UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1995 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to __________ Commission file number 1-10639 CONNER PERIPHERALS, INC. (Exact name of registrant as specified in its charter) DELAWARE 94-2968210 (State of incorporation) (I.R.S. Employer Identification No.) 3081 ZANKER ROAD, SAN JOSE, CALIFORNIA 95134 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (408)456-4500 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- As of July 28, 1995, 53,353,169 shares of the Registrant's Common Stock were issued and outstanding. CONNER PERIPHERALS, INC. FORM 10-Q INDEX PAGE ---- Cover Page 1 Index 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - June 30, 1995 and December 31, 1994 3 Condensed Consolidated Statements of Operations - Three months and six months ended June 30, 1995 and 1994 4 Condensed Consolidated Statements of Cash Flows - Six months ended June 30, 1995 and 1994 5 Notes to Unaudited Condensed Consolidated Financial Statements 6-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-15 PART II. OTHER INFORMATION Item 1. Legal Proceedings 16 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18 2 PART I- FINANCIAL INFORMATION Item 1. Financial Statements CONNER PERIPHERALS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Data) (Unaudited) ASSETS ------ June 30, December 31, 1995 1994 ---------- ------------ Current assets: Cash, cash equivalents and short-term investments $ 388,363 $ 443,239 Accounts receivable, net 379,032 307,454 Inventory 237,365 255,880 Deferred income taxes and other 158,080 163,137 ---------- ---------- Total current assets 1,162,840 1,169,710 Property, plant and equipment, net 233,143 237,066 Goodwill and other intangibles, net 36,752 39,255 Other 13,275 15,398 ---------- ---------- $1,446,010 $1,461,429 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable $ 227,094 $ 139,559 Accrued expenses 186,484 190,372 Current portion of long term debt 3,053 34,922 ---------- ---------- Total current liabilities 416,631 364,853 Long-term debt, less current portion 527,896 627,059 Deferred income taxes 129,395 129,668 Other 932 1,525 Minority interest 3,122 1,648 Stockholders' equity: Preferred stock, $0.001 par value; 20,000,000 shares authorized, none outstanding -- -- Common stock and paid-in-capital, $0.001 par value; 100,000,000 shares authorized, 53,268,787 and 52,460,734 shares issued and outstanding 268,956 260,592 Retained earnings 99,078 76,084 ---------- ---------- Total stockholders' equity 368,034 336,676 ---------- ---------- $1,446,010 $1,461,429 ========== ========== The accompanying notes are an integral part of these condensed financial statements 3 CONNER PERIPHERALS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data) (Unaudited) Three months ended Six months ended June 30, June 30, ------------------ ----------------------- 1995 1994 1995 1994 -------- -------- ---------- ---------- Net sales $642,338 $650,079 $1,252,733 $1,214,037 Cost of sales 522,855 507,852 1,041,470 943,995 -------- -------- ---------- ---------- Gross profit 119,483 142,227 211,263 270,042 -------- -------- ---------- ---------- Operating expenses: Selling, general and administrative 56,046 49,146 107,044 97,362 Research and development 32,755 31,954 70,192 62,898 Amortization of goodwill and other intangibles 2,531 3,727 5,083 7,499 -------- -------- ---------- ---------- Total operating expenses 91,332 84,827 182,319 167,759 -------- -------- ---------- ---------- Income from operations 28,151 57,400 28,944 102,283 Interest expense (8,967) (11,728) (20,511) (24,379) Other income/(expense), net 5,804 129 16,676 4,518 -------- -------- ---------- ---------- Income before income taxes and extraordinary item 24,988 45,801 25,109 82,422 Provision for income taxes (8,246) (14,331) (8,286) (27,148) -------- -------- ---------- ---------- Income before extraordinary item 16,742 31,470 16,823 55,274 Extraordinary item: Gain on extinguishment of debt (less applicable income taxes of $1,135 and $4,288, respectively) 1,633 -- 6,171 -- -------- -------- ---------- ---------- Net income $ 18,375 $ 31,470 $ 22,994 $ 55,274 ======== ======== ========== ========== Net income per share: Primary: Income before extraordinary item $ 0.31 $ 0.60 $ 0.32 $ 1.06 Extraordinary item 0.03 -- 0.11 -- -------- -------- ---------- ---------- 0.34 $ 0.60 $ 0.43 $ 1.06 ======== ======== ========== ========== Fully diluted: Income before extraordinary item $ 0.30 $ 0.50 $ 0.32 $ 0.89 Extraordinary item 0.02 -- 0.11 -- -------- -------- ---------- ---------- $ 0.32 $ 0.50 $ 0.43 $ 0.89 ======== ======== ========== ========== Weighted average shares: Primary 53,462 52,400 53,094 52,208 ========= ======== ========= ========== Fully diluted 73,734 74,712 53,340 