WD Media 10Q 2004 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarter Ended June 29, 2003
Commission File Number 0-16852

KOMAG, INCORPORATED

(Registrant)

Incorporated in the State of Delaware
I.R.S. Employer Identification Number 94-2914864
1710 Automation Parkway, San Jose, California 95131
Telephone: (408) 576-2000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act rule 12b-2). Yes [ X ] No [ ]

Indicate by check mark whether the Registrant has filed all reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [X] No [ ]

On June 29, 2003, 23,551,172 shares of the Registrant’s common stock, $0.01 par value, were issued and outstanding.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	ITEM 1. Legal Proceedings
	ITEM 2. Changes in Securities
	ITEM 3. Defaults Upon Senior Securities
	ITEM 4. Submission of Matters to a Vote of Security Holders
	ITEM 5. Other Information
	ITEM 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

INDEX
KOMAG, INCORPORATED


		Page No.
PART I	FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (Unaudited)
	Consolidated statements of operations — three and six months ended June 29, 2003 and June 30, 2002	3
	Consolidated balance sheets — June 29, 2003 and December 29, 2002	4
	Consolidated statements of cash flows — six months ended June 29, 2003 and June 30, 2002	5
	Notes to consolidated financial statements	6-12
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13-37
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	38
Item 4.	Controls and Procedures	38
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	39
Item 2.	Changes in Securities	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Submission of Matters to a Vote of Security Holders	39
Item 5.	Other Information	40
Item 6.	Exhibits and Reports on Form 8-K	40
SIGNATURES		41

PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


			Successor			Predecessor			Successor				Predecessor
			Company			Company			Company			Company

			Three Months			Three Months			Six Months			Six Months
			Ended			Ended			Ended			Ended
			Jun 29, 2003			Jun 30, 2002			Jun 29, 2003			Jun 30, 2002

Net sales			$	105,347		$	50,590		$	210,862		$	111,955
Cost of sales				82,511			51,620			165,250			106,788

	Gross profit (loss)			22,836			(1,030	)		45,612			5,167
Operating expenses:
	Research, development, and engineering			10,402			9,405			20,311			18,796
	Selling, general, and administrative			4,038			4,090			8,600			8,256
	Amortization of intangible assets			—			535			—			3,609
	Restructuring/impairment charges			—			4,318			—			4,318

				14,440			18,348			28,911			34,979

	Operating income (loss)			8,396			(19,378	)		16,701			(29,812	)
Other income (expense):
	Interest income			132			96			240			193
	Interest expense			(3,359	)		—			(6,744	)		—
	Other income, net			245			396,112			1,302			399,147

				(2,982	)		396,208			(5,202	)		399,340

	Income before reorganization costs, income taxes, minority interest/ equity interest in net loss of related companies, and cumulative effect of change in accounting principle			5,414			376,830			11,499			369,528
Reorganization costs, net				—			5,520			—			6,511
Provision for income taxes				814			339			1,845			719

	Income before minority interest/equity interest in net loss of related companies, and cumulative effect of change in accounting principle			4,600			370,971			9,654			362,298
Minority interest/equity interest in net loss of related companies				—			(865	)		—			(2,374	)

	Income before cumulative effect of change in accounting principle			4,600			370,106			9,654			359,924
Cumulative effect of change in accounting principle				—			—			—			(47,509	)

		Net income	$	4,600		$	370,106		$	9,654		$	312,415

Basic net income per share			$	0.20					$	0.41

Diluted net income per share			$	0.19					$	0.40

Number of shares used in basic per share computation				23,344						23,323

Number of shares used in diluted per share computation				24,304						24,125

See notes to consolidated financial statements.

KOMAG, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands)

ASSETS


				Jun 29, 2003			Dec 29, 2002

				(Unaudited)			(Note)

Current assets
	Cash and cash equivalents			$	44,361		$	23,520
	Accounts receivable (less allowances of $1,901 in 2003 and $1,101 in 2002)				52,650			46,241
	Inventories				19,772			14,925
	Prepaid expenses and deposits				3,098			2,288

			Total current assets		119,881			86,974
Property, plant, and equipment, net					185,508			196,414
Land and buildings held for sale					24,600			24,600
Intangible assets, net					7,480			9,142
Other assets					70			70

				$	337,539		$	317,200

		LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
	Current portion of long-term debt			$	20,242		$	10,229
	Trade accounts payable				36,465			35,371
	Accrued expenses and other liabilities				18,836			13,717

			Total current liabilities		75,543			59,317
Long-term debt					122,914			129,923

			Total liabilities		198,457			189,240
Stockholders’ equity
	Common stock				235			232
	Additional paid-in capital				171,946			171,876
	Deferred stock-based compensation				(834	)		(2,229	)
	Accumulated deficit				(32,265	)		(41,919	)

			Total stockholders’ equity		139,082			127,960

				$	337,539		$	317,200

Note: The balance sheet at December 29, 2002 was derived from the audited consolidated financial statements at that date.

See notes to consolidated financial statements.

KOMAG, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)


			Successor			Predecessor
			Company			Company

			Six Months			Six Months
			Ended			Ended
			Jun 29, 2003			Jun 30, 2002

Operating Activities
Net income			$	9,654		$	312,415
Adjustments to reconcile net income to net cash provided by operating activities:
	Gain on extinguishment of liabilities subject to compromise and revaluation of assets and liabilities pursuant to fresh-start reporting			—			(396,376	)
	Cumulative effect of change in accounting principle			—			47,509
	Impairment charges related to property, plant, and equipment			—			216
	Depreciation and amortization on property, plant, and equipment			20,713			25,998
	Amortization of intangible assets			1,870			3,609
	Amortization of deferred stock-based compensation			1,400			—
	Non-cash interest charges			3,297			—
	Gain on disposal of assets			(724	)		(1,783	)
	Minority interest/equity interest in net loss of related companies			—			2,374
Changes in operating assets and liabilities:
	Accounts receivable, net			(6,409	)		4,234
	Inventories			(4,847	)		(2,069	)
	Prepaid expenses and deposits			(810	)		(1,480	)
	Trade accounts payable			1,094			5,870
	Accrued expenses and other liabilities			5,119			1,693

