| KOMAG INC /DE/ Item 1A Risk Factors These risks and uncertainties are not the only ones facing our company |
| Additional risks and uncertainties that we are unaware of or currently deem immaterial may also become important factors that may harm our business |
| If any of the following risks actually occur, or other unexpected events occur, our business, financial condition or results of operations could be materially adversely affected, the value of our stock could decline, and investors may lose part or all of their investment |
| Further, this Form 10-K contains forward-looking statements, and actual results may differ significantly from the results contemplated by our forward-looking statements |
| Risks Related to Our Business Our business is concentrated in the disk drive market, so 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 |
| Our products are incorporated into disk drives manufactured by our customers for the desktop personal computer market as well as the enterprise storage systems market and electronic device market |
| Because of the concentration of our products in the disk drive market, which we expect to continue, our business is linked to the success of this market |
| The disk drive market has historically been seasonal and cyclical, and has experienced periods of oversupply and reduced production levels, resulting in significantly reduced demand for disks and pricing pressures |
| It is very difficult to achieve and maintain profitability and revenue growth in the disk drive industry because the average selling price of a disk drive rapidly declines over its commercial life as a result of technological enhancement, productivity improvement and increases in supply |
| In addition, intense price competition among personal computer manufacturers also tends to cause the average selling price of a disk drive to decline even further |
| The effect of these cycles on suppliers has been magnified by disk drive manufacturers’ practice of ordering components, including disks, in excess of their needs during periods of rapid growth, thereby increasing the severity of the drop in the demand for components during periods of reduced growth or contraction |
| Further, downturns in the disk drive market may cause disk drive manufacturers to delay or cancel projects, reduce their production, or reduce or cancel orders for our products |
| This, in turn, may lead to longer sales cycles, delays in payment and collection, pricing pressures, and unused capacity, causing us to realize lower revenues and margins and causing our operating results to suffer |
| For example, in the fourth quarter of fiscal year 2003, disk drive manufacturers appear to have overbuilt product, which resulted in an excess supply of disk drives that was not fully corrected until approximately the third quarter of fiscal year 2004 |
| This increases the chance that our 11 _________________________________________________________________ [61]Table of Contents revenues and margins could be lower than the expectations of investors and analysts, which could make our stock price more volatile |
| We are in the process of significantly increasing the scope of our manufacturing operations in Malaysia, and if we fail to successfully manage and integrate our expanding operations, we may be unable to exploit potential market opportunities, which would materially and adversely affect our business |
| We are in the process of significantly increasing the scope of our manufacturing operations in Malaysia |
| We currently have a manufacturing capacity of approximately 31 million units per quarter and plan to increase our capacity to approximately 43 million units per quarter by the end of 2006 |
| We are expanding our capacity as a result of commitments we have made to certain customers pursuant to strategic supply agreements |
| In the event we do not increase our capacity as planned on a timely basis, we could lose significant future orders from major customers |
| In the event we are successful in expanding our manufacturing capacity as planned, there can be no assurance we will receive sufficient orders to utilize fully our additional capacity |
| In addition, the high utilization of our expanded capacity is dependent on our obtaining sufficient operating supplies and raw materials from our limited and sole-source suppliers to accommodate the increased capacity |
| We do not have binding commitments from these limited and sole-source suppliers to provide sufficient supplies and raw materials to fully utilize the additional capacity |
| Addressing the challenges of our capacity expansion requires, and will continue to require, substantial management attention and financial resources |
| We expect to fund our expansion efforts with cash from operations and customer advances |
| In the event that our expansion efforts require additional funding, or if we have insufficient resources to fund our expansion efforts, we may need to seek additional capital, which may not be available on favorable terms, or at all |
| If we are unable to successfully develop and integrate our expanded manufacturing operations in Malaysia in a timely and effective manner, our business could be materially and adversely affected |
| We receive a large percentage of our net sales from only a few disk drive manufacturing customers, the loss of any of which would adversely affect our sales |
| Our customers are disk drive manufacturers |
| Because of our small customer base, the loss of any one significant customer could have a materially adverse impact on our business operations |
| A relatively small number of disk drive manufacturers dominates the disk drive market |