74,519 ========= ======== ========= ========== The accompanying notes are an integral part of these condensed financial statements 4 CONNER PERIPHERALS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) (Unaudited) Six months ended June 30, ------------------- 1995 1994 --------- -------- Cash flows from operating activities: Net income $ 22,994 $ 55,274 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Depreciation and amortization 48,297 44,393 Extraordinary item, net (6,171) -- Gain from sale of building (6,098) -- Minority interest and other 881 4,246 Changes in assets and liabilities: Accounts receivable, net (71,578) (21,282) Inventory 18,515 (102,294) Accounts payable and accrued expenses 78,259 17,890 Other (20,013) (21,938) --------- -------- Cash provided by/(used in) operating activities 65,086 (23,711) --------- -------- Cash flows from investing activities: Proceeds from Read Rite stock sale 18,664 -- Proceeds from note receivable 10,807 -- Proceeds from sale of building 15,925 -- Capital expenditures (52,313) (56,505) Purchases of investments held to maturity (76,681) (66,532) Purchases of investments available for sale (659,669) (59,989) Maturity of investments held to maturity 131,950 124,878 Sale of investments available for sale 613,457 106,124 Purchase of minority interest (3,000) -- Merger with Quest Development Corporation -- (8,500) --------- -------- Cash provided by/(used in) investing activities (860) 39,476 --------- -------- Cash flows from financing activities: Repayments of long-term debt (118,409) (31,631) Issuance of common stock 8,364 12,516 --------- -------- Cash used in financing activities (110,045) (19,115) --------- -------- Net decrease in cash and cash equivalents (45,819) (3,350) Cash and cash equivalents at beginning of the period 202,386 197,499 --------- -------- Cash and cash equivalents at end of the period 156,567 194,149 Short-term investments 231,796 215,567 --------- -------- Total cash and short-term investments $ 388,363 $409,716 ========= ======== The accompanying notes are an integral part of these condensed financial statements 5 CONNER PERIPHERALS, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - Basis of Presentation ------------------------------ The accompanying unaudited condensed consolidated financial statements for the three and six-month periods ended June 30, 1995 and 1994, have been prepared on substantially the same basis as the annual consolidated financial statements. In the opinion of management, the unaudited condensed consolidated financial statements reflect all material adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position, operating results and cash flows for the interim periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements, and notes thereto, for the year ended December 31, 1994, included in the Company's 1994 Annual Report on Form 10-K. NOTE 2 - Inventories -------------------- Inventories consisted of the following components: June 30, December 31, 1995 1994 -------- ------------ (In Thousands) Purchased components $102,096 $ 86,970 Work-in-process 61,075 72,692 Finished goods 74,194 96,218 -------- -------- $237,365 $255,880 ======== ======== NOTE 3 - Acquisitions --------------------- In February 1995, the Company increased its ownership interest in Arcada Software, Inc. from 78% to 81% through the purchase of additional shares from a minority stockholder for $3,000,000. NOTE 4 - Warranty Expense ------------------------- The Company provides for the estimated cost which may be incurred under its various product warranties upon product shipment. During the quarter ended June 30, 1995, the Company lowered its estimate of its future disk drive warranty costs by $7,600,000 as a benefit to cost of sales due to cost saving opportunities and expected future warranty cost reductions resulting from the Company's relocation of its disk drive service center from Singapore to Malaysia. NOTE 5 - Restructuring ---------------------- There have been no significant changes to the Company's estimate of the total cost of restructuring subsequent to December 31, 1994. Charges to restructuring reserves for the three and six-month periods ended June 30, 1995 were not material. 