of KMT's net income (loss). KMT recorded net income of $2.0 and a $0.2 million net loss for the three- and nine-month periods ended September 30, 2001, compared to net losses of $1.5 million and $3.7 million for the same periods ended October 1, 2000. Equity in Unconsolidated Company In November 2000, we formed Chahaya Optronics, Inc. (Chahaya) with two venture capital firms. We contributed key personnel, design and tooling, manufacturing systems, equipment, facilities, and support services in exchange for a 45% interest in Chahaya. Chahaya currently occupies facilities located in Fremont, California, and was formed to provide manufacturing services, primarily in the field of optical components and subsystems. We recorded an investment in Chahaya for $12.0 million in the fourth quarter of 2000. The investment included $4.0 million for future cash payments and $8.0 million for facilities, facility services, and equipment. In June 2001, our investment was reduced by $4.0 million due to cancellation of the shares related to the future $4 million cash contribution. This reduced our ownership percentage to 35%. As of September 30, 2001, our remaining liability for facilities and facility services is $6.8 million. In the third quarter and first nine months of 2001, we recorded losses of $1.0 million and $2.7 million as our 35% equity share of Chahaya's net loss. We use the equity method to account for our investment in Chahaya. Reorganization Costs In connection with the Chapter 11 filing, we recorded reorganization costs of $2.8 million in the third quarter of 2001. This included $0.6 million in professional fees, and $2.3 million in accretion to bring the note -24- payable to Western Digital to its face value of $30.1 million, offset by interest received on accumulated cash due to the Chapter 11 proceeding. LIQUIDITY AND CAPITAL RESOURCES Cash and short-term investments of $12.1 million at the end of the third quarter of 2001 decreased by $68.5 million from the end of the previous fiscal year. Based on current operating forecasts, the Company estimates that the cash balance is adequate to support its continuing operations. Additionally, the Company is currently in negotiations to complete a debtor-in-possession financing agreement for up to $20 million. Working capital increased by $195.5 million compared to the end of the previous fiscal year, which resulted primarily from the reclassification of the senior unsecured bank debt to Liabilities Subject to Compromise. Consolidated operating activities used $29.3 million in cash during the first nine months of 2001. The components of this change include the following: - The year-to-date 2001 net loss of $262.3 million, net of non-cash depreciation and amortization of $73.9 million, impairment charges of $43.0 million, accretion and amortization of interest on debt of $134.1 million, other non-cash charges of $1.9 million, and a $10.8 million non-cash deferred income tax credit used $20.2 million in cash. - Lower accounts receivable, a direct consequence of the revenue declines over the last three quarters, generated $8.2 million in cash. - Lower inventories, reflecting the revenue declines over the last three quarters, as well as anticipated flat shipments throughout the remainder of 2001, generated $9.3 million in cash. - Lower accounts payable, reflecting reduced manufacturing operations as well as a reclassification to Liabilities Subject to Compromise, used $6.6 million. - Lower other liabilities, reflecting payments for severance and building exit costs, continuing payments on equipment leases, and a reclassification to Liabilities Subject to Compromise, used $22.9 million. We spent $24.9 million on fixed assets during the first nine months of 2001. Net short-term investment activity provided $8.3 million in cash, while other net investing activities provided $0.6 million in cash. Repayment of debt used $15.0 million in cash, while sales of common stock generated $0.2 million. Current noncancellable capital commitments as of September 30, 2001 totaled $1.9 million. Year-to-date capital expenditures were $24.9 million, and primarily included costs for facilities and installation costs for certain production equipment transferred from the closed U.S. HMT manufacturing plants to Malaysia. For the remainder of 2001, we plan to spend less than $5 million on property, plant, and equipment. In June 2000, we replaced our credit facilities with a senior unsecured loan restructure agreement with our lenders, and a separate subordinated unsecured convertible debt agreement with other creditors. As a result, we have $201.7 million in senior unsecured bank debt outstanding that matured on June 30, 2001, and $9.3 million of convertible debt that was originally scheduled to mature in 2005. In addition, we have a note payable to Western Digital with a principal balance of $30.1 million which was originally scheduled to mature in April, 2002. Upon completion of the HMT merger in the fourth quarter of 2000, our debt increased with HMT's convertible debt -25- which was originally scheduled to mature in 2004. The principal amount of these notes is $230.0 million. As a result, under the terms of the loan restructure agreement for the senior bank debt and the subordination provisions for the HMT convertible notes, we did not pay interest on the HMT subordinated notes when it became due on July 15, 2001. In addition, our failure to pay our senior bank debt when due caused a default under the HMT subordinated notes as of July 30, 2001. As of August 24, 2001 (the petition date for reorganization under Chapter 11) and currently, we have $201.7 million in senior unsecured bank debt outstanding that matured on June 30, 2001, and $9.3 million of convertible debt that was originally scheduled to mature in 2005. Also, we have a note payable to Western Digital with a principal balance of $30.1 million which was originally scheduled to mature in April, 2002. In addition, we have $230 million of HMT subordinated convertible debt which was originally scheduled to mature in 2004. The repayment of all of this indebtedness is subject to the Plan of Reorganization. Through the Chapter 11 Bankruptcy petition date of August 24, 2001, unpaid accrued interest on the aforementioned debt was $17.3 million. Additionally, contractual interest expense for the period from August 25, 2001, to September 30, 2001, was $3.5 million. Our independent auditors have included a going-concern explanatory paragraph in our Form 10-K for our fiscal year ended December 31, 2000. This emphasis paragraph represents our auditors' conclusion that there is substantial doubt as to our ability to continue as a going-concern for a reasonable time. OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below include all of the risks and uncertainties which we believe to be material at this time, but are not the only ones facing our company. Additional risks and uncertainties that we do not presently know of, or we currently deem immaterial, may also impair our business operations. If any of the following risks actually occur, they could materially adversely affect our business, financial condition or operating results. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. RISKS RELATED TO OUR FINANCIAL POSITION AND OUR COMMON STOCK ON AUGUST 24, 2001, WE FILED A VOLUNTARY PETITION FOR REORGANIZATION UNDER CHAPTER 11 OF THE UNITED STATES BANKRUPTCY CODE, WHICH WILL NEGATIVELY IMPACT OUR OPERATING RESULTS. Chapter 11 permits us to remain in control of our business, protected by a stay of all creditor action, while we attempt to negotiate and confirm a Plan of Reorganization with our creditors. Due to our Chapter 11 case, our deteriorating financial condition and our inability to date to restructure our existing debt, we believe our stakeholders are concerned about our bankruptcy proceedings. Some of our customers, suppliers and employees have expressed this apprehension, which may have an adverse effect on our ability to continue to run our operations at the level at which they currently operate. -26- THERE IS A SIGNIFICANT LIKELIHOOD THAT HOLDERS OF EQUITY IN OUR COMPANY WILL NOT RECEIVE ANY DISTRIBUTIONS UNDER OUR PLAN OF REORGANIZATION. The Plan of Reorganization contemplates a complete change of equity ownership in our company as it exists today, with existing shares cancelled and current shareholders receiving only a small fraction of ownership in the reorganized company. Moreover, in a bankruptcy case, in the absence of the consent of all classes of impaired claims, all creditors generally would have to be paid prior to our stockholders receiving any distribution. As a result, it is possible -- if not likely - that equity holders in our company ultimately will have their shares cancelled and will not receive any distributions at all under the Plan of Reorganization. We may be unsuccessful in our attempts to confirm a Plan of Reorganization with our creditors. Many Chapter 11 cases are unsuccessful, and virtually all involve substantial expense and damage to the business. If we are unsuccessful in obtaining confirmation of a Plan of Reorganization, our assets would be liquidated. In addition, the fact that our assets are located in Malaysia may make it more difficult to distribute our assets on liquidation. In a liquidation, all other creditors would be paid prior to our shareholders. THE VALUATION OF NEWLY-ISSUED SECURITIES SUCH AS NEW COMMON STOCK IS SUBJECT TO ADDITIONAL UNCERTAINTIES AND CONTINGENCIES, ALL OF WHICH ARE DIFFICULT TO PREDICT. Under a Plan of Reorganization, we may issue new common stock. Actual market prices of such securities at issuance will depend upon, among other things, prevailing interest rates, conditions in the financial markets, the anticipated initial holdings of pre-petition creditors, some of which may prefer to liquidate their investment rather than hold it on a long-term basis, and other factors which generally influence the prices of securities. It should be noted that there is presently no trading market for new common stock and there can be no assurance that a trading market will develop. Further, there is a significant likelihood that the existing holders of our common stock will not receive any newly-issued securities under the Plan of Reorganization. UPON CONSUMMATION OF A PLAN OF REORGANIZATION, CERTAIN HOLDERS OF CLAIMS MAY RECEIVE A MAJORITY OF SHARES OF NEW COMMON STOCK WHICH WOULD PUT THEM IN A POSITION TO CONTROL THE OUTCOME OF ACTIONS REQUIRING STOCKHOLDER APPROVAL. If holders of significant numbers of shares of new common stock were to act as a group, such holders may be in a position to control the outcome of actions requiring stockholder approval, including the election of directors and approval of significant corporate transactions, as well as to influence the management and affairs of the reorganized company. This concentration of ownership could also facilitate or hinder a negotiated change of control of the reorganized debtor and, consequently, impact upon the value of the new common stock. Further, the possibility that one or more of the holders of significant numbers of shares of new common stock may determine to sell all or a large portion of their shares of new common stock in a short period of time may adversely affect the market price of the new common stock -27- THE MARKET PRICE OF OUR COMMON STOCK HAS BEEN DEPRESSED, AND MAY DECLINE FURTHER. The market price of our common stock has been depressed in response to actual and anticipated events, including: - our filing under Chapter 11; - variations in our operating results; - variations in macroeconomic conditions; - changes in demand for computers and data storage; - perceptions of the disk drive industry's relative strength or weakness; - developments in our relationships with our customers and/or suppliers; - announcements of alliances, mergers or other relationships by or between our competitors and/or customers; - announcements of technological innovations or new products by us or our competitors; - the success or failure of new product qualifications in programs with certain manufacturers; and; - developments related to patents or other intellectual property rights. We expect this volatility to continue in the future. In addition, any shortfall or changes in our revenue, gross margins, earnings, or other financial results, could cause the price of our common stock to fluctuate significantly. In recent years, the stock market in general has experienced extreme price and volume fluctuations, which have particularly affected the market price of many technology companies, and which may be unrelated to the operating performance of those companies. These broad market fluctuations may adversely affect the market price of our common stock. Volatility in the price of stocks of companies in the hard disk drive industry has been particularly high. From the second quarter of 1997 through October 31, 2001, the price of our stock fell to a low of $0.01 from a high of $35.13. The market price of our common stock may decline further if we continue to be unable to reorganize our existing debt. OUR SECURITIES HAVE BEEN DELISTED FROM NASDAQ FOR FAILURE TO COMPLY WITH NASDAQ'S MINIMUM BID REQUIREMENT, WHICH WILL HARM THE TRADING MARKET AND PRICE OF OUR SECURITIES. The trading of our common stock on the Nasdaq National Market System depended on our meeting certain asset, revenue, and stock price tests. We were out of compliance with Nasdaq's minimum bid requirement because our stock has traded below $1.00 per share for more than 30 