| According to TrendFocus, four of these manufacturers (HGST, Maxtor, Seagate, and Western Digital) accounted for approximately 75prca of worldwide hard disk drive sales in 2005 |
| In addition, we anticipate that Seagate’s proposed acquisition of Maxtor would make the combined Seagate-Maxtor company the largest disk drive manufacturer in the industry |
| We expect that the success of our business will continue to depend on a limited number of customers |
| In 2005, 32prca of our net sales were to Maxtor, 24prca were to Western Digital , 21prca were to HGST, and 16prca were to Seagate |
| In 2004, 47prca of our net sales were to Maxtor, 14prca were to Western Digital, 29prca were to HGST, and 4prca were to Seagate |
| If the combined Seagate-Maxtor company or any one of our other significant customers reduces its disk requirements, cancels existing orders, develops or expands capacity to produce its own disks, or requires us to reduce our prices before we are able to reduce costs, and we are unable to replace these orders with sales to new customers, our sales would be reduced and our business, financial condition, and operating results would suffer |
| Our ability to maintain strong relationships with our significant customers is essential to our future performance |
| Any further mergers, acquisitions, consolidations, or other significant transactions involving our significant customers may adversely affect our business and operating results |
| In addition, if our customers cancel orders, our sales could suffer and we are generally not entitled to receive cancellation penalties to offset the loss of sales revenue |
| Our sales are generally made pursuant to purchase orders that are subject to cancellation, modification, or rescheduling without significant penalties |
| As a result, if a customer cancels, modifies, or reschedules an order, we may have already made expenditures that are not recoverable, and our profitability will suffer |
| Furthermore, if our current customers do not continue to place orders with us or if we are unable to obtain orders from new customers, our sales and operating results will suffer |
| 12 _________________________________________________________________ [62]Table of Contents The proposed Seagate acquisition of Maxtor will reduce our total number of significant customers, which may result in reduced sales and thereby adversely affect our business, revenues and operating results |
| In December 2005, two of our major customers, Seagate Technology and Maxtor Corporation, announced that they entered into a definitive agreement under which Seagate will acquire Maxtor |
| The transaction is expected to be completed in the second half of 2006, subject to obtaining shareholder approvals and customary regulatory approvals |
| Until the closing, Seagate and Maxtor will continue to operate as separate businesses |
| Upon closing of the proposed merger, we anticipate that the combined Seagate-Maxtor company will be the largest disk drive manufacturer in the industry |
| Since each of Seagate and Maxtor are currently two of our largest customers, the anticipated merger will reduce our total number of customers |
| We cannot forecast with any certainty the impact that Seagate’s proposed acquisition of Maxtor may have on our business, revenues, and operating results |
| We face high levels of competition for customers in the disk industry, and the merger and consolidation of two of our significant customers may further reduce our bargaining power, result in reduced demand for our products, lead to downward pricing pressure, and otherwise negatively impact our revenues |
| The combined Seagate-Maxtor company may have greater financial resources and greater technical and manufacturing resources than Seagate and Maxtor have as stand-alone companies |
| In addition, there can be no assurance that the proposed merger will be successfully completed in a timely manner without disruption to their business operations, or that the combined company will maintain each of Seagate’s and Maxtor’s prior purchasing levels of our products |
| In addition, the new combined company may impose new product requirements, modifications and demands on us as they seek to maximize their post-merger operational efficiencies and economies of scale |
| If we fail to mitigate the effects of these risks and pressures, and successfully serve the evolving customer requirements of the combined Seagate-Maxtor company, our business and operations would be adversely affected |
| Our agreements with several of our major customers require us to meet certain production volumes, and if we fail to successfully perform under these agreements, we may incur substantial costs and expenses, and our business could be materially and adversely affected |
| We have entered into strategic supply agreements with several of our major customers that require us to meet certain production volume goals |
| Pursuant to these agreements, monies have been advanced to us to help fund the expansion of our capacity, and if we fail to meet the agreed upon volume goals, we may need to refund some of our customer advances |
| Even if we succeed in expanding our production capacity in a timely and effective manner as required by our contractual obligations, there can be no assurance that we will meet the product specifications or timetables required by our customers for delivery |
| Our inability to perform successfully and competently our obligations under our agreements may cause us to incur substantial costs and expenses, and would have an adverse effect on our business, results of operations, and financial condition |
| Because we depend on a limited number of suppliers, if our suppliers experience capacity constraints or production failures, our production, operating results and growth potential could be harmed |