6 NOTE 6 - Reduction of Debt and Extraordinary Item ------------------------------------------------- During the six-month period ended June 30, 1995, the Company purchased at a discount, certain of its 6.5% and 6.75% Convertible Subordinated Debentures with a face value of $56,102,000. The Company also prepaid and retired the remaining $41,666,000 of its outstanding Series A and Series B Senior Notes with a prepayment fee of $1,100,000. As a result of these transactions, the Company recorded a net extraordinary gain for the three and six-month periods ended June 30, 1995 of $1,633,000 and $6,171,000 (less applicable income taxes of $1,135,000 and $4,288,000) or $0.03 and $0.11 per share, respectively. NOTE 7 - Other Income/(Expense), Net ------------------------------------ Other income/(expense), net consisted of the following components: Three months ended Six months ended June 30, June 30, ------------------- ------------------ 1995 1994 1995 1994 --------- -------- -------- -------- (In Thousands) (In Thousands) Interest income $5,662 $ 3,680 $11,931 $ 7,953 Gain on sale of building -- -- 6,098 -- Minority interest (581) (511) (1,474) 2,037 Other 723 (3,040) 121 (5,472) ------ ------- ------- ------- $5,804 $ 129 $16,676 $ 4,518 ====== ======= ======= ======= NOTE 8 - Supplemental Cash Flow Disclosure ------------------------------------------- Six months ended June 30, ----------------- 1995 1994 -------- ------- (In Thousands) Cash paid during the period for: Interest $24,264 $25,421 Income taxes $13,333 $ 3,943 NOTE 9 - Litigation ------------------- The Company and certain of its officers and certain directors are defendants in a securities class action lawsuit which purports to represent a class of investors who purchased or otherwise acquired the Company's common stock between January 1992 and May 1993. Certain officers and directors are also defendants in a related stockholders derivative suit. The complaints seek unspecified damages and other relief. The Company intends to defend the actions vigorously. 7 In 1993, the Company was served with a patent infringement complaint, filed by IBM, alleging that products manufactured by the Company have infringed certain patents owned by IBM. In addition, the complaint sought declaratory relief to the effect that disk drives produced by IBM did not infringe certain patents held by the Company and sought to have such patents declared invalid. The Company answered the complaint, denying all material allegations and counterclaiming that IBM disk drives infringe certain patents owned by the Company, including those patents contained in the IBM complaint. During the first quarter of 1995, the Company received a newly issued patent concerning various aspects of the power management features incorporated in the Company's disk drives. Promptly following the issuance of the patent, the Company filed a complaint with the United States International Trade Commission alleging that various disk drives produced by IBM infringe the new power management patent, and seeking an exclusion order concerning IBM products incorporating these infringing drives. The Company filed a lawsuit in Federal Court, Southern District of New York, seeking damages and injunctive relief related to the infringement of the power management patent. In late July 1995, the Company and IBM agreed to dismiss all of the litigation against each other and entered into patent cross license agreements. The Company and IBM also established a five year commercial relationship, whereby, IBM would buy the Company's products. The outcome of the litigation settlement did not have an adverse effect on the Company's results of operations or financial position. In December 1994, the Internal Revenue Service concluded a field audit of the Company's federal income tax returns for the fiscal years 1989 and 1990 and issued to the Company a " Notice of Deficiency " (Notice) with respect to those fiscal years. The majority of the proposed adjustments to income in the Notice related to the allocation of income between the Company and its foreign manufacturing subsidiaries. The Notice resulted in proposed tax deficiencies of approximately $43,000,000 and assessed interest. On March 20, 1995, the Company filed a Petition in the United States Tax Court entitled Conner Peripherals, Inc. v. Commissioner of Internal Revenue, Docket No. 4322-95. The Company believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or results of operations. In 1992, the Company filed a patent infringement lawsuit against Western Digital Corporation (Western Digital) alleging the infringement of five of the Company's patents by Western Digital. Western Digital has filed a counterclaim alleging infringement of certain of its patents by the Company. The Company believes it has valid claims against Western Digital and meritorious defenses to the claims asserted by Western Digital. NOTE 10 - Presentation ---------------------- Certain prior year quarter and prior year financial statement balances have been reclassified to conform to the 1995 presentation. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS --------------------- The following table sets forth certain income statement data for the quarters ended June 30, 1995 and 1994 and March 31, 1995, as a percentage of net sales in these periods. This data has been derived from the unaudited condensed consolidated financial statements. Three months ended June 30, March 31, ------------------ ---------- 1995 1994 1995 -------- -------- ---------- Net sales 100.0% 100.0% 100.0% Cost of sales 81.4 78.1 85.0 ----- ----- ----- Gross profit 18.6 21.9 15.0 ----- ----- ----- Selling, general and administrative 8.7 7.6 8.4 Research and development 5.1 4.9 6.1 Amortization of goodwill and other intangibles 0.4 0.6 0.4 ----- ----- ----- Income from operations 4.4 8.8 0.1 Income taxes and other 1.8 4.0 -- ----- ----- ----- Income before extraordinary item 2.6 4.8 0.1 Extraordinary item 0.3 -- 0.7 ----- ----- ----- Net income 2.9% 4.8% 0.8% ===== ===== ===== NET SALES --------- Net sales for the second quarter of 1995 were $642.3 million, a decrease of 1.2% from the same quarter of 1994 and an increase of 5.2% from the first quarter of 1995. The decrease in net sales over the second quarter of 1994 resulted primarily from a decrease in unit volume shipments of disk drive products and disk drive weighted average unit prices, partially offset by a more favorable product mix towards the Company's high-performance disk drives, sales of disk media to third-party customers, higher average unit prices resulting from new tape drive products and an increase in software revenue. Volume shipments of disk drive products were relatively consistent with the first quarter of 1995 due primarily to an industry shortage of key componentry. However, the increase in net sales over the first quarter of 1995 was primarily due to a more favorable product mix towards new disk and tape drive products which sell at higher than average unit prices and less severe disk drive price erosion, partially offset by lower shipment volume of tape drives. 9 No customer accounted for more than 10% of net sales for the second quarter of 1995 while Compaq Computer represented approximately 18% of net sales for the same quarter a year ago. Sales to Packard Bell represented approximately 10% of net sales during the first quarter of 1995. The following table summarizes the net sales percentages between OEM and distributor customers and foreign and domestic customers. Three months ended June 30, March 31, -------------------------- ---------- 1995 1994 1995 -------- ---------- ---------- OEM 76% 76% 75% Distributor 24 24 25 ---- ---- ---- Total 100% 100% 100% ==== ==== ==== Foreign 49% 47% 50% Domestic 51 53 50 ---- ---- ---- Total 100% 100% 100% ==== ==== ==== During the second half of 1994, the Company experienced a decline in sales of disk drive products to major U.S. OEM customers. As a result, the Company implemented a program to improve its timely introduction of disk drive products, supporting an effort to address new design-in opportunities with major OEM customers. The Company has introduced several new products intended to meet the needs of these major OEM customers and recapture lost market share. While the Company has made progress in meeting these objectives during the second quarter of 1995 through the adoption of certain of the Company's high-capacity desktop and high-performance disk drives by major OEM customers, there can be no assurance that the Company's efforts to regain its position with major OEM customers will be successful, or that continued improvement in sales to such customers will occur in subsequent quarters. The Company believes that an increase in sales to major OEM customers is important to the Company's long-term competitive position. As is common in the microcomputer industry, the Company's shipment patterns during a quarter are frequently characterized by significantly higher shipment volume in the third month of the quarter than that experienced in the first two months of the quarter. This pattern often causes quarterly results to be difficult to predict. Furthermore, order lead-times have been reduced by many of the Company's customers. This trend has impacted the visibility of future orders and, accordingly, has also affected the predictability of financial results. During the first quarter of 1995, shipment delays were experienced for certain disk drive products introduced during the first quarter of 1995 and the fourth quarter of 1994 due to certain technical issues and shortages of key components, particularly headstacks, as certain vendors were unable to meet the volume ramp of several new disk drive products. The Company generally resolved the product technical issues but experienced a continued shortage of certain key componentry during the second quarter of 1995. No assurance can be given that these events will not recur in the future. During the second quarter of 1995, demand for certain of the Company's new disk drive products exceeded availability. These products were available to customers on an allocation basis. This situation appears to be continuing for certain of the Company's disk drive products into the third quarter of 1995. There can be no assurance that these trends will or will not continue throughout the third quarter or into future periods. 