consecutive trading days. Our stock was delisted from Nasdaq on September 17, 2001 and is now trading on the OTC Bulletin Board. In addition, low-priced stocks are subject to additional risks, including additional state regulatory requirements and the potential loss of effective trading markets. After the Plan of Reorganization is confirmed by the Bankruptcy Court, we will attempt to list our common stock for trading on the Nasdaq National Market System. However, it is possible that we will not be able to meet the Nasdaq listing requirements -28- RISKS RELATED TO OUR BUSINESS CONCERNS ABOUT THE GOING-CONCERN EXPLANATORY PARAGRAPH IN OUR AUDIT REPORT COULD DETRIMENTALLY AFFECT OUR OPERATING RESULTS AND FINANCIAL CONDITION. Our independent auditors have included a going-concern explanatory paragraph for our fiscal year ended December 31, 2000. This emphasis paragraph represents our auditors' conclusion that there is substantial doubt as to our ability to continue as a going-concern for a reasonable time. If we are unable to restructure our debt and raise additional funds, our auditors may not remove the explanatory paragraph from their opinion, and our operating results and financial conditions could be detrimentally affected due to any of the following: - our customer relationships and orders with our customers could deteriorate; - suppliers could reduce their willingness to extend credit; - employee attrition could increase; and/or - new lenders could be unwilling to refinance our existing debt. DEMAND FOR DISK DRIVES IS LARGELY TIED TO DEMAND FOR PERSONAL COMPUTERS AND FLUCTUATIONS IN AND REDUCED DEMAND FOR PERSONAL COMPUTERS MAY RESULT IN CANCELLATIONS OR REDUCTIONS IN DEMAND FOR OUR PRODUCT. Trend Focus estimates that 74% of the disks consumed during 2000 were incorporated into disk drives for the desktop personal computer market. Because of this concentration in a single market, our business is tightly linked to the success of the personal computer market. Historically, demand for personal computers has been seasonal and cyclical. During the first nine months of 2001, personal computer manufacturers generally announced lower expectations for sales. Due to the high fixed costs of our business, fluctuations in demand resulting from this seasonality and cyclicality can lead to disproportionate changes in the results of our operations. If cancellations or reductions in demand for our products occur in the future, our business, financial condition, and results of operations could be seriously harmed. DELAYS AND CANCELLATIONS OF OUR CUSTOMER ORDERS MAY CAUSE US TO UNDERUTILIZE OUR PRODUCTION CAPACITY, WHICH COULD SIGNIFICANTLY REDUCE OUR GROSS MARGINS AND RESULT IN SIGNIFICANT LOSSES. Our business has a large amount of fixed costs. If there is a decrease in demand for our products, our production capacity could be underutilized, and, as a result, we may experience: - equipment write-offs; - restructuring charges; - reduced average selling prices; - increased unit costs; and - employee layoffs. IF WE ARE NOT ABLE TO ATTRACT AND RETAIN KEY PERSONNEL, OUR OPERATIONS COULD BE HARMED. Our future success depends on the continued service of our executive officers, our highly-skilled research, development, and engineering team, our manufacturing team, and our key administrative, sales, and marketing and support personnel. Competition for skilled personnel is intense. In particular, our bankruptcy filing and our financial performance have increased the difficulty of attracting and retaining skilled scientists and other knowledgeable -29- workers. Recently, we have experienced higher rates of turnover in the last year than at other times in our history, and we may not be able to attract, assimilate, or retain highly-qualified personnel to maintain the capabilities that are necessary to compete effectively. If we are unable to retain existing or hire key personnel, our business, financial condition, and operating results could be harmed. OUR FUTURE EARNINGS MAY BE REDUCED BECAUSE OF THE MERGER WITH HMT. The merger has been treated as a purchase for accounting purposes. This creates expenses in our future statement of operations that we would not have otherwise incurred, which could have a material adverse effect on the market price of our common stock. We incurred direct transaction costs of $9.0 million in connection with the merger. Under current purchase accounting rules, we have recorded intangible assets totaling $109.6 million related to patents, existing technology, assembled workforce, and goodwill in connection with the merger. These amounts will continue to be amortized through December 31, 2001, and will be subject to potential impairment charges thereafter. THERE IS A HIGH CONCENTRATION OF CUSTOMERS IN THE DISK DRIVE MARKET, AND WE RECEIVE A LARGE PERCENTAGE OF OUR REVENUES FROM ONLY A FEW CUSTOMERS, THE LOSS OF ANY OF WHICH WOULD ADVERSELY AFFECT OUR SALES. Our customers consist of disk drive manufacturers. Given the relatively small number of disk drive manufacturers, we expect that we will continue to depend on a limited number of customers. This high customer concentration is due to the following factors: - the high-volume requirements of the dominant disk drive manufacturers; - a 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; and - the increases in storage densities which have led to decreases in the platter count per drive. With lower platter counts, captive disk drive manufacturers have excess internal media capacity and they rely less on independent sources of media. During the third quarter of 2001, 69% of our sales were to Western Digital and 24% were to Maxtor Corporation. In fiscal 2000, 50% of our sales were to Western Digital, 28% were to Maxtor Corporation, and 17% were to Seagate Technology. If our customers reduce their media requirements or develop capacity to produce thin-film disks for internal use, our sales will be reduced. As a result, our business, financial condition and operating results could suffer. IF WE ARE NOT ABLE TO RAISE FUTURE CAPITAL FOR THE SUBSTANTIAL CAPITAL EXPENDITURES NEEDED TO OPERATE OUR BUSINESS COMPETITIVELY, WE MAY BE FORCED TO REDUCE OR SUSPEND OPERATIONS. The disk media business is capital-intensive, and we believe that in order to remain competitive, we will likely require additional financing resources over the next several years for capital expenditures, working capital and research and development. If we cannot raise additional funds, we may be forced to reduce or suspend operations. -30- BECAUSE OUR PRODUCTS REQUIRE A LENGTHY SALES CYCLE WITH NO ASSURANCE OF A SALE OR HIGH VOLUME PRODUCTION, WE MAY EXPEND FINANCIAL AND OTHER RESOURCES WITHOUT MAKING A SALE. With short product life cycles and rapid technological change, we must qualify new products