| We rely on a limited number of qualified suppliers for some of the materials and equipment used in our manufacturing processes, including aluminum blanks, aluminum substrates, nickel plating solutions, polishing and texturing supplies, and sputtering target materials |
| is our sole supplier of aluminum substrate blanks, which is a fundamental component in producing our disks |
| We also rely on Heraeus Incorporated, for a substantial quantity of our sputtering target requirements, and on OMG Fidelity, Inc |
| for supplies of nickel plating solutions |
| As a result of increased worldwide demand, the supply of sputtering target materials has been constrained over the past year, and has recently intensified, resulting in longer lead times and product allocation from certain target suppliers |
| The increasing demand for many of these materials provides our sole-source suppliers with additional bargaining power |
| 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 sources of materials and supplies were limited or unavailable for a significant period of time or the costs of such materials were to increase, our production, operating results, and ability to grow our business could be adversely affected |
| 13 _________________________________________________________________ [63]Table of Contents We cannot be assured that we will be able to obtain adequate supplies of critical materials and equipment in a timely and economic manner, or at all |
| The success of our products also depends on our ability to effectively integrate materials that use leading-edge technology |
| If we are unable to successfully manage the integration of materials obtained from third party suppliers, our business, financial condition and operating results could suffer |
| If we are unable to perform successfully in the highly competitive and increasingly concentrated disk industry, we may not be able to maintain or gain additional market share, and our operating results would be harmed |
| The market for our products is highly competitive, and we expect competition to continue in the future |
| Competitors in the thin-film media industry fall primarily into two groups: Asian-based independent disk manufacturers, and captive disk manufacturers |
| Our major Asian-based independent competitors include Fuji Electric, Hoya, and Showa Denko |
| The captive disk manufacturers who produce thin-film media internally for their own use include HGST, Maxtor, and Seagate |
| Many of these competitors have greater financial resources than we have, which could allow them to adjust to fluctuating market conditions better than we |
| Further, they may have greater technical and manufacturing resources, more marketing power, and a broader array of products |
| To the extent our competitors continue to consolidate and achieve greater economies of scale, we will face additional competitive challenges |
| Our competitors may also lower their product prices to gain market share, develop new technology which would significantly reduce the cost of their products, or offer more products than we do and therefore enter into agreements with customers to supply their products as part of a larger supply agreement |
| Price declines are also affected by any imbalances between demand and supply |
| For most of 2002, as in the several years prior, disk supply exceeded demand |
| As independent suppliers like us struggled to utilize their capacity, the excess disk supply caused average selling prices for disks to decline |
| Supply and demand conditions have improved since 2002, resulting in a more stable pricing environment |
| Supply and demand factors and industry-wide competition could adjust in the future and force disk prices down, which, in turn, would put pressure on our gross margin |
| Additionally, the average selling price of disks and disk drives rapidly declines over their commercial life as a result of technological enhancements, productivity improvements and industry supply increases |
| We may be forced to lower our prices or add new products and features at lower prices to remain competitive, and we may otherwise be unable to introduce new products at higher prices |
| We cannot be assured that we will be able to compete successfully in this kind of price competitive environment |
| 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 |
| If we are not able to attract and retain key personnel, including a successor Chief Executive Officer for our company, our business and 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, many of whom would be extremely difficult to replace |
| In February 2006, our Chief Executive Officer, Thian Hoo Tan, announced his intention to retire as an officer and director of the Company later in 2006 |
| We have started an executive search for a successor |
| This search has been initiated as part of our succession planning, and will include both internal and external candidates |
| Tan in a timely manner, and even if a successor is hired, we may not be able to successfully retain such person for an extended period of time, which could adversely affect our business |
| Acquiring and retaining talented personnel who possess the advanced skills we require has been difficult, particularly at our Malaysian manufacturing facilities where there is high growth in the marketplace We may not be able to attract, assimilate, or retain highly-qualified personnel to maintain the capabilities that are necessary to compete effectively |
| Further, we do not have key person life insurance on any of our key personnel |
| If we are unable to retain existing or hire key personnel, our business, financial condition, and operating results could be harmed |