10 GROSS PROFIT ------------ The Company's gross profit as a percentage of net sales (gross margin) for the second quarter of 1995 was 18.6% compared to 21.9% for the same quarter of 1994 and 15.0% for the first quarter of 1995. The decrease in gross margin compared to the prior year quarter is largely due to severe price erosion for disk drive products with capacities of 540 megabytes and less. This decline was partially offset by the reduction of warranty reserves totaling $7.6 million during the second quarter of 1995 resulting from the Company's decision to move the disk drive service center from Singapore to Malaysia. This move was initiated to take advantage of cost saving opportunities in Malaysia which reduced the Company's existing warranty reserves and is also expected to reduce warranty costs in the future. Changes in the mix of shipments towards the Company's new disk and tape drive products and sales of disk media to third-party customers which carry higher than average gross margins also had a positive impact on the Company's total gross margin. The increase in gross margin as compared to the first quarter of 1995 was primarily due to higher disk and tape drive average unit prices, particularly due to the Company's higher mix of shipments towards the new and higher capacity disk and tape products and reduced warranty reserves as discussed above. This increase was partially offset by an increase in the mix of shipments of the Company's older DAT (Digital Audio Tape) tape drives which carry lower than average gross margins. The demand for the Company's disk drives depends principally on demand for high- performance microcomputers manufactured by its customers. A slowdown in demand for such computers, reduction in demand from significant OEM customers, or continued price erosion in this intensely competitive industry may have an exaggerated effect on the demand for the Company's products and/or profitability in any given period. In addition, the disk drive industry has been characterized by periods of excess manufacturing capacity contributing to higher inventory levels and severe price erosion resulting in lower gross margins. While current demand for the Company's products remain strong, there can be no assurance that this trend will not recur and that gross margins will recover to historical levels. The Company anticipates that pricing and gross margin pressures will continue as the industry migrates rapidly to higher storage capacity products for entry level systems. In addition, competition in the tape drive industry continues to be aggressive, placing pressure on pricing and gross margins of tape drive products. The Company has launched several new disk and tape drive products during 1995 and anticipates the launch of additional products during the remainder of 1995. The failure of the Company to successfully launch or achieve required production volumes at anticipated costs for one or more of the new products could have a material adverse effect on the Company's revenues, profitability and competitive position. As is common in periods of product transition, the Company has experienced certain difficulties and delays in achieving volume production of certain products. Such delays have included the launch of the Company's high performance Cayman disk drive products during the first quarter of 1995. During the second quarter of 1995, the Company generally resolved these product technical issues and launched these products into volume manufacturing. In addition, shortages of certain key disk drive components occurred during the first and second quarters of 1995 which inhibited the Company's ability to satisfy customer demand. There can be no assurance that the Company will not experience such difficulties during the remainder of 1995. 