				30,357			2,210
Reorganization costs, net				—			6,511

		Net cash provided by operating activities		30,357			8,721
Investing Activities
Acquisition of property, plant, and equipment				(9,807	)		(6,855	)
Purchases of short-term investments				—			(338	)
Proceeds from short-term investments at maturity				—			335
Proceeds from disposal of assets				724			2,688
Investment in intangible assets				(208	)		(70	)
Changes in deposits and other assets				—			29

		Net cash used in investing activities		(9,291	)		(4,211	)
Financing Activities
Proceeds from issuance of common stock				68			—
Payment of debt				(293	)		—

		Net cash used in financing activities		(225	)		—

Increase in cash and cash equivalents				20,841			4,510
Cash and cash equivalents at beginning of period				23,520			17,486

		Cash and cash equivalents at end of period	$	44,361		$	21,996

See notes to consolidated financial statements.

KOMAG, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNE 29, 2003

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation of the consolidated financial position, operating results, and cash flows for the periods presented, have been included. Operating results for the six-month period ended June 29, 2003, are not necessarily indicative of the results that may be expected for the year ending December 28, 2003.

Komag, Incorporated (KUS) filed a voluntary petition for reorganization under chapter 11 of the United States Bankruptcy Code on August 24, 2001 (the Petition Date). The petition was filed with the United States Bankruptcy Court for the Northern District of California. The petition related only to the Company’s U.S. corporate parent, KUS, and did not include any of its subsidiaries.

KUS proposed, and in May 2002 the Bankruptcy Court confirmed, the Further Modified First Amended Plan of Reorganization (the Plan), which became effective on June 30, 2002. KUS emerged from bankruptcy on that date. In accordance with Statement of Position 90-7 (SOP 90-7), Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, issued by the American Institute of Certified Public Accountants, the Company adopted fresh-start reporting and reflected the effects of the adoption in the consolidated financial statements for the six months ended June 30, 2002. Fresh-start reporting requires the recording of assets and liabilities at fair value, and requires the recording of stockholders’ equity based on the reorganization (enterprise) value.

As a result of the adoption of fresh-start reporting, the consolidated statements of operations and statements of cash flows for periods ended after June 30, 2002 are prepared on a basis of accounting that is different from that utilized for periods ended prior to June 30, 2002. Therefore, the Company’s consolidated statements of operations and cash flows for the three and six months ended June 29, 2003 are not comparable to the consolidated statements of operations and cash flows for the three and six months ended June 30, 2002.

Certain reclassifications have been made to prior period balances in order to conform to the current period presentation.

Fiscal Year:The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. The three-month reporting periods included in this report consisted of 13 weeks.

Inventories:Inventories are stated at the lower of cost (first-in, first-out method) or market, and consist of the following (in thousands):


	Jun 29, 2003		Dec 29, 2002

Raw material	$	11,816	$	9,281
Work in process		6,267		2,350
Finished goods		1,689		3,294

	$	19,772	$	14,925

Stock-Based Compensation:The Company uses the intrinsic value method to account for employee stock-based compensation. The intrinsic value method is in accordance with the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, compensation cost is recorded on the date of grant to the extent that the fair value of the underlying share of common stock exceeds the exercise price for a stock option or the purchase price for a share of common stock.

In accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure — an Amendment of SFAS No. 123, the Company provides pro forma disclosure of the effect on net income and earnings per share had the fair value method, as prescribed by SFAS No. 123, been used.

The following table reflects the effect on the Company’s net income and earnings per share after emergence from bankruptcy (the Successor Company) for the three and six months ended June 29, 2003, and on the Company’s net income prior to emergence from bankruptcy (the Predecessor Company) for the three and six months ended June 30, 2002, had the fair value method been applied to all outstanding and unvested awards.

Upon emergence from chapter 11 on June 30, 2002, the Company had a significant change in the structure of stockholders’ equity. Accordingly, earnings per share of the Predecessor Company are not presented, as the amounts are not meaningful. The table is in thousands, except per share data.


		Successor			Predecessor			Successor			Predecessor
		Company			Company			Company			Company

		Three Months			Three Months			Six Months			Six Months
		Ended			Ended			Ended			Ended
		Jun 29, 2003			Jun 30, 2002			Jun 29, 2003			Jun 30, 2002

Net income, as reported		$	4,600		$	370,106		$	9,654		$	312,415
Add: Stock-based compensation expense included in reported net income, net of related tax effects			588			—			1,400			-
Deduct: Stock-based compensation expense determined under the fair value method for all awards, net of related tax effects			(1,091	)		(2,447	)		(2,013	)		(4,895	)

Pro forma net income		$	4,097		$	367,659		$	9,041		$	307,520

Net income per share:
	Basic — as reported	$	0.20					$	0.41

	Diluted — as reported	$	0.19					$	0.40

	Basic — pro forma	$	0.18					$	0.39

	Diluted — pro forma	$	0.17					$	0.37

For pro forma disclosure purposes, the Company used the Black-Scholes option pricing model to estimate the fair value of each option and stock purchase right grant on the date of grant. The following assumptions were used for grants in the first quarter of 2003 (there were no grants in the second quarter of 2003): a risk-free interest rate of 2.68%; a volatility factor of the expected market price of the Company’s common stock of 87.1%; and a weighted-average expected option life of four years. The weighted average fair value of options granted during the first quarter of 2003 was $4.34. There were no grants in the first half of 2002.