| 14 _________________________________________________________________ [64]Table of Contents If our production capacity is underutilized, our gross margin will be adversely affected and we could sustain significant losses |
| Our business is characterized by high fixed overhead costs, including expensive plant facilities and production equipment |
| Our per-unit costs and our gross profit are significantly affected by the number of units we produce and the amount of our production capacity that we utilize |
| We are in the process of significantly expanding our production capacity to approximately 43 million units per quarter by the end of 2006 from approximately 30 million units per quarter at the end of 2005 |
| We have in the past, and may in the future, experience periods of underutilized capacity |
| For example, in the third quarter of 2004, we completed the installation of additional equipment, which increased our production capacity from approximately 20 million disks a quarter to approximately 24 million disks a quarter |
| Our finished disk shipments were below this capacity level in the third quarter and fourth quarter of 2004 |
| If our capacity utilization decreases for any reason, including lack of customer demand or cancellation or delay of customer orders, we could experience significantly higher unit production costs, lower margins, and potentially significant losses, as occurred for several years prior to 2003 |
| Underutilization of our production capacity could also result in equipment write-offs, restructuring charges, and employee layoffs |
| If our production capacity is underutilized for any reason, our financial results and our business would be severely harmed |
| Changes in the accounting treatment of stock-based awards will adversely affect our reported results of operations |
| In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) Nodtta 123R, Share-Based Payment (SFAS 123R) |
| SFAS 123R is a revision of SFAS Nodtta 123, Accounting for Stock-Based Compensation (SFAS 123) |
| SFAS 123R became effective for Komag beginning in the first quarter of 2006 |
| SFAS 123R requires all share-based payments to employees to be recognized in the financial statements based on their fair values and does not permit pro forma disclosure as an alternative to financial statement recognition |
| The adoption of the SFAS 123R fair value method will have an adverse impact on our reported results of operations because the stock-based compensation expense will be charged directly against our reported earnings |
| Internal disk operations of disk drive manufacturers may adversely affect our ability to sell our disk products |
| Disk drive manufacturers such as HGST, Maxtor, and Seagate have large internal thin-film media manufacturing operations, and are able to produce a substantial percentage of their disk requirements |
| We compete directly with these internal operations when we market our products to these disk drive companies, and compete indirectly when we sell our disks to customers who must compete with vertically-integrated disk drive manufacturers |
| Vertically-integrated companies have the opportunity 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 disk manufacturers to sell disks at lower prices and can severely affect our profitability |
| Vertically-integrated companies are also able to achieve a large manufacturing scale that supports the development resources necessary to advance technology rapidly |
| HGST previously announced that it intends to consolidate its internal thin-film media manufacturing operations in China, which could result in decreased demand for our products by HGST or increased pricing pressure |
| We may not have sufficient resources or manufacturing scale to be able to compete effectively with these companies as to production costs or technology development, which would negatively impact our net sales and market share |
| All of our manufacturing operations are in Malaysia and our foreign operations and international sales subject us to additional risks inherent in doing business on an international level that could make it more costly and difficult to conduct our business |
| Our manufacturing operations are consolidated in Malaysia |
| As a result, technology developed at our US-based research and development center must be first implemented for high-volume production at our Malaysian facilities |
| Therefore, we rely heavily on electronic communications between our US headquarters and our Malaysian facilities to transfer specifications and procedures, diagnose operational issues, and meet 15 _________________________________________________________________ [65]Table of Contents customer requirements |
| If our operations in Malaysia or overseas communications are disrupted for a prolonged period for any reason, including a failure in electronic communications with our US operations, the manufacture and shipment of our products would be delayed, and our results of operations would suffer |
| In addition, a tsunami, flood, earthquake, political instability, act of terrorism or other disaster or condition that adversely affects our facilities or ability to manufacture our products could significantly harm our business, financial condition and operating results |
| Additionally, because a large portion of our payroll, certain manufacturing and operating expenses, and inventory and capital purchases is transacted in the Malaysian ringgit (ringgit), we are particularly sensitive to any change in the foreign currency exchange rate for the ringgit |
| For approximately seven years, the exchange rate between the ringgit and the US dollar was pegged at 3dtta8 ringgits to one US dollar by the Malaysian government |