11 SELLING, GENERAL AND ADMINISTRATIVE ----------------------------------- The Company's selling, general and administrative expenses (SG&A) for the second quarter of 1995 were $56.0 million, or 8.7% of sales, compared to $49.1 million, or 7.6% of sales, for the same quarter in 1994 and $51.0 million, or 8.4% of sales, for the first quarter of 1995. The increase in SG&A in the second quarter of 1995 as compared to the prior year quarter is primarily due to an increase in sales and marketing efforts within the tape and software product groups and a larger international sales force to support a growing European market. The increase in SG&A compared to the first quarter of 1995 was primarily attributable to profit sharing contributions made during the second quarter of 1995 partially offset by a reduction in legal expenses due to the settlement of the IBM litigation. RESEARCH AND DEVELOPMENT ------------------------ The Company's investment in research and development (R&D) for the second quarter of 1995 was $32.8 million, or 5.1% of sales. This remained relatively flat when compared to $32.0 million, or 4.9% of sales for the same quarter in 1994. The R&D expenses for the first quarter of 1995 were $37.4 million, or 6.1% of sales. The decrease in R&D expenditures as compared to the first quarter of 1995 is primarily due to the ramp up of certain disk drive product launches from new product development in the first quarter of 1995 to volume manufacturing in the second quarter of 1995. Due to the timing of new R&D programs and the release of new products to volume manufacturing, the level of R&D spending may vary from quarter to quarter in absolute dollars and as a percentage of sales. As product life cycles have shortened and the need to rapidly introduce new products has become essential, the Company has increased its focus on new product launch activities. The Company believes this investment has improved the efficiency and effectiveness of its new product launch operations. The level of R&D spending reflects management's belief that such spending is essential in order for the Company to regularly and predictably introduce new products and remain competitive. The Company is initiating a business process re-engineering program of its infrastructure and operations to reduce operating expenses, including SG&A and R&D, during the third quarter of 1995. The Company anticipates seeing the benefits of this program commencing in the fourth quarter of 1995. AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES ---------------------------------------------- The Company's amortization of goodwill and other intangibles was $2.5 million in the second quarter of 1995 compared to $3.7 million in the same quarter in 1994 while remaining relatively flat compared to $2.6 million in the first quarter of 1995. Amortization decreased from the second quarter of 1994 primarily as a result of lower intangible balances. Goodwill and other intangibles are being amortized over their remaining estimated useful lives ranging from 1 to 8 years. 12 INTEREST EXPENSE, OTHER INCOME/EXPENSE -------------------------------------- Interest expense was $9.0 million for the second quarter of 1995 compared to $11.7 million for the same quarter of 1994 and $11.5 million for the first quarter of 1995. Interest expense declined as compared to the same quarter of 1994 and the first quarter of 1995 due to the Company's early retirement of its Senior Notes and a portion of its Convertible Subordinated Debentures during the first and second quarters of 1995. Other income/expense was a net gain of $5.8 million in the second quarter of 1995 compared to a net gain of $.1 million in the same quarter of 1994 and $10.9 million in the first quarter of 1995. The increase in the net gain in the second quarter of 1995 as compared to the prior year quarter relates primarily to increased rates of return on invested funds and lower foreign exchange losses as a result of the declining value of the U.S. dollar during the second quarter of 1994 against certain foreign currencies. The decrease as compared to the first quarter of 1995 is primarily due to the gain of $6.1 million recognized in the first quarter of 1995 on the sale of a manufacturing building located in Singapore. INCOME TAXES ------------ The Company's effective tax rate for the first and second quarters of 1995 was approximately 33% excluding the impact of the extraordinary item recorded during both quarters which were recorded at the rate of 41%. The tax effect of the extraordinary items were $4.3 million and $1.1 million for the first and second quarters of 1995, respectively. EXTRAORDINARY ITEM ------------------ The Company purchased at a discount, certain of its 6.5% and 6.75% Convertible Subordinated Debentures (Debentures) with a total face value of $56.1 million during the first and second quarters of 1995. In addition, the Company prepaid and retired the remaining $41.7 million of its outstanding Series A and Series B Senior Notes with a prepayment fee of $1.1 million. As a result of these transactions, the Company recorded a net extraordinary gain of $1.6 million and $4.5 million (less applicable income taxes of $1.1 million and $3.2 million) or $0.02 and $0.09 on a fully diluted basis per share for the three-month periods ended June 30, 1995 and March 31, 1995, respectively. The Company anticipates that some portion of its outstanding Debentures may be purchased from time to time during the remainder of 1995 depending on the price, market conditions and other considerations. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- At June 30, 1995, the Company's principal sources of liquidity consisted of cash and short-term investments of $388.4 million and a combined $100 million revolving credit facility with several financial institutions which is subject to the continued maintenance of certain financial covenants. The Company had no borrowings outstanding under this credit facility as of June 30, 1995. As of this date, the Company had outstanding letters of credit and guarantees of approximately $48.6 million. 13 Cash provided by operating activities was approximately $65.1 million for the six-month period ended June 30, 1995 compared to cash used in operating activities of $23.7 million for the same period in 1994. This increase was primarily attributable to an increase in accounts payable and other accrued expenses and a decrease in inventory partially offset by increases in accounts receivable. Capital expenditures for the six-month period ended June 30, 1995, amounted to $52.3 million. These expenditures primarily related to the purchase of manufacturing and R&D equipment for the Company's operations, upgrades in computer equipment and the expansion of the Company's disk media manufacturing in Singapore. An initial capital investment of approximately $44 million has been designated to build a new disk media manufacturing MINT (Magnetic Information Technology) line in Singapore. This line is scheduled to begin production during the first half of 1996. For the six-month period ended June 30, 1995, approximately $2.0 million in capital expenditures relates to this expansion. The Company plans to spend approximately $44 million on additional capital expenditures during the remainder of 1995. During the six-month period ended June 30, 1995, the Company's cash expenditures to retire its Debentures in the open market and normal repayments of long-term debt were $118.4 million. The Company received $15.9 million in cash proceeds during the period for the sale of a manufacturing building located in Singapore. In addition, $28.7 million was received from proceeds of the sale of Read-Rite stock and proceeds from notes receivable. The Company believes that current capital resources and cash generated from operations will be sufficient to meet its liquidity and capital expenditure requirements for the foreseeable future. FOREIGN CURRENCY RISKS ---------------------- The Company's cash flows are substantially U.S. dollar denominated. However, the Company is exposed to certain foreign currency fluctuations, primarily British Pound Sterling, Malaysian Ringgit, Italian Lira and Singapore Dollars. At June 30, 1995, the Company had outstanding foreign currency forward contracts aggregating approximately $61.2 million. These contracts mature at various periods through September 1995 and are consistent with the amounts and timing of the underlying anticipated cash flow requirements and purchase commitments. LITIGATION ---------- The Company and certain of its officers and certain directors are defendants in a securities class action lawsuit which purports to represent a class of investors who purchased or otherwise acquired the Company's common stock between January 1992 and May 1993. Certain officers and directors are also defendants in a related stockholders derivative suit. The complaints seek unspecified damages and other relief. The Company intends to defend the actions vigorously. In 1993, the Company was served with a patent infringement complaint, filed by IBM, alleging that products manufactured by the Company have infringed certain patents owned by IBM. In addition, the complaint sought declaratory relief to the effect that disk drives produced by IBM did not infringe certain patents held by the Company and sought to have such patents declared invalid. The Company answered the complaint, denying all material allegations and counterclaiming that IBM disk drives infringe certain patents owned by the Company, including those patents contained in the IBM complaint. 