For pro forma disclosure purposes, the Company used the Black-Scholes option pricing model to estimate the fair value of employee purchase rights under the Amended and Restated 2002 Employee Stock Purchase Plan (ESPP). The following assumptions were used in the first and second quarters of 2003: a risk-free interest rate of 1.18%; a volatility factor of the expected market price of the Company’s common stock of 62.2%; and a weighted-average expected purchase rights life of six months. The weighted-average fair value of purchase rights granted during the first and second quarters of 2003 was $1.77. There was no ESPP Plan in effect in the first half of 2002.

Because the Company does not pay dividends, there was no dividend yield included in the pro forma disclosure calculation.

Net Income Per Share:The Company determines net income per share in accordance with SFAS No. 128, Earnings per Share.

Basic net income per common share is computed by dividing income available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing income available to common stockholders by the weighted-average number of shares and dilutive potential shares of common stock outstanding during the period. The dilutive effect of outstanding options and stock purchase rights is reflected in diluted earnings per share by application of the treasury stock method.

The following table sets forth the computation of net income per share (in thousands, except per share amounts):


		Successor		Successor
		Company		Company

		Three Months		Six Months
		Ended		Ended
		Jun 29, 2003		Jun 29, 2003

Numerator: Net income		$	4,600	$	9,654

Denominator for basic income per share — weighted average shares			23,344		23,323
Effect of dilutive securities:
	Stock purchase rights		664		646
	Stock options		259		156
	Warrants		37		—

Denominator for dilutive income per share			24,304		24,125

Basic net income per share		$	0.20	$	0.41

Diluted net income per share		$	0.19	$	0.40

Incremental common shares attributable to outstanding common stock warrants of zero and 1,000,000 for the three and six months ended June 29, 2003, respectively, were not included in the diluted net income per share calculation because the effect would have been anti-dilutive.

Recent Accounting Pronouncements:In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to Komag’s existing financial instruments effective June 30, 2003, the beginning of the first fiscal period after June 15, 2003. The Company does not expect the adoption of this statement to have a material impact on its consolidated financial statements.

Note 2. Related Parties and Major Customers

Prior to June 30, 2002, sales to Western Digital Corporation (Western Digital) were reported as related party transactions, as Western Digital owned more than 5% of the Company’s outstanding common stock. For the periods subsequent to June 30, 2002, Western Digital was no longer a related party, as it owned less than 5% of the Company’s outstanding stock. Sales to Western Digital for the three and six months ended June 30, 2002 were $28.3 million and $69.3 million, respectively.

The following table reflects the percentage of the Company’s revenue by major customer:


	Three Months Ended						Six Months Ended

Customer	Jun 29, 2003			Jun 30, 2002			Jun 29, 2003			Jun 30, 2002

Western Digital		39	%		56	%		43	%		62	%
Maxtor		38	%		38	%		37	%		30	%
IBM		12	%		1	%		11	%		1	%
Hitachi Global Storage Technologies		11	%		—			9	%		—
Seagate		—			4	%		—			6	%

Note 3. Interest Expense

In the second quarter and first half of 2003, the Company recorded $3.4 million and $6.7 million, respectively, in interest expense, which primarily represented interest on the Company’s debt issued on emergence from chapter 11. No interest expense was recorded in the first half of 2002, as interest expense was suspended while the Company was in chapter 11.

Note 4. Reorganization Costs, Net

No reorganization expenses were recorded in the second quarter and first half of 2003, compared to $5.5 million and $6.5 million, respectively, in the second quarter and first half of 2002. Reorganization expenses in the first half of 2002 primarily reflected professional fees related to the chapter 11 bankruptcy proceeding, and a $5.0 million adjustment associated with a chapter 11-related creditor claim.

Note 5. Income Taxes

The Company’s income tax provisions of $0.8 million and $0.3 million for the second quarters of 2003 and 2002, respectively, and $1.8 million and $0.7 million for the first half of 2003 and 2002, respectively, represent foreign income taxes and foreign withholding taxes on royalty and interest payments.

The Company’s wholly-owned thin-film media operation, KMS, received a five-year extension of its initial tax holiday, which expired in June 2003, for its first plant site. The Company received an oral approval for an additional eight-year extension on the tax holiday on the first plant site, which would extend it through June 2011. The Company is awaiting the written approval. KMS has also been granted additional tax holidays for its second and third plant sites in Malaysia. These tax holidays are effective through December 2006 and 2008, respectively.

Note 6. Minority Interest/Equity Interest in Net Loss of Related Companies

The minority interest for Kobe USA’s 20% share of KMT’s net income in the second quarter and first half of 2002 was less than $0.1 million. KMT ceased operations in the third quarter of 2002.

In the second quarter and first half of 2002, the Company recorded $0.9 million and $2.4 million losses, respectively, as its equity share in the net loss of Chahaya, a former equity investment. Chahaya ceased operations in the fourth quarter of 2002. The Company currently has no minority or equity interests in related companies.

Note 7. Goodwill and Other Intangible Assets

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which requires that goodwill not be amortized, but be subject to an impairment test at least annually.

The Company completed a transitional impairment analysis of its goodwill during the six months ended June 30, 2002 and recorded a transitional impairment loss of $47.5 million as of the first day of fiscal 2002. The transitional impairment loss of $47.5 million was recognized as the cumulative effect of a change in accounting principle in the Company’s consolidated statement of operations.

Upon the adoption of fresh-start reporting as of June 30, 2002, the Company recorded goodwill of $33.9 million, which equaled the reorganization value in excess of amounts allocable to identifiable net assets recorded in accordance with SOP 90-7. In the fourth quarter of 2002, the Company performed its first annual goodwill impairment analysis under SFAS No. 142. Because the Company’s fair value based on market capitalization was significantly less than net book value at December 29, 2002, the Company wrote off the entire $33.9 million goodwill balance in the fourth quarter of 2002.

Upon the adoption of fresh-start reporting as of June 30, 2002, the Company recorded other intangible assets in the amount of $17.6 million. As of June 29, 2003, other intangible assets included; 1) developed technology of $3.1 million (less accumulated amortization of $0.9 million), which is being amortized on a straight-line basis over its estimated useful life of three and one-half years; 2) a volume purchase agreement of $7.7 million (less accumulated amortization of $2.8 million), which is being amortized on a straight-line basis over its useful life of two and three-quarter years; and 3) patent costs of $0.4 million (less accumulated amortization of zero).