| On July 21, 2005, Malaysia removed its currency peg to the US dollar in favor of a managed float system |
| The change in exchange rates could adversely affect the amount we spend on our payroll, certain manufacturing and operating expenses, and raw materials and capital purchases |
| In 2005, our spending on payroll, manufacturing, and operating expenses, and raw materials and capital purchases that were denominated in ringgit was approximately dlra232dtta7 million |
| Additionally, in 2005, we paid approximately dlra78dtta6 million US dollars to a Malaysian supplier for raw materials purchases, based on a cost plus a percentage arrangement |
| This Malaysian supplier incurs certain costs that are denominated in ringgit; therefore, any change in the valuation of the ringgit could materially impact the cost per unit we pay for such raw materials |
| Furthermore, our ability to transfer funds from our Malaysian operations to the US is subject to Malaysian rules and regulations |
| There are a number of other risks associated with conducting business outside of the US Our Malaysian operations account for substantially all of our net sales |
| Our sales are primarily made to Asian customers, including the foreign subsidiaries of domestic disk drive companies |
| 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; • difficulties in staffing and managing foreign operations; • political, social, and economic instability; • increased exposure to threats and acts of terrorism; • exposure to taxes in multiple jurisdictions; • local infrastructure problems or failures including but not limited to loss of power and water supply; and • transportation delays and interruptions |
| If we do not effectively manage the risks associated with international operations and sales, our business, financial condition, and operating results could suffer |
| Because our products require a lengthy sales cycle with no assurance of high volume sales, we may expend significant financial and other resources without a return |
| We must frequently qualify new products with our disk drive manufacturing customers, based on criteria such as quality, storage capacity, performance, and price |
| Qualifying disks for incorporation into new disk drive products requires us to work extensively with our 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 twelve months or longer |
| During this time, we may expend substantial financial resources and management time and effort, while having no assurances that a sale will result, or that disk drive programs ultimately will result in 16 _________________________________________________________________ [66]Table of Contents high-volume production |
| To the extent we expend significant resources to qualify products without realizing sales, our operations will suffer |
| Disk drive programs are highly customized |
| If we fail to respond to our customers’ demanding requirements, we will not be able to compete effectively |
| The disk industry is subject to rapid technological change, and if we are unable to anticipate and develop products and production technologies on a timely basis, our competitive position could be harmed |
| Customization has increased the risk of product obsolescence, and as a result, supply chain management, including just-in-time delivery, has become a standard industry practice |
| In order to sustain customer relationships and sustain profitability, we must be able to develop new products and technologies in a timely fashion in order to 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 |
| The success of any new product introduction is dependent on a number of factors, including market acceptance, our ability to manage the risks associated with product transitions, and the risk that a new product will have quality problems or other defects in the early stages of introduction that were not anticipated in the design of such product |
| Accordingly, we have invested, and intend to continue to invest heavily, in our research and development program |
| If we cannot respond to this rapidly changing environment or fail to meet our customers’ demanding product and qualification requirements, we will not be able to compete effectively |
| As a result, we would not be able to maximize the use of our production facilities, and our profitability would be negatively impacted |
| If we do not keep pace with the rapid technological change in the disk drive industry, we will not be able to compete effectively, and our operating results could suffer |
| Our products primarily serve the 3 1/2-inch disk drive market where product performance, consistent quality, price, and availability are of great competitive importance |
| The continuing need for high-capacity disk drives requires disks with higher storage capacity |
| Higher storage capacity on the surface of a disk is achieved by increasing its areal density |
| Areal density continues to increase rapidly, requiring significant improvement in every aspect of disk design |
| These advances require substantial on-going process and technology development |
| New process technologies, including SAF and PMR, must support cost-effective, high-volume production of disks that meet these ever-advancing customer requirements for enhanced magnetic recording performance |
| We may not be able to develop and implement these technologies in a timely manner in order to compete effectively against our competitors’ products or entirely new data storage technologies |
| In addition, we must transfer our technology from our US-based research and development center to our Malaysian manufacturing operations |
| If we cannot advance our process technologies or do not successfully transfer those advanced technologies at high yields to 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 market share and face increased price competition from other manufacturers, and our operating results would suffer |
