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Friday, May 1,
1998
Applied Magnetics Corp.
(NYSE: APM)
Phone: 805-683-5353
Website: http://www.appmag.com
Price (4/30/98): $10 1/4
HOW DID IT FIND TROUBLE?
Just over a year ago investors were charged up by Applied Magnetics' attempt
to acquire competitor Read-Rite (Nasdaq: RDRT). They pushed the stock
to $60 a share. Even before that deal fell through, though, this manufacturer
of recording heads for computer hard drives saw its stock start trending
back down. After the entire disk drive industry drove into a ditch, what
once was attractive proved repellent.
While Applied Magnetics has suffered due to an industry-wide glut of hard
drives and price competition, it's been especially victimized by its slow
transition from advanced inductive thin film head products to the higher
performance heads for new magnetoresistive (MR) drives. Investors cut off
Applied's head after its main customer, drive maker Western Digital
(NYSE: WDC), announced in November that it was being victimized by cutthroat
competition and then in December said it would make major production cuts
and an accelerated transition to MR technology.
The results for the first half of FY98 have been ugly. Revenues fell from
$123 million in the September period to just $74 million in the December
first quarter. Including an $8 million pre-tax charge to close a production
facility in Ireland, Applied recorded a $40 million loss, or a loss of $1.67
per share. The company had expected March quarter sales to be sequentially
flat, but they actually plunged to $59 million, down from $126 million a
year ago, due to reduced demand from Western Digital for inductive thin film
products. That led to a $32 million loss, or a loss of $1.33 per share.
Part of this ugliness has been caused by huge research and development spending
($52 million for the first half of FY98 vs. $53 million for all of FY97)
for MR and giant MR (GMR) production lines. Yet even Applied's new offerings
have been caught by accelerated product transitions: two of its MR programs
were killed earlier than expected, leading first quarter MR sales to fall
to $1.8 million from $7.1 million a year earlier.
While the company has succeeded in cutting costs in recent quarters, it has
also been forced to trim its capital spending for FY98 from $170 million
to $100 million. Even worse, the company has failed to get its heads qualified
for new programs during the first quarter, as originally expected. Although
we're now in the third quarter, no new qualifications have been announced.
Bad news with no sign of good times to come makes for surefire trouble.
BUSINESS DESCRIPTION
Founded in 1957, Applied Magnetics is a leading independent manufacturer
of magnetic recording heads, head-gimbal assemblies (HGAs), and headstack
assemblies (HSAs) for computer hard disk drives.
Hard drives include one to ten disks. A head flies just micro-inches above
these disks, writing and reading data. Drives require one head for each active
disk side, so two to twenty heads per drive. Demand for older inductive thin
film heads peaked in the March quarter of '97, and the company has since
been making the transition to MR technology, which has a higher storage capacity
and allows for faster transfer rates.
Western Digital accounted for 79% of the firm's sales last year, with Micropolis
(now out of business), NEC, and Quantum among Applied's other customers.
Vertically integrated drive makers Seagate and IBM were the leading MR head
producers last year, with TDK and Yamaha not far behind and Alps coming on
strong. Among independent head makers,
Read-Rite
is Applied's major competitor.
Insiders own 5.4% of the stock.
FINANCIAL FACTS
Income Statement*
12-month sales: $380.2 million
12-month income: ($38.5 million)
12-month EPS: ($1.79)
Profit Margin: N/A
Market Cap: $317.8 million
(*Includes $8 million pre-tax restructuring charge.)
Balance Sheet
Cash: $86.9 million
Current Assets: $161.3 million
Current Liabilities: $92.7 million
Long-term Debt: $118.9 million
Ratios
Price-to-earnings: N/A
Price-to-sales: 0.8
HOW COULD YOU HAVE SEEN IT COMING?
Some have argued that Applied's hostile bid for Read-Rite was really an attempt
to acquire that company's MR technology. Since Read-Rite itself has been
heavily dependent on Western Digital and thus slower to transition from inductive
heads to MR, such a theory would suggest Applied was having real troubles
ramping its MR products.
Other concerns popped up throughout 1997 as the company's customers defected
or went under. In February, Quantum sold part of its head operations to Japan's
MKE, its contract manufacturer. That meant Quantum would have less use for
Applied. In June, NEC struck a contract manufacturing deal with IBM. Then
in November, Singapore Technologies' Micropolis unit bit the dust.
As the continued industry consolidation left Applied with fewer customers,
the company proved massively exposed both to competitive factors and product
transitions affecting Western Digital.
WHERE TO FROM HERE?
First Call now shows a mean earningsestimate for FY98 ending in September
of a loss of $4.53 per share. One analyst sees a $0.12per share loss in FY99.
On April 20, the company said third quarter revenues will likely decline
by more than 25% sequentially before increasing in the fourth quarter, as
MR head sales "become a significant source of revenue, pending qualification
on 2.8 gigabyte per 3.5-inch disk MR programs."
If Applied qualifies for a 2.1 gigabyte program, its inductive thin-film
sales should continue through the December quarter. Its MR heads are also
being considered for 3.4 gigabyte and above programs. The firm will also
deliver its first GMR sample products this quarter.
The company has $87 million in cash and $46 million under an existing credit
facility. That should be enough, assuming the firm succeeds in getting its
MR technology approved by some drive manufacturers and starts generating
profits to continue the MR and GMR ramp up to improve yields. But that's
the crucial next step.
While industry analysts expect 15% long-term drive growth, component growth
should be higher -- in the 20% to 40% range -- since the demand for storage
is outpacing technological gains that boost the gigabytes per disk. That's
the investment thesis for the component manufacturers, particularly the head
makers. The problem is that IBM and others have taken the lead in rolling
out MR heads.
Applied Magnetics can't play the game if it doesn't get picked by the drive
makers. And today, the company is looking like the scrawny left kicking weeds
on the sidelines.
Still, Applied reported a 19% net margin in FY97, suggesting how profitable
the company can be at the top of its product cycle. Analysts are also looking
for the disk drive industry to recover toward the end of 1998. Investors
should take notice when and if the company announces a new MR head customer.
That won't necessarily signal a turnaround, but it's a sure prerequisite.
-- Louis Corrigan
(TMFSeymor@aol.com)
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