frequently, and we must also achieve high volume production rapidly. Hard disk drive programs have increasingly become "bimodal" in that a few programs are high-volume and the remaining programs are relatively small in terms of volume. Supply and demand balance can change quickly from customer to customer and from program to program. Further, qualifying thin-film disks for incorporation into a new disk drive product requires us to work extensively with the customer and the customer's other suppliers to meet product specifications. Therefore, customers often require a significant number of product presentations and demonstrations, as well as substantial interaction with our senior management, before making a purchasing decision. Accordingly, our products typically have a lengthy sales cycle, which can range from six to 12 months, during which time we may expend substantial financial resources and management time and effort, while not being sure that a sale will result, or that our share of the program ultimately will result in high-volume production. IF OUR CUSTOMERS CANCEL ORDERS THEY MAY NOT BE REQUIRED TO PAY ANY PENALTIES AND OUR SALES COULD SUFFER. Our sales are generally made pursuant to purchase orders that are subject to cancellation, modification, or rescheduling without significant penalties. If our current customers do not continue to place orders with us, if orders by existing customers do not recover to the levels of earlier periods, or if we are unable to obtain orders from new customers, our sales and operating results will suffer. OUR CUSTOMERS' INTERNAL DISK OPERATIONS MAY LIMIT OUR ABILITY TO SELL OUR PRODUCT. During 2000, IBM and Seagate Technology produced more than 85% of their media requirements internally, and MMC Technology supplied approximately half of Maxtor's requirement for media. Recently, Maxtor agreed to purchase MMC Technology. To date, MMC Technology and the captive media operations of IBM and Seagate Technology have sold minimal quantities of disks in the merchant market. Disk drive manufacturers such as Seagate Technology and IBM have large internal media manufacturing operations. We compete with these internal operations directly, when we market our products to these disk drive companies, and indirectly, when we sell our disks to customers who must compete with vertically-integrated disk drive manufacturers. Vertically-integrated companies have the ability to keep their disk-making operations fully utilized, thus lowering their costs of production. This cost advantage contributes to the pressure on us and other independent media manufacturers to sell disks at prices so low that we are unprofitable, and we cannot be sure when, if ever, we can achieve a low enough cost structure to return to profitability. Vertically-integrated companies are also able to achieve a large scale that supports the development resources necessary to advance technology rapidly. As a result, we may not have sufficient resources to be able to compete effectively with these companies. Therefore, our business, financial condition, and operations could suffer. BECAUSE WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS, IF OUR SUPPLIERS EXPERIENCE CAPACITY CONSTRAINTS OR PRODUCTION FAILURES, OUR PRODUCTION AND OPERATING RESULTS COULD BE HARMED. We rely on a limited number of suppliers for some of the materials and equipment used in our -31- manufacturing processes, including aluminum substrates, nickel plating solutions, polishing and texturing supplies, and sputtering target materials. For instance, Kobe is our sole supplier of aluminum blanks. Further, the supplier base has been weakened by the poor financial condition of the industry, and some suppliers have either exited the business or failed. Additionally, several suppliers have expressed concern about continuing to supply us because of our financial condition. Our production capacity would be limited if one or more of these materials were to become unavailable or available in reduced quantities, or if we were unable to find alternative suppliers. If our source of materials and supplies were unavailable for a significant period of time, our production and operating results could be adversely affected. IF WE ARE UNABLE TO SUCCESSFULLY COMPETE IN THE HIGHLY COMPETITIVE THIN-FILM MEDIA INDUSTRY, WE MAY NOT BE ABLE TO GAIN ADDITIONAL MARKET SHARE OR WE MAY LOSE OUR EXISTING MARKET SHARE, AND OUR OPERATING RESULTS WOULD BE HARMED. THE IMBALANCE BETWEEN DEMAND AND SUPPLY HAS FURTHER INTENSIFIED THE COMPETITION IN THE INDUSTRY. The market for our products is highly competitive, and we expect competition to continue in the future. Competitors in the thin-film disk industry fall into two groups: Asian-based manufacturers and U.S. captive manufacturers. Our Asian-based competitors include Fuji, Mitsubishi, Trace, Showa Denko, and Hoya. The U.S. captive manufacturers include the disk media operations of Seagate Technology, IBM, and for all intents and purposes, MMC Technology. Many of these competitors have greater financial resources than we have. If we are not able to compete successfully in the future, we would not be able to gain additional market share for our products, or we may lose our existing market share, and our operating results could be harmed. In 2000 and the first nine months of 2001, as in 1999, media supply exceeded media demand. As independent suppliers struggled to utilize their capacity, the excess media supply caused average selling prices for disk products to decline. Pricing pressure on component suppliers has also been compounded by high consumer demand for sub-$1,000 personal computers. Further, structural change in the disk media industry, including combinations, failures, and joint venture arrangements, may be required before media supply and demand are in balance. However, structural changes would intensify the competition in the industry. DISK DRIVE PROGRAM LIFE CYCLES ARE SHORT, AND DISK DRIVE PROGRAMS ARE HIGHLY CUSTOMIZED. IF WE FAIL TO RESPOND TO OUR CUSTOMERS' DEMANDING REQUIREMENTS, WE WOULD NOT BE ABLE TO COMPETE EFFECTIVELY. Our industry experiences rapid technological change, and our inability to timely anticipate and develop products and production technologies could harm our competitive position. In general, the life cycles of recent disk drive programs have been shortening. Additionally, media must be more customized to each disk drive program. Short program life cycles and customization have increased the risk of product obsolescence. Supply chain management, including just-in-time delivery, has become a standard industry practice. In order to sustain customer relationships and achieve profitability, we must be able to develop in a timely fashion new products and technologies that can help customers reduce