Amortization of intangible assets in the second quarter and first half of 2003 was $0.9 million and $1.8 million, respectively, and was included in cost of sales. Amortization of intangible assets in the second quarter and first half of 2002 was $0.5 million and $3.6 million, respectively, and was included in operating expenses.

Note 8. Accrued Expenses and Other Liabilities

The following table summarizes accrued expenses and other liabilities balances as of June 29, 2003 and December 29, 2002 (in thousands):


	Jun 29, 2003		Dec 29, 2002

Accrued compensation and benefits	$	11,615	$	7,732
Restructuring liabilities		1,057		2,356
Other liabilities		6,164		3,629

	$	18,836	$	13,717

Cash payments under the Company’s restructuring liabilities were $0.5 million and $1.3 million in the second quarter and first half of 2003, respectively.

Note 9. 2002 Qualified Stock Plan and 2002 Employee Stock Purchase Plan

In April 2003, the Company’s Board of Directors approved an amendment to the 2002 Qualified Stock Plan (2002 Stock Plan) to accelerate the date on which the additional 750,000 shares will be reserved under the 2002 Stock Plan, and to increase the total number of shares to be reserved for issuance by only 450,000 shares, a 300,000 share decrease from the aforementioned 750,000 share increase that was originally approved by stockholders in October 2002.

In April 2003, the Company’s Board of Directors approved an amendment to the 2002 Employee Stock Purchase Plan to increase the total number of shares subject to purchase under the Plan by 300,000 shares so that a total of 600,000 shares will be available for purchase. The Board proposed that the 300,000 shares to be used for this increase come from the reduction to the 2002 Stock Plan increase as noted above.

These amendments were approved by stockholders at the annual meeting of stockholders on May 20, 2003.

Note 10. Subsequent Events

In July 2003, the Company received written approval for the exemption of withholding tax on royalty payments made by its Malaysian operations to its subsidiary in the Netherlands. The exemption is for a period of five years effective retroactively from January 2002 through December 2006. As a result, the Company will record an income tax benefit of approximately $2.5 million in the third quarter of 2003 related to withholding taxes that were previously accrued by the Company but are no longer payable as a result of the exemption.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Part I., Financial Information, Item 1. Consolidated Financial Statements of this report.

The following discussion contains predictions, estimates, and other forward-looking statements that involve a number of risks and uncertainties about our business. These statements may be identified by the use of words such as “expects,” “anticipates,” “intends,” “plans,” and similar expressions. In addition, forward-looking statements include, but are not limited to, statements about our beliefs, estimates or plans about our ability to maintain low manufacturing and operating costs, our ability to estimate shipping volumes, pricing pressures, selling, general, and administrative expenses, research, development, and engineering expenses, spending on property, plant, and equipment, expected sales of higher density disks and the market for disk drives generally, our beliefs regarding our liquidity needs, and estimates of debt payments, accrual of interest, and future cash needs.

The Company’s business is subject to a number of risks and uncertainties. While this discussion represents our current judgment on the future direction of our business, these risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. Some of the important factors that may influence possible differences are continued competitive factors, technological developments, pricing pressures, changes in customer demand, and general economic conditions, as well as those discussed below in “Other Factors that May Affect Future Operating Results.”

Results of Operations

Overview

Our business is capital-intensive and is characterized by high fixed costs, making it imperative that we sell disks in high volume. Our contribution margin per disk sold varies with changes in selling price, input material costs, and production yield. As demand for our disks increases, our total contribution margin increases, improving our financial results because we do not have to increase our fixed cost structure in proportion to increases in demand and resultant capacity utilization. Conversely, our financial results would deteriorate rapidly if the disk market were to worsen.

Adverse conditions in the thin-film media market, which began in mid-1997, impacted our business through the majority of 2002. Disk drive demand grew rapidly during the mid-1990s, and industry forecasts were for continued strong growth. Along with many of our competitors (both independent disk manufacturers and captive disk manufacturers owned by vertically integrated disk drive companies), in 1996 we committed to expansion programs and substantially increased media manufacturing capacity in 1997. In 1997, the rate of growth in demand for disk drives fell. Disk drive manufacturers abruptly reduced their orders for media from independent suppliers and relied more heavily on internal capacity to supply a larger proportion of their media requirements. The media industry’s capacity expansion, coupled with the

decrease in the rate of demand growth, resulted in excess media production capacity. Due to classic micro-economic forces, this excess industry capacity caused sharp declines in average selling prices for disk products as independent suppliers struggled to utilize their capacity.

In addition, by the end of 1998, most disk drives manufactured were transitioned to the use of advanced magneto-resistive media and recording heads. This transition led to unprecedented increases in areal density and, therefore, the amount of data that could be stored on a single disk platter. Increased storage capacity per disk allows drive manufacturers to offer lower-priced disk drives by incorporating fewer components into their disk drives. Because of this lower disk-per-drive ratio, overall disk demand decreased during the period from 1997 through the majority of 2002, resulting in substantial excess disk production capacity. Significant captive capacity employed by certain disk drive manufacturers also continues to impair the market opportunities for independent disk suppliers such as our company.

As a result of the continuing excess disk production capacity in our industry, we closed U.S. manufacturing operations, merged with HMT Technology Corporation, and consolidated our combined U.S.-based manufacturing operations in Malaysia over the three-year period from 1999 through 2001. In June 2002, we announced that we would close the KMT research and development facility in Santa Rosa, California. The closure was completed in the third quarter of 2002.