| If we fail to improve the quality of, and control contamination in our manufacturing processes, we will lose our ability to remain competitive |
| The manufacture of our products 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 particles and other yield-limiting 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 production 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 17 _________________________________________________________________ [67]Table of Contents processes or maintain stringent quality controls, or if contamination problems arise, we will not remain competitive, and our operating results would be harmed |
| An industry trend towards glass-based applications could negatively impact our ability to remain competitive |
| Our finished disks are manufactured primarily from aluminum substrates, which are the primary substrate used in desktop PC, enterprise applications, and high-capacity consumer applications |
| Some disk manufacturers emphasize the use of glass as a basis for the manufacture of their disks to primarily serve the mobile PC market and certain other consumer applications |
| These applications are expected to achieve significant growth in the near future |
| To the extent glass-based applications were to achieve significant growth in the market place, we may lose market share if we were unable to move rapidly to produce glass-based disks to address the demand |
| If we do not protect our patents and other intellectual property rights, our revenues could suffer |
| Our protection of our intellectual property is limited |
| It is commonplace to protect technology through patents and other forms of intellectual property rights in technically sophisticated fields |
| We may not receive patents for our pending or future patent applications, and any patents that we own or that are issued to us may be invalidated, circumvented or challenged |
| In the disk and disk drive industries, companies and individuals have initiated 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 adequately our technology |
| In addition, 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, and such infringements could have a negative impact on our ability to compete effectively |
| 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 events may affect our production, which could materially reduce our revenues and harm our operating results |
| We may face intellectual property infringement claims that are costly to resolve, may divert our management’s attention, and may negatively impact our operations |
| We have occasionally received, and may receive in the future, communications from third parties that assert violation of intellectual property rights alleged to cover certain of our products or manufacturing processes or equipment |
| We evaluate on a case-by-case basis whether it would be necessary to defend against such claims or to seek licenses to the rights referred to in such communications |
| We may have to litigate to enforce patents issued or licensed to us, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of our proprietary rights and the proprietary rights of others |
| Enforcing or defending our proprietary rights could be expensive and might not bring us timely and effective relief |
| In certain cases, we may not be able to negotiate necessary licenses on commercially reasonable terms, or at all |
| Also, if we have to defend such claims, we could incur significant expenses and our management’s attention could be diverted from our core business |
| Further, we may not be able to anticipate claims by others that we infringe on their technology or successfully defend ourselves against such claims |
| Any litigation resulting from such claims could have a material adverse effect on our business and financial results |
| Historical quarterly results may not accurately predict our performance due to a number of uncertainties and market factors, and as a result it is difficult to predict our future results |
| Our operating results historically have fluctuated significantly on both a quarterly and annual basis |
| 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, or order cancellations; • changes in our product mix and average selling prices; 18 _________________________________________________________________ [68]Table of Contents • modified, adjusted, or rescheduled shipments; • actions by our competitors, including announcements of new products or technological innovations; • availability of disks versus demand for disks; • the cyclical nature of the disk drive industry; • our ability to develop and implement new and efficient manufacturing process technologies; • increases in our production and engineering costs associated with initial design and production of new product programs; • our ability to execute future product development and production ramps effectively; • fluctuations in exchange rates, particularly between the US dollar and the Malaysian ringgit; • the ability 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; • 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; • structural changes within the disk industry, including combinations, failures, and joint venture arrangements; and • changes in tax regulations in foreign jurisdictions that could potentially reduce our tax incentives in areas such as Malaysian capital allowances, tax holidays, and exemptions on withholding tax on royalty payments made by our Malaysian operations to our subsidiary in the Netherlands |
| 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 |
| Many of our expenses are relatively fixed and difficult to reduce or modify |