their time-to-market performance, and continue to maintain operational excellence that supports high-volume manufacturing ramps and tight inventory management throughout the supply chain. If we cannot respond to this rapidly changing environment or fail to meet our customers' demanding product and qualification requirements, we would not be able to compete effectively. As a result, we would not be able to maximize the use of our production facilities and minimize our inventory losses. -32- IF WE DO NOT KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE AND CONTINUE TO IMPROVE THE QUALITY OF OUR MANUFACTURING PROCESSES, WE WILL NOT BE ABLE TO COMPETE EFFECTIVELY AND OUR OPERATING RESULTS WOULD SUFFER. Our thin-film disk products primarily serve the 3 1/2-inch hard disk drive market, where product performance, consistent quality, price, and availability are of great competitive importance. To succeed in an industry characterized by rapid technological developments, we must continuously advance our thin-film technology at a pace consistent with, or faster than, our competitors'. Advances in hard disk drive technology demand continually lower glide heights and higher storage densities. Over the last several years, storage density has roughly doubled each year, requiring significant improvement in every aspect of disk design. These advances require substantial on-going process and technology development. New process technologies must support cost-effective, high-volume production of thin-film disks that meet these ever-advancing customer requirements for enhanced magnetic recording performance. We may not be able to develop and implement such technologies in a timely manner in order to compete effectively against our competitors' products and/or entirely new data storage technologies. In addition, we must transfer our technology from our U.S. research and development center to our Malaysian manufacturing operations. If we cannot advance our process technologies or do not successfully implement those advanced technologies in our Malaysian operations, or if technologies that we have chosen not to develop prove to be viable competitive alternatives, we would not be able to compete effectively. As a result, we would lose our market share and face increased price competition from other manufacturers, and our operating results would suffer. The manufacture of our high-performance, thin-film disks requires a tightly controlled multi-stage process, and the use of high-quality materials. Efficient production of our products requires utilization of advanced manufacturing techniques and clean room facilities. Disk fabrication occurs in a highly controlled, clean environment to minimize dust and other yield- and quality-limiting contaminants. In spite of stringent manufacturing controls, weaknesses in process control or minute impurities in materials may cause a substantial percentage of the disks in a lot to be defective. The success of our manufacturing operations depends in part on our ability to maintain process control and minimize such impurities in order to maximize yield of acceptable high-quality disks. Minor variations from specifications could have a disproportionately adverse impact on our manufacturing yields. If we are not able to continue to improve on our manufacturing processes, our operating results would be harmed. IF WE DO NOT PROTECT OUR PATENTS AND INFORMATION RIGHTS, OUR REVENUES WILL SUFFER. 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 common for companies and individuals to initiate actions against others in the industry to enforce intellectual property rights. Although we attempt to protect our intellectual property rights through patents, copyrights, trade secrets, and other measures, we may not be able to protect our technology adequately. Competitors may be able to develop similar technology and also may have or may develop intellectual property rights and enforce those rights to prevent us from using such technologies, or demand royalty payments from us in return for using such technologies. Either of these actions may affect our production, which would materially reduce our revenues and harm our results of operations. -33- WE MAY FACE INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS WHICH ARE COSTLY TO RESOLVE, AND WHICH MAY DIVERT OUR MANAGEMENT'S ATTENTION. We have occasionally received, and may receive in the future, communications from third parties which assert violation of intellectual rights alleged to cover certain of our products or manufacturing processes or equipment. We evaluate whether it would be necessary to defend against the claims or to seek licenses to the rights referred to in such communications. In those cases, we may not be able to negotiate necessary licenses on commercially reasonable terms. Also, if we have to defend those claims, we could incur significant expenses and our management's attention could be diverted from our other business. Any litigation resulting from such claims could have a material adverse effect on our business and financial results. We may not be able to anticipate claims by others that we infringe their technology or successfully defend ourselves against such claims. Similarly, we may not be able to discover significant infringements of our technology or successfully enforce our rights to our technology if we discover infringing uses by others. HISTORICAL QUARTERLY RESULTS MAY NOT ACCURATELY PREDICT OUR FUTURE PERFORMANCE, WHICH IS SUBJECT TO FLUCTUATION DUE TO MANY UNCERTAINTIES. Our operating results historically have fluctuated significantly on both a quarterly and annual basis. As a result, our operating results in any quarter may not reflect our future performance. We believe that our future operating results will continue to be subject to quarterly variations based on a wide variety of factors, including: - timing of significant orders, order cancellations, modifications, and quantity adjustments and rescheduled shipments; - availability of media versus demand; - the cyclical nature of the hard disk drive industry; - our ability to develop and implement new manufacturing process technologies; - increases in our production and engineering costs associated with initial design and production of new product programs; - the extensibility of our process equipment to meet more stringent future product requirements; - our ability to introduce new products that achieve cost-effective high-volume production in a timely manner, timing of product announcements, and market acceptance of new products; - changes in our product mix and average selling prices; - the availability of our production capacity, and the extent to which we can use that capacity; - changes in our manufacturing efficiencies, in particular product yields and