With the relocation of our manufacturing operations to our Malaysian facilities, our San Jose, California site is focused solely on activities related to research, process development, and product prototyping. Our selling, general, and administrative functions also remain in California. The shift of high-volume production to our cost-advantaged Malaysian manufacturing plants has improved our overall cost structure, resulting in lower unit production costs, and has improved our ability to respond to the continuing price pressures in the disk industry. We expect to maintain low costs by fully utilizing our Malaysian operations. In addition, we may acquire other low cost operations and enter into long-term contracts with suppliers to reduce or stabilize costs and grow our business.

As discussed in Note 1, we emerged from chapter 11 bankruptcy on June 30, 2002. In accordance with SOP 90-7, we adopted fresh-start reporting and reflected the effects of the adoption in the consolidated financial statements for the six months ended June 30, 2002. Fresh-start reporting requires the recording of assets and liabilities at fair value, and stockholders’ equity based on reorganization (enterprise) value. Because our consolidated statements of operations for the three and six months ended June 29, 2003, were prepared on a different basis of accounting (in accordance with fresh-start reporting requirements), they are not comparable to our consolidated statements of operations for the three and six months ended June 30, 2002.

Net Sales

Consolidated net sales increased by 108% to $105.3 million in the second quarter of 2003, from $50.6 million in the second quarter of 2002. The overall increase primarily reflected an increase in finished unit sales volume to 16.3 million units in the second quarter of 2003 from 8.2 million units in the second quarter of 2002. The volume increase was somewhat offset by a decline in the finished unit average selling price, to $5.67 in the second quarter of 2003 from $5.90 in the second quarter of 2002.

Other disk sales in the second quarter of 2003 were $13.7 million, compared to $2.6 million in the second quarter of 2002. The increase reflected higher sales of textured aluminum substrates and single-sided disks.

Consolidated net sales in the first half of 2003 increased by $98.9 million, to $210.9 million in the first half of 2002 from $112.0 million in the first half of 2002. The increase was driven primarily by a 86% increase in finished unit sales volume, to 33.0 million units in the first half of 2003 from 17.7 million units in the first half of 2002. The volume increase was somewhat offset by a decline in the finished unit average selling price, to $5.62 in the first half of 2003 from $5.87 in the first half of 2002.

Other disk sales in the first half of 2003 were $26.1 million, compared to $8.3 million in the first half of 2002. The increase reflected higher sales of textured aluminum substrates and single-sided disks.

The finished unit shipment increases in the second quarter and first half of 2003 compared to the same periods in 2002 primarily reflected market share gains, which began in the second half of 2002, and which resulted from our early qualification on new advanced programs with our customers. The finished unit average selling price declines in the second quarter and first half of 2003 compared to the same periods in 2002 primarily related to our efforts to increase market share, as well as continued general customer pricing pressure.

In the third quarter of 2003, we expect slightly higher finished unit shipment volume and revenue, offset by a decrease in other disk revenue, or relatively flat total net sales compared to the second quarter of 2003.

In the second quarter of 2003, sales to Western Digital, Maxtor, IBM, and Hitachi Global Storage Technologies accounted for 39%, 38%, 12%, and 11%, respectively, of our revenue. In the second quarter of 2002, sales to Western Digital, Maxtor, Seagate, IBM, and Hitachi Global Storage Technologies accounted for 56%, 38%, 4%, 1%, and zero, respectively, of our revenue.

We expect to continue to derive a substantial portion of our sales from Western Digital and Maxtor, and from a small number of other customers. Historically, our sales have been concentrated among several significant customers, and we expect it to remain concentrated. However, our customer sales distribution may vary from quarter to quarter based on the qualifications of our disks in specific customers’ drive programs and the success of those programs in the disk drive marketplace. As a result of the April 1999 acquisition of Western Digital’s media operation and the related volume purchase agreement, we expect our sales to remain highly concentrated with Western Digital. The volume purchase agreement expires in April 2005.

Sales of 60GB and 80GB per platter disks increased to 50% of net sales in the second quarter of 2003, compared to less than 2% in the same period of 2002. The increase was the result of the continued rapid customer evolution to higher storage densities. There was also a decrease in lower GB disks, from

98% in the second quarter of 2002 to 50% in the second quarter of 2003. We anticipate sales of 60/80GB per-platter disks to increase for the remainder of 2003.

Gross Margin (Loss)

Our overall gross margin percentage for the second quarter of 2003 was 21.7%, a 23.7 point increase compared to a gross loss percentage of 2.0% for the second quarter of 2002. For the first half of 2003, we achieved a gross margin percentage of 21.6% compared to a gross margin percentage of 4.6% for the first six months of 2002, an improvement of 17.0 points. The economies of scale associated with higher sales and production volumes (as discussed above) significantly lowered our fixed cost per disk, and accounted for 27.8 points of the gross margin percentage increase in the second quarter of 2003 and 21.3 points of the gross margin percentage increase in the first half of 2003. However, lower costs per disk from the higher sales and production volumes were somewhat offset by the declines in the finished unit average selling prices (as discussed above), which accounted for a 4.1 point decrease in the gross margin percentage in the second quarter of 2003 and a 4.3 point decrease in the gross margin percentage in the first half of 2003.

We expect to maintain our variable cost per unit at levels similar to the first half of 2003 while continuing to advance our technology. We expect our fixed cost per unit in the remainder of 2003 to vary based on changes in production volumes from the level achieved in the first six months of 2003.

Research, Development, and Engineering Expenses

Research, development, and engineering expenses of $10.4 million in the second quarter of 2003 were $1.0 million higher compared to the $9.4 million in the second quarter of 2002. The increase primarily reflected $0.6 million of bonus expense, and $0.3 million of deferred stock-based compensation expense. There was no deferred stock-based compensation expense in the second quarter of 2002.

Research, development, and engineering expenses of $20.3 million in the first half of 2003 were $1.5 million higher than the $18.8 million in the first half of 2002. The increase primarily reflected $1.5 million of bonus expense, and $0.6 million of deferred stock-based compensation expense, offset by a net $0.6 million decrease in other spending. There was no deferred stock-based compensation expense in the first half of 2002.