| The fixed nature of our operating expenses will magnify any adverse effect of a decrease in revenue on our operating results |
| Because of these and other factors, period to period comparisons of our historical results of operations are not a good predictor of our future performance |
| If our future operating results are below the expectations of stock market analysts, our stock price may decline |
| Our ability to predict demand for our products and our financial results for current and future periods may be affected by economic conditions |
| This may adversely affect both our ability to adjust production volumes and expenses and our ability to provide the financial markets with forward-looking information |
| If our revenue levels are below expectations, our operating results are likely to suffer |
| If we make unprofitable acquisitions or are unable to successfully integrate future acquisitions, our business could suffer |
| We have in the past acquired, and in the future may acquire, businesses, products, equipment, or technologies that we believe will complement or expand our existing business |
| Acquisitions involve numerous risks, including the following: • difficulties in integrating the operations, technologies, products and personnel of the acquired companies, especially given the specialized nature of our technology; • diversion of management’s attention from normal daily operations of the business; • potential difficulties in completing projects associated with in-process research and development; 19 _________________________________________________________________ [69]Table of Contents • initial dependence on unfamiliar supply chains or relatively small supply partners; and • the potential loss of key employees of the acquired companies |
| Acquisitions may also cause us to: • issue stock that would dilute our current stockholders’ percentage ownership; • assume liabilities; • record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges; • incur amortization expenses related to certain intangible assets; • incur large and immediate write-offs; or • become subject to litigation |
| Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that any future acquisitions by us will be successful and will not materially adversely affect our business, operating results, or financial condition |
| The failure to manage and successfully integrate acquisitions we make could harm our business and operating results in a material way |
| Even if an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to products or the integration of the company into our company |
| The nature of our operations makes us susceptible to material environmental liabilities, which could result in significant compliance and 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, which may result in significant costs |
| 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 in California or 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 |
| Even if we are in compliance in all material respects with all present environmental regulations, it is often difficult to estimate the future impact of environmental matters, including potential liabilities |
| If we have to make significant capital expenditures or pay significant expense in connection with remedial actions or to continue to comply with applicable environmental laws, our business, financial condition and operating results could suffer |
| Furthermore, our manufacturing processes rely on the use of hazardous materials, and any accidental hazardous discharge could result in significant liability and clean-up expenses, which could harm our business, financial condition, and results of operations |
| 20 _________________________________________________________________ [70]Table of Contents From time to time, we may have to defend lawsuits in connection with the operation of our business |
| We are subject to litigation in the ordinary course of our business |
| If we do not prevail in any lawsuit which may occur we could be subject to significant liability for damages, our patents and other proprietary rights could be invalidated, and we could be subject to injunctions preventing us from taking certain actions |
| If any of the above occurs, our business and financial position could be harmed |
| Earthquakes, tsunamis or other natural or man-made disasters could disrupt our operations |
| Our US facilities are located in San Jose, California |
| In addition, Kobe and other Japanese suppliers of our 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 |
| Terrorist attacks may adversely affect our business and operating results |
| The continued threat of terrorist activity and other acts of war or hostility, including the war in Iraq, have created uncertainty in the financial and insurance markets, and have significantly increased the political, economic, and social instability in some of the geographic areas in which we operate |
| Acts of terrorism, either domestic or foreign, could create further uncertainties and instability |
| To the extent this results in disruption or delays of our manufacturing capabilities or shipments of our products, our business, operating results, and financial condition could be adversely affected |
| Compliance with the rules and regulations concerning corporate governance may be costly, time-consuming, and difficult to achieve, which could harm our operating results and business |
| The Sarbanes-Oxley Act (the Act), which was signed into law in October 2002, mandates that, among other things, companies maintain rigorous corporate governance measures, and imposes comprehensive reporting and disclosure requirements |