input costs for direct materials, operating supplies and other running costs; - prolonged disruptions of operations at any of our facilities for any reason; - changes in the cost of or limitations on availability of labor; and - structural changes within the disk media industry, including combinations, failures, and joint venture arrangements. We cannot forecast with certainty the impact of these and other factors on our revenues and operating results in any future period. Our expense levels are based, in part, on expectations as to future revenues. If our revenue levels are below expectations, our operating results are likely to suffer. Because thin-film disk manufacturing requires a high level of fixed costs, our gross margins are extremely sensitive to changes in volume. -34- At constant average selling prices, reductions in our manufacturing efficiency cause declines in our gross margins. Additionally, decreasing market demand for our products generally results in reduced average selling prices and/or low capacity utilization that, in turn, adversely affect our gross margins and operating results. OUR DEPENDENCE ON OUR MALAYSIAN OPERATIONS EXPOSES US TO UNAVOIDABLE RISKS IN TRANSMITTING TECHNOLOGY FROM U.S. FACILITIES TO MALAYSIAN FACILITIES, AND WHICH COULD IMPACT OUR RESULTS OF OPERATIONS. During the third quarter of 1999, we announced that all media production would be consolidated into our Malaysian factories. In the fourth quarter of 2000, we decided to end the manufacture of aluminum substrates in Santa Rosa, California, and end production of polished disks in HMT's Eugene, Oregon, facility. Currently, all aluminum substrates are manufactured by our Malaysian factory and a Malaysian vendor. In addition, all polished disks are manufactured by our Malaysian factories. Further, we recently transferred the manufacturing capacity of HMT's Fremont, California, facility to Malaysia, and have closed all of our U.S. media manufacturing operations, leaving us fully dependent on our Malaysian manufacturing operations. Technology developed at our U.S. research and development center must now be first implemented at our Malaysian facilities without the benefit of being implemented at a U.S. factory. Therefore, we rely heavily on electronic communications between our U.S. facilities and Malaysia to transfer technology, diagnose operational issues, and meet customer requirements. If our operations in Malaysia or overseas communications are disrupted for a prolonged period for any reason, shipments of our products would be delayed, and our results of operations would suffer. OUR FOREIGN OPERATIONS AND INTERNATIONAL SALES SUBJECT US TO ADDITIONAL RISKS INHERENT IN DOING BUSINESS ON AN INTERNATIONAL LEVEL THAT MAKE IT MORE COSTLY OR DIFFICULT TO CONDUCT OUR BUSINESS. We are subject to a number of risks of conducting business outside of the U.S. Our sales to customers in Asia, including the foreign subsidiaries of domestic disk drive companies, account for substantially all of our net sales from our U.S. and Malaysian facilities. Our customers assemble a substantial portion of their disk drives in the Far East and subsequently sell these products throughout the world. Therefore, our high concentration of Far East sales does not accurately reflect the eventual point of consumption of the assembled disk drives. We anticipate that international sales will continue to represent the majority of our net sales. We are subject to these risks to a greater extent than most companies because, in addition to selling our products outside the U.S., our Malaysian operations will account for a large majority of our sales in 2001. Accordingly, our operating results are subject to the risks inherent with international operations, including, but not limited to: - compliance with changing legal and regulatory requirements of foreign jurisdictions; - fluctuations in tariffs or other trade barriers; - foreign currency exchange rate fluctuations since certain costs of our foreign manufacturing and marketing operations are incurred in foreign currency, including purchase of certain operating supplies and production equipment from Japanese suppliers in yen-denominated transactions; - difficulties in staffing and managing foreign operations; - political, social and economic instability; -35- - exposure to taxes in multiple jurisdictions; - local infrastructure problems or failures; and - transportation delays and interruptions. In addition, our ability to transfer funds from our Malaysian operations to the U.S. is subject to Malaysian rules and regulations. In 1999, the Malaysian government repealed a regulation that restricted the amount of dividends that a Malaysian company may pay to its stockholders. If not repealed, this regulation would have potentially limited our ability to transfer funds to the U.S. from our Malaysian operations. If similar regulations are enacted in the future, the cost of our Malaysian operations would increase, and our operating margin would be significantly reduced. IF WE ARE UNABLE TO CONTROL CONTAMINATION IN OUR MANUFACTURING PROCESSES, WE MAY HAVE TO SUSPEND OR REDUCE OUR MANUFACTURING OPERATIONS. It is possible that we will experience manufacturing problems from contamination or other causes in the future. For example, if our disks are contaminated by microscopic particles, they might not be fit for use by our customers. If contamination problems arise, we would have to suspend or reduce our manufacturing operations, and our operations could suffer. THE NATURE OF OUR OPERATIONS MAKES US SUSCEPTIBLE TO MATERIAL ENVIRONMENTAL LIABILITIES, WHICH COULD RESULT IN SIGNIFICANT CLEAN-UP EXPENSES AND ADVERSELY AFFECT OUR FINANCIAL CONDITION. We are subject to a variety of federal, state, local, and foreign regulations relating to: - the use, storage, discharge, and disposal of hazardous materials used during our manufacturing process; - the treatment of water used in our manufacturing process; and - air quality management. We are required to obtain necessary permits for expanding our facilities. We must also comply with new regulations on our existing operations. Public attention has increasingly been focused on the environmental impact of manufacturing operations that use hazardous materials. If we fail to comply with environmental regulations or fail to obtain the necessary permits: - we could be subject to significant penalties; - our ability to expand or operate at locations in California or our locations in Malaysia could be restricted; - our ability to establish additional operations in other locations could be restricted; or - we could be required to obtain costly equipment or incur significant expenses to comply with environmental regulations. Any accidental hazardous discharge could result in significant