Selling, General, and Administrative Expenses

Selling, general, and administrative expenses of $4.0 million in the second quarter of 2003 were $0.1 million lower compared to the $4.1 million incurred in the second quarter of 2002. Higher support and other costs of $0.7 million, and higher deferred stock-based compensation expense of $0.3 million were more than offset by a $1.1 million decrease in bonus expense. There was no deferred stock-based compensation expense in the second quarter of 2002.

Selling, general, and administrative expenses of $8.6 million in the first half of 2003 were $0.3 million higher than the $8.3 million incurred in the first half of 2002. The year-over-year increase reflected higher deferred stock-based compensation expense of $0.6 million and higher support and other costs of $1.5 million, offset by a $1.8 million decrease in bonus expense. There was no deferred stock-based compensation expense in the first half of 2002.

Amortization of Intangible Assets

Amortization of intangible assets primarily included $0.7 million of amortization on the volume purchase agreement with Western Digital, and $0.2 million of developed technology amortization in each of the first two quarters of 2003. These amounts were included in cost of sales. See Note 7.

Amortization of intangible assets in the second quarter of 2002 was $0.5 million. Amortization of intangible assets in the first quarter of 2002 was $3.1 million, which included the remaining amortization of $2.6 million under the original Western Digital volume purchase agreement, which ended in the first quarter of 2002. These amounts were included in operating expenses.

Interest Income and Interest Expense

Interest income was $0.1 million in each of the first and second quarters of 2003 and 2002.

Total cash and cash equivalents were $44.4 million at the end of the second quarter of 2003, and $22.3 million at the end of the second quarter of 2002.

We recorded $3.4 million of interest expense in the second quarter of 2003 and $6.7 million in the first half of 2003. Interest expense primarily represented interest on our debt issued on emergence from chapter 11. No interest expense was recorded in the first two quarters of 2002, as interest expense was suspended while we were in chapter 11.

We expect interest expense in the third quarter of 2003 to be similar to the previous two quarters.

Other Income, Net

Other income, net in the second quarter of 2003 was $0.2 million, and primarily reflected scrap sales. Other income, net in the first quarter of 2003 was $1.1 million, and primarily reflected a $0.7 million gain on the sale of certain idle manufacturing equipment and other assets, and a $0.3 million property tax refund.

Other income, net was $396.1 million in the second quarter of 2002, and included income of $379.0 million associated with the debt extinguishment and other liabilities subject to compromise as of June 30, 2002, and income of $17.3 million to revalue our assets and liabilities at June 30, 2002 to fair value as prescribed by fresh-start reporting under SOP 90-7. Other income, net was $3.0 million in the first quarter of 2002, and primarily reflected a $2.4 million gain on the sale of certain idle manufacturing equipment.

Reorganization Costs, Net

No reorganization costs were recorded in the first half of 2003, compared to $6.5 million in the first half of 2002. Reorganization costs in the first half of 2002 primarily reflected professional fees related to the chapter 11 bankruptcy proceeding, and a $5.0 million adjustment associated with a chapter 11-related creditor claim. We do not anticipate incurring any further reorganization costs.

Income Taxes

Our income tax provisions of $0.8 million for the second quarter of 2003 and $0.3 million for the second quarter of 2002, and $1.8 million for the first half of 2003 and $0.7 million for the first half of 2002, represent foreign income taxes and foreign withholding taxes on royalty and interest payments. The increases reflected higher withholding taxes on increased royalties related to higher net sales in 2003 compared to the comparable periods in 2002.

Our wholly-owned thin-film media operation, KMS, received a five-year extension of its initial tax holiday, which expired in June 2003, for its first plant site. We received an oral approval for an additional eight-year extension on the tax holiday on the first plant site, which would extend it through June 2011. We are awaiting written approval. KMS has also been granted additional tax holidays for its second and third plant sites in Malaysia. These tax holidays are effective through December 2006 for the first plant site and December 2008 for the second plant site.

In July 2003, we received written approval for the exemption of withholding tax on royalty payments made by our Malaysian operations to our subsidiary in the Netherlands. The exemption is for a period of five years effective retroactively from January 2002 through December 2006. As a result, we will record an income tax benefit of approximately $2.5 million in the third quarter of 2003 related to withholding taxes we previously accrued which are no longer payable as a result of the exemption.

Minority Interest/Equity Interest in Net Loss of Related Companies

The minority interest for Kobe USA’s 20% share of KMT’s net income in the second quarter and first half of 2002 was less than $0.1 million. KMT ceased operations in the third quarter of 2002.

In the second quarter of 2002 we recorded a $0.9 million loss, and in the first half of 2002 we recorded a $2.4 million loss, as our equity share in the net loss of Chahaya, a former equity investment. Chahaya ceased operations in the fourth quarter of 2002. We have no minority or equity interests in related companies.

Cumulative Effect of Change in Accounting Principle

We adopted SFAS No. 142 and recorded the effects of adoption in June 2002 on a cumulative effect basis as of the first day of the 2002 fiscal year.

In accordance with SFAS No. 142, we were required to perform a transitional impairment analysis of our goodwill. The transitional impairment loss of $47.5 million was recognized in the first quarter of 2002 as the cumulative effect of a change in accounting principle in our consolidated statement of operations.

Critical Accounting Policies

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates if our assumptions are incorrect. We believe that the following discussion addresses our most critical accounting policies. These policies are most important to the portrayal of our financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Allowance for Sales Returns

We estimate our allowance for sales returns based on historical data as well as current knowledge of product quality. Historically, we have not experienced material differences between our estimated reserves for sales returns and actual results. However, it is possible that the failure rate on products sold could be higher than it has historically been, which could result in significant changes in future returns. Since estimated sales returns are recorded as a reduction in revenues, any significant difference between our estimated and actual experience or changes in our estimate would be reflected in our reported revenues in the period we determine that difference.