14 During the first quarter of 1995, the Company received a newly issued patent concerning various aspects of the power management features incorporated in the Company's disk drives. Promptly following the issuance of the patent, the Company filed a complaint with the United States International Trade Commission alleging that various disk drives produced by IBM infringe the new power management patent, and seeking an exclusion order concerning IBM products incorporating these infringing drives. The Company filed a lawsuit in Federal Court, Southern District of New York, seeking damages and injunctive relief related to the infringement of the power management patent. In late July 1995, the Company and IBM agreed to dismiss all of the litigation against each other and entered into patent cross license agreements. The Company and IBM also established a five year commercial relationship, whereby, IBM would buy the Company's products. The outcome of the litigation settlement did not have an adverse effect on the Company's results of operations or financial position. In December 1994, the Internal Revenue Service concluded a field audit of the Company's federal income tax returns for the fiscal years 1989 and 1990 and issued to the Company a "Notice of Deficiency" (Notice) with respect to those fiscal years. The majority of the proposed adjustments to income in the Notice related to the allocation of income between the Company and its foreign manufacturing subsidiaries. The Notice resulted in proposed tax deficiencies of approximately $43 million and assessed interest. On March 20, 1995, the Company filed a Petition in the United States Tax Court entitled Conner Peripherals, Inc. v. Commissioner of Internal Revenue, Docket No. 4322-95. The Company believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or results of operations. In 1992, the Company filed a patent infringement lawsuit against Western Digital Corporation (Western Digital) alleging the infringement of five of the Company's patents by Western Digital. Western Digital has filed a counterclaim alleging infringement of certain of its patents by the Company. The Company believes it has valid claims against Western Digital and meritorious defenses to the claims asserted by Western Digital. 15 PART II - OTHER INFORMATION Item 1. Legal Proceedings Reference is made to Note 9 of notes to unaudited condensed consolidated financial statements. Item 4. Submission of Matters to a Vote of Security Holders (a) The Company held its Annual Meeting of Stockholders on April 25, 1995. (b) At the meeting Finis F. Conner, David T. Mitchell, L. Paul Bremer, III, W. Howard Lester, Mark S. Rossi, Linda Wertheimer Hart and R. Elton White were elected to serve as directors of the Company for the ensuing year and until their successors are elected. Effective May 17, 1995, Mr. Mitchell resigned as an Officer of the Company and from the Board of Directors. (c) Other matters voted on at the meeting: (i) Ratification and approval of an amendment to the Company's Employee Stock Purchase Plan increasing the total number of shares of the Company's Common Stock reserved for issuance thereunder by 2,300,000 shares to a total of 6,800,000 shares. The stockholders approved the amendment to the Employee Stock Purchase Plan by a vote of 38,452,617 Common equivalent shares for, 6,326,167 Common equivalent shares against and 710,849 Common equivalent shares abstaining. (ii) Ratification and approval of the Company's 1995 Director Stock Plan, under which a total of 300,000 shares were reserved for issuance. The stockholders approved the plan by a vote of 34,956,240 Common equivalent shares for, 9,794,011 Common equivalent shares against and 739,382 Common equivalent shares abstaining. (iii) Ratification of the appointment of Price Waterhouse LLP as certified public accountants for the Company for the fiscal year ending December 31, 1995. The stockholders ratified the appointment by a vote of 44,613,248 Common equivalent shares for, 324,760 Common equivalent shares against and 551,625 Common equivalent shares abstaining. 16 (iv) Separate tabulation with respect to each nominee for office: Finis F. Conner: For: 44,190,810 Withheld: 1,298,823 David T. Mitchell: For: 44,156,511 Withheld: 1,333,122 L. Paul Bremer, III: For: 43,888,451 Withheld: 1,601,182 W. Howard Lester: For: 44,200,176 Withheld: 1,289,457 Mark S. Rossi: For: 44,228,420 Withheld: 1,261,213 Linda Wertheimer Hart: For: 44,214,415 Withheld: 1,275,218 R. Elton White: For: 44,222,225 Withheld: 1,267,408 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 11.1 Statement Regarding Computation of Earnings Per Share 22.1 Published Report Regarding Matters Submitted to a Vote of Security Holders. (see page 16, Part I, Item 4 of the June 30, 1995 Form 10-Q) 27.0 Article 5 of Regulation S-X - Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed on behalf of Registrant during the quarter ended June 30, 1995. 17 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. CONNER PERIPHERALS, INC. (Registrant) Date: August 11, 1995 /s/ P. Jackson Bell ----------------- ------------------- P. Jackson Bell Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 18 CONNER PERIPHERALS, INC. INDEX TO EXHIBITS Exhibit Number Description ------- ----------- 11.1 Statement Regarding Computation of Earnings Per Share 27.0 Article 5 of Regulation S-X - Financial Data Schedule 19