liability and clean-up expenses, which could harm our business, financial condition, and results of operations. -36- DOWNTURNS IN THE DISK DRIVE MANUFACTURING MARKET AND RELATED MARKETS MAY DECREASE OUR REVENUES AND MARGINS. The market for our products depends on economic conditions affecting the disk drive manufacturing and related markets. Downturns in these markets may cause disk drive manufacturers to delay or cancel projects, reduce their production or reduce or cancel orders for our products. In this environment, customers may experience financial difficulty, cease operations or fail to budget for the purchase of our products. This, in turn, may lead to longer sales cycles, delays in payment and collection, and price pressures, causing us to realize lower revenues and margins. In particular, many of our customers and potential customers have experienced declines in their revenues and operations. In addition, the terrorist acts of September 11, 2001 and subsequent terrorist activities have created an uncertain economic environment and we cannot predict the impact of these events, or of any related military action, on our customers or business. We believe that, in light of these events, some businesses may curtail or eliminate spending on technology related to our products. WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR BUSINESS, AND CALIFORNIA'S ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES. California is in the midst of an energy crisis that could disrupt our research and development activities and increase our expenses. In the event of an acute power shortage, which occurs when power reserves for the State of California fall below 1.5%, California has, on occasion, implemented, and may in the future continue to implement, rolling blackouts throughout the state. We currently do not have back-up generators or alternate sources of power in the event of a blackout, and our insurance does not provide coverage for any damages we or our customers may suffer as a result of any interruption in our power supply. If blackouts interrupt our power supply, we would be temporarily unable to continue operations at our California-based facilities. This could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations. Furthermore, the regulatory changes affecting the energy industry instituted in 1996 by the California government have caused power prices to increase. Under the revised regulatory scheme, utilities were encouraged to sell their plants, which had traditionally produced most of California's power, to independent energy companies that were expected to compete aggressively on price. Instead, due in part to a shortage of supply, wholesale prices have increased dramatically over the past year. If wholesale prices continue to increase, our operating expenses will likely increase, as our headquarters and certain facilities are in California. EARTHQUAKES OR OTHER NATURAL OR MAN-MADE DISASTERS COULD DISRUPT OUR OPERATIONS. Our U.S. facilities are located in San Jose, Fremont, and Santa Rosa in California. In addition, Kobe and other Japanese suppliers of key manufacturing supplies and sputtering machines are located in areas with seismic activity. Our Malaysian operations have been subject to temporary production interruptions due to localized flooding, disruptions in the delivery of electrical power, and, on one occasion in 1997, by smoke generated by large, widespread fires in Indonesia. If any natural or man-made disasters do occur, operations could be disrupted for prolonged periods, and our business would suffer. -37- ADDITIONAL ASSET IMPAIRMENTS COULD ADVERSELY IMPACT OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS. As a result of recently issued financial accounting standards, in 2002 we will be required to evaluate our existing intangible assets and goodwill that were acquired in prior purchase business combinations, and make any necessary reclassifications in order to conform with the new criteria for recognition apart from goodwill. We will also be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations. These changes could have a material adverse affect on our accounting for goodwill and other intangible assets and could adversely affect our financial condition and results of operations. Other risk factors that may affect our financial performance are listed in our various SEC filings, including our Form 10-K for the fiscal year ended December 31, 2000, which was filed on March 26, 2001 and our Form 10-Qs for the fiscal quarter ended April 1, 2001, which was filed on May 15, 2001, and July 1, 2001, which was filed on August 7, 2001. We undertake no obligation to publicly release the result of any revisions to these forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. -38- PART II. OTHER INFORMATION ITEM 1. Legal Proceedings Komag, Incorporated (KUS) filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code on August 24, 2001 (the "Petition Date"). The petition was filed with the United States Bankruptcy Court for the Northern District of California. The case has been assigned to the Honorable James R. Grube under case number 01-54143-JRG. The petition affects only the Company's U.S. corporate parent, KUS, and does not include any of its subsidiaries, including Komag Material Technology (KMT), or Komag USA (Malaysia) Sdn (KMS). The Company is operating its business as a debtor-in-possession. See Notes 1, 2, and 3 for additional information. Asahi Glass Company, Ltd. (Asahi) has asserted that a technology cooperation agreement (the agreement) between the Company and Asahi gives Asahi exclusive rights, even as to Komag, to certain low-cost glass substrate-related intellectual property developed by the Company. In connection with the Chapter 11 Bankruptcy filing, the Bankruptcy Court, on October 19, 2001, ordered that the agreement be rejected, effective as of the petition date. The Company suspended the development of its low-cost glass substrate program on October 17, 2001. The Company currently has entered into a settlement Stipulation with Asahi to resolve the dispute regarding ownership of intellectual property and "know-how" developed by the Company prior to June 29, 2001, the agreed date of termination of the agreement. As part of that Stipulation, Asahi waived claims against the Company relating to the agreement. The Company believes that the resolution of the dispute will not have a significant financial impact on the Company's financial results. ITEM 2. Changes in Securities Not Applicable. ITEM 3. Defaults Upon Senior Securities On June 30, 2001, the $201.7 million principal amount of the Company's senior bank debt became due. As of November 12, 2001, this amount, as well as accrued interest of $4.4 million from June 1, 2001 through August 24, 2001, has not