From December 29, 2002 to June 29, 2003, our allowance for sales returns increased by $0.8 million. The increase primarily reflects current estimates of expected returns in the third quarter of 2003.

Long-lived Assets

Long-lived assets are evaluated as one group for impairment whenever events or changes in circumstances indicate that these assets may be impaired or the estimated useful lives are no longer appropriate. We consider the primary indicators of impairment to include significant decreases in unit volumes, unit prices or significant increases in production costs. We review our long-lived assets for impairment based on estimated future undiscounted cash flows attributable to the assets. In the event that these cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values utilizing discounted estimates of future cash flows. The discount rate used is based on the estimated incremental borrowing rate at the date of the event that triggers the impairment. Land and buildings held for sale are evaluated for impairment on a quarterly basis and are stated at the lower of cost or fair value, less estimated selling costs.

Liquidity and Capital Resources

Cash and cash equivalents of $44.4 million at the end of the second quarter of 2003 increased by $20.8 million from the end of the 2002 fiscal year. The increase primarily reflected a $30.4 million increase resulting from consolidated operating activities, offset by $9.8 million of spending on the acquisition of property, plant, and equipment.

Consolidated operating activities generated $30.4 million in cash in the first half of 2003. The primary components of this change include the following:

	•		net income of $9.7 million, net of non-cash depreciation of $20.7 million, $3.3 million of non-cash interest expense, $1.9 million of non-cash amortization, and $1.4 million of deferred stock-based compensation expense, less a $0.7 million gain on asset disposals;

	•		an accounts receivable increase of $6.4 million primarily due to increased sales in the last month of the quarter;

	•		a prepaid expense increase of $0.8 million primarily due to insurance premium renewals;

	•		an inventory increase of $4.8 million for certain key materials;

	•		an accounts payable increase of $1.1 million related to the inventory increase; and

	•		an accrued expenses and other liabilities increase of $5.1 million, which primarily reflected higher wage and bonus accruals.

In the first half of 2003, we spent $9.8 million on equipment acquisitions to improve our manufacturing and research and development capabilities, and received $0.7 million in proceeds from the sale of idle manufacturing equipment. Sales of idle manufacturing equipment may vary from quarter to quarter. We also repaid $0.3 million of debt.

Current non-cancelable capital commitments as of June 29, 2003 totaled $3.9 million. For the remainder of 2003, we plan to spend approximately $10.0 million on property, plant, and equipment for projects designed to improve yield and productivity, as well as to improve equipment capability for the manufacture of advanced products.

We lease our research and administrative facility in San Jose, California under an operating lease. We also lease and sublease another building in San Jose. Both of these leases expire in 2007, and have renewal options for five years. We also lease a building, which we no longer occupy, in Santa Rosa, California. This lease expires in April 2004. We have no capital leases.

At June 29, 2003, the future minimum commitments for non-cancelable operating facility leases, equipment leases, and a facility sublease are as follows (in thousands):


	Minimum
	Lease		Sublease
	Payments		Payments

Remainder of 2003	$	1,840	$	751
2004		3,639		1,539
2005		3,425		1,585
2006		3,308		1,633
2007		403		414

	$	12,615	$	5,922

We have available liquidity through a revolving credit facility (the Exit Facility) we entered into on June 30, 2002 simultaneously with our emergence from bankruptcy that allows for advances of up to $15.0 million at any time outstanding, with a $3.0 million letter of credit sub-facility. The Exit Facility expires June 30, 2005. As of June 29, 2003, there were no borrowings under the Exit Facility. Our total outstanding borrowings under the Exit Facility at any one time may not exceed the lesser of $15.0 million or 70% of the fair market value of certain of our assets less a reserve, and less additional reserves that may be created by the Administrative Agent from time to time, as set forth in the Exit Facility agreement. The Exit Facility is secured by a first-priority security interest in substantially all of our assets, including tangible and intangible assets (except in the case of our ownership interest in its foreign subsidiaries, which is limited to a pledge of 65% of such equity interests). Interest is payable monthly in arrears at a rate of 12% per annum on the outstanding principal amount. We paid a commitment fee of $0.3 million to obtain the Exit Facility, and we pay ongoing unused commitment fees due on a monthly basis at an annual rate of 0.5% on the average unused portion of the $15.0 million facility during the preceding month.

The Exit Facility contains affirmative, negative and financial covenants binding on us and our subsidiaries. The negative covenants include restrictions on our ability to incur indebtedness and make guarantees, grant liens, sell assets, declare dividends, make investments, and make capital expenditures. Financial covenants include the maintenance of minimum adjusted tangible net worth, minimum adjusted working capital and a total cash debt service coverage ratio.

In accordance with our confirmed Plan, in addition to the $15.0 million Exit Facility (discussed above), we issued $85.3 million of cash pay notes and $43.5 million of paid-in-kind (PIK) notes (Senior Secured Notes), $7.0 million of subordinated PIK notes (Junior Secured Notes), and $1.7 million of secured and unsecured promissory notes.

As of June 29, 2003, the future minimum principal payments due under these debt agreements are as follows (in thousands):


	Minimum
	Principal
	Payments

Remainder of 2003	$	10,121
2004		20,249
2005		20,261
2006		20,273
2007		72,144
2008		108

	$	143,156

Based on current operating forecasts, we estimate that the cash balance and cash from operations will be adequate to support our continuing operations, capital spending plan, and interest and debt payments for at least the next twelve months. Additionally, we can borrow under the Exit Facility, which is described above. We currently have no borrowings under the Exit Facility.

RISK FACTORS

Investing in our securities involves a high degree of risk. You should carefully consider the risks and uncertainties described below when considering whether or not to invest in our company. 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, our business, financial condition or results of operations could be materially adversely affected, the value of our stock could decline, and you may lose part or all of your investment. Further, this report contains forward looking statements and actual results may differ significantly from the results contemplated by our forward looking statements.

RISKS RELATED TO OUR FINANCIAL POSITION AND OUR COMMON STOCK

We recently emerged from a chapter 11 bankruptcy reorganization and have a history of losses.