| The Act also imposes increased civil and criminal penalties on a corporation, its chief executive and chief financial officers, and members of its board of directors, for securities law violations |
| In addition, the Nasdaq National Market, on which our common stock is traded, has adopted and is considering the adoption of additional comprehensive rules and regulations relating to corporate governance |
| These rules, laws, and regulations have increased the scope, complexity, and cost of our corporate governance, reporting, and disclosure practices |
| Because compliance with these rules, laws, and regulations is costly and time-consuming, our management’s attention could be diverted from managing our day-to-day business operations, and our operating expenses could increase |
| In addition, because of the inherent limitations in all financial control systems, it is possible that, in the future, a material weakness may be found in our internal controls over financial reporting, which could affect our ability to insure proper financial reporting |
| Further, our board members, Chief Executive Officer, and Chief Financial Officer face an increased risk of personal liability in connection with the performance of their duties |
| As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business |
| In the future, we may need additional capital, which may not be available on favorable terms, or at all |
| Our business is capital-intensive and we may need more capital in the future |
| Our future capital requirements will depend on many factors, including: • the rate of our sales growth; • the level of our profits or losses; • the timing and extent of our spending to expand manufacturing capacity, support facilities upgrades and product development efforts; • the timing and size of business or technology acquisitions; 21 _________________________________________________________________ [71]Table of Contents • the timing of introductions of new products and enhancements to our existing products; and • the length of product life cycles |
| If we require additional capital it is uncertain whether we will be able to obtain additional financing on favorable terms, if at all |
| Further, if we issue equity securities in connection with additional financing, our stockholders may experience dilution and/or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock |
| If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products and services in a timely manner, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements or may be forced to limit the number of products and services we offer, any of which could seriously harm our business |
| Anti-takeover provisions in our certificate of incorporation could discourage potential acquisition proposals or delay or prevent a change of control |
| We have in place protective provisions designed to provide our board of directors with time to consider whether a hostile takeover is in our and our stockholders’ best interests |
| Our certificate of incorporation provides for three classes of directors |
| As a result, a person could not take control of the board until the third annual meeting after the closing of the takeover, since a majority of our directors will not stand for election until that third annual meeting |
| This provision could discourage potential acquisition proposals and could delay or prevent a change in control of the company, and also could diminish the opportunities for a holder of our common stock to participate in tender offers, including offers at a price above the then-current market price for our common stock |
| These provisions also may inhibit fluctuations in our stock price that could result from takeover attempts |
| Risks Related to our Indebtedness We are leveraged, and our debt obligations will continue to make us vulnerable to economic downturns |
| In 2004, we completed a public common stock offering of 4dtta0 million shares (of which 0dtta5 million were sold by selling stockholders) and a public dlra80dtta5 million Convertible Subordinated Notes offering |
| Debt service obligations arising from the offering of our Convertible Subordinated Notes could limit our ability to borrow more money for operations and implement our business strategy in the future |
| Our holding company structure makes us dependent on cash flow from our subsidiaries to meet our obligations |
| Most of our operations are conducted through, and most of our assets are held by, our subsidiaries |
| Therefore, we are dependent on the cash flow of our subsidiaries to meet our debt obligations |
| Our subsidiaries are separate legal entities that have no obligation to pay any amounts due under the Convertible Subordinated Notes, or to make any funds available therefore, whether by dividends, loans, or other payments |
| Our subsidiaries have not guaranteed the payment of the Convertible Subordinated Notes, and payments on the Convertible Subordinated Notes are required to be made only by us |
| Except to the extent we may ourselves be a creditor with recognized claims against our subsidiaries, subject to any limitations contained in our debt agreements, all claims of creditors and holders of preferred stock, if any, of our subsidiaries will have priority with respect to the assets of such subsidiaries over the claims of our creditors, including holders of the Convertible Subordinated Notes |
| The assets of our subsidiaries may not be available to make payments on our debt obligations |
| We may not have direct access to the assets of our subsidiaries unless these assets are transferred by dividend or otherwise to us |
| The ability of our subsidiaries to pay dividends or otherwise transfer assets to us is subject to various restrictions, including restrictions under other agreements to which we are a party under applicable law |