been repaid. As a result, under the terms of the loan restructure agreement for the senior bank debt and the subordination provisions for the $230 million of HMT subordinated convertible notes, the Company did not pay interest of $6.6 million on the outstanding HMT subordinated convertible notes when it became due on July 15, 2001. The Company then became in interest payment default under the HMT subordinated convertible notes. As of November 7, 2001, accrued interest on the HMT subordinated convertible notes is $8.3 million. In addition, the Company's failure to pay the bank debt when due caused a default under the HMT subordinated convertible notes as of July 30, 2001. This indebtedness and all of the Company's other indebtedness and obligations are now the subject of our bankruptcy proceedings, and will be restructured in accordance with the Company's Plan of Reorganization. ITEM 4. Submission of Matters to a Vote of Security Holders Not Applicable. -39- ITEM 5. Other Information On September 17, 2001, the Company withdrew its appeal to the Nasdaq Listing Qualifications Panel, and voluntarily delisted its common stock from the Nasdaq National Market. The Company's stock is currently trading on the OTC Bulletin Board under the symbol KMAGQ. On October 19, 2001, Nasdaq delisted the 5 3/4% subordinated convertible bonds due in January, 2004, that were originally issued by HMT Technology Corporation. ITEM 6. Exhibits and Reports on Form 8-K a) Exhibits Exhibit 10.1 - Amendment Number 1 to Volume Purchase Agreement with Western Digital Corporation dated October 5, 2001. b) Reports on Form 8-K On August 30, 2001, the Company filed Form 8-K, announcing that it had filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Court. On September 27, 2001, the Company filed Form 8-K, relating to its September 17, 2001, press release announcing its withdrawal of its appeal to the Nasdaq Listing Qualifications Panel, and its September 21, 2001, press release announcing its intent to file a Plan of Reorganization with the Bankruptcy Court in connection with its Chapter 11 Bankruptcy filing. -40- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. KOMAG, INCORPORATED (Registrant) DATE: November 20, 2001 BY: /s/ Thian Hoo Tan ---------------------------------------- Thian Hoo Tan Chief Executive Officer DATE: November 20, 2001 BY: /s/ Edward H. Siegler ---------------------------------------- Edward H. Siegler Vice President, Chief Financial Officer DATE: November 20, 2001 BY: /s/ Kathleen A. Bayless ---------------------------------------- Kathleen A. Bayless Vice President, Corporate Controller -41- Exhibit Index Exhibit Number - ------------ Exhibit 10.1 - Amendment Number 1 to Volume Purchase Agreement with Western Digital Corporation dated October 5, 2001. EX-10.1 3 f77201ex10-1.txt EXHIBIT 10.1 EXHIBIT 10.1 AMENDMENT NO. 1 TO VOLUME PURCHASE AGREEMENT This Amendment No. 1 ("Amendment"), with an effective date of October 5, 2001, to the Volume Purchase Agreement (as amended, "VPA") dated as of April 8, 1999 between Western Digital Corporation, a Delaware corporation ("WDC"), and Komag, Inc., a Delaware corporation ("Komag"), is made by and among WDC, Komag and Komag USA (Malaysia) Sdn., a Malaysia unlimited liability company ("Komag Malaysia"). RECITALS A. WDC and Komag entered into the VPA whereby Komag and/or Komag Malaysia would supply WDC's media requirements for a three year period. B. As permitted by Section 12.4 of the VPA, Komag and Komag Malaysia entered into an Assignment of Rights and Delegation of Duties under the VPA, with an effective date of December 12, 1999, pursuant to which Komag assigned to Komag Malaysia its rights and delegated the performance of its duties under the VPA. C. WDC wishes to accept Komag Malaysia as the assignee of Komag and its rights and obligations under the VPA, and WDC, Komag and Komag Malaysia wish to amend the VPA to extend its term and to make certain other changes. D. On August 24, 2001, Komag filed a voluntary petition under chapter 11 of title 11 of the United States Code (the "Bankruptcy Code"), thereby commencing Case No. 01-54143-JRG currently pending before the United States Bankruptcy Court for the Northern District of California (the "Bankruptcy Court"). Komag currently is managing its affairs as a debtor in possession pursuant to sections 1107 and 1108 of the Bankruptcy Code. AGREEMENT FOR GOOD AND VALUABLE CONSIDERATION, the receipt of which is hereby acknowledged, the parties agree as follows: 1. In the table at the end of section 1.19.1 of the VPA, the entry in the bottom row, middle column, shall be amended in its entirety to read as follows: "Until the end of the term of the agreement as defined in section 9.1" 2. In the table at the end of section 4.1 of the VPA, the entry in the bottom row, middle column, shall be amended in its entirety to read as follows: "Until the end of the term of the agreement as defined in section 9.1" 1 3. In the table at the end of section 4.1 of the VPA, the heading in the top row, right column shall be amended in its entirety to read as follows: "PURCHASE REQUIREMENTS DURING EACH 12 MONTH PERIOD" 4. Section 9.1 of the VPA shall be amended in its entirety to read as follows: "This VPA shall continue in force for an initial term of six years from the Effective Date and shall be automatically renewed for successive two (2) year periods thereafter; provided, however, that either party may elect to not renew this VPA by notifying the other party no later than one year prior to the expiration of the initial term or any succeeding term of its intention to not have the VPA automatically renewed at the expiration of such term." 5. All other terms of the VPA shall remain the same. 6. Komag Malaysia, as the assignee of Komag under the VPA, hereby agrees to be bound by all of the terms and conditions of and to perform the obligations of Komag under the VPA, as amended. Western Digital hereby acknowledges Komag's assignment of its rights and delegation of its performance under the VPA to Komag Malaysia and accepts Komag Malaysia as the assignee of Komag and all its rights and obligations under the VPA, as amended; provided, however, that Komag agrees to continue to provide its personnel and resources in support of Komag Malaysia's qualification obligations under the VPA. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their duly authorized representatives as of the Effective Date. Western Digital Corporation Komag, Inc. By: ______________________ By: ______________________ Name: ______________________ Name: ______________________ Title: ______________________ Title: ______________________ Komag USA (Malaysia) Sdn. By: ______________________ Name: ______________________ Title: ______________________ 2 -----END PRIVACY-ENHANCED MESSAGE-----