We sought protection under chapter 11 of the United States Bankruptcy Code in August 2001. We incurred net losses of approximately $68.1 million and $296.4 million during the fiscal years ended December 31, 2000, and December 30, 2001, respectively. For the nine-month period ended September 29, 2002, we incurred a $50.9 million loss before a gain of $396.4 million for extinguishment of liabilities subject to compromise and revaluation of assets and liabilities for fresh-start reporting, and before a cumulative change in accounting principle loss of $47.5 million. For the fourth quarter ended December 29, 2002, we recorded a net loss of $27.5 million after a $33.9 million non-cash goodwill impairment charge. We were profitable in the first and second quarters of 2003, reporting net income of $5.1 million and $4.6 million, respectively. These were our first profitable quarters (excluding one-time credits) since the fourth quarter of 1997. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” While our shipments and revenues have increased in the last three quarters, and we achieved profitability in the first two quarters of 2003, we cannot assure you that we will sustain current shipment and income levels, grow, or maintain profitability.

We continue to be leveraged and our debt service requirements make us vulnerable to economic downturn and impose restrictions on our operations.

Our long-term debt and short-term debt was approximately $143.2 million as of June 29, 2003. While we believe that our cash balance and future operating cash flow, together with our financing arrangements, will be sufficient to finance our operating requirements, our indebtedness restricts our ability to obtain additional financing in the future. Also, we may be more leveraged than some of our competitors, which may place us at a competitive disadvantage and makes us more susceptible to downturns in our business in the event our income is not sufficient to cover our debt service requirements. In addition , the Exit Facility (a revolving credit facility of up to $15.0 million), Senior Notes Indenture, and Junior Notes Indenture that we entered into as part of our emergence from bankruptcy contain covenants that impose operating and financial restrictions on us. These covenants could adversely affect our ability to finance future operations, potential acquisitions or capital needs or to engage in other business activities that may be in our interest. In addition, if we cannot achieve the financial results necessary to maintain compliance

with these covenants, we could be declared in default and be required to sell or liquidate our assets to repay outstanding debt.

Our historical financial information is not comparable to our current financial condition and results of operations, making it difficult to analyze our financial prospects.

As a result of our emergence from bankruptcy on June 30, 2002, we are operating our business with a new capital structure. We were also subject to the fresh-start reporting prescribed by generally accepted accounting principles, and our balance sheet as of June 29, 2003 reflects the application of these rules. Accordingly, our financial condition and results of operations are not comparable to the financial condition and results of operations reflected in our historical financial statements ended prior to June 30, 2002, making it difficult to assess our future prospects based on historical performance.

We have significant stockholders who own a large percentage of our common stock and could substantially influence all matters requiring stockholder approval.

We have several significant stockholders who, in the aggregate, currently own approximately 73% of our common stock, and together are able to significantly influence all matters requiring approval by our stockholders, including new financings, the election of directors and the approval of mergers or other business combinations. To the extent that the interests of these stockholders are different than those of other stockholders, important company decisions may not reflect the interests of all stockholders.

Sales of stock by significant stockholders holders may negatively affect the market price.

We have several significant stockholders who, in the aggregate, currently own approximately 73% of our common stock, and who are not restricted as to the prices at which they may sell the stock. Shares sold below the current level at which the shares of our common stock are trading may adversely affect the market price of our common stock. This large amount of stock, if sold all at once or in blocks, could have a negative effect on the market price of our common stock.

We expect to experience volatility in our stock price, which could negatively affect your investment.

An investment in our common stock involves substantial risks. The stock market generally, and the market for stocks of companies with lower market capitalizations, like us, in particular, have from time to time experienced and likely will again experience significant price and volume fluctuations that are unrelated to the operating performance of a particular company.

The Senior Secured Notes are subordinated to the Exit Facility. The Junior Secured Notes are, in turn, subordinated to the Senior Secured Notes. Because of our debt obligations, in the event of a dissolution, equity holders would be unlikely to receive distributions.

We currently have no balance outstanding under the Exit Facility, but we can choose to make a draw under the Exit Facility at any time so long as certain conditions are satisfied. The Senior Secured

Notes are subordinated in right of payment to the Exit Facility, and the Junior Secured Note are, in turn, subordinated in right of payment to the Senior Secured Notes. As a result of such subordination, in the event of an acceleration declared because of (1) our liquidation or insolvency, (2) a payment default, (3) a covenant default, or (4) the occurrence of other events of default, our assets will be available to pay obligations on the Senior Secured Notes only after the Exit Facility is paid in full and on the Junior Secured Notes only after the Senior Secured Notes have been paid in full. There may not be sufficient assets remaining to pay amounts due on any or all of the Senior Secured Notes or the Junior Secured Notes then outstanding. In the event of liquidation or insolvency, holders of equity securities would receive a distribution only after payment in full to each of the Exit Facility, the Senior Secured Notes, the Junior Secured Notes, and other creditors, and it is likely there would be nothing left to distribute to equity holders at such time.

If there is not an active market for our notes, the trading price and liquidity of the notes could be materially adversely affected.

We cannot assure you that any market for our notes will develop more fully or, if it does develop more fully, that it will be maintained. If an active market for the notes fails to be maintained or sustained, the trading price and liquidity of the notes could be materially adversely affected.

Since emerging from bankruptcy, we have not paid any dividends on our common stock and do not anticipate doing so in the foreseeable future.

We currently anticipate that all of our earnings, if any, will be retained for repayment of our outstanding debt and for development and expansion of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. In addition, the Exit Facility contains covenants that restrict payment of cash dividends.

RISKS RELATED TO OUR BUSINESS

Demand for disk drives is largely tied to demand for personal computers and fluctuations in and reduced demand for personal computers may result in cancellations or reductions in demand for our product.

Trend Focus, a data-gathering and data-publishing company, estimates that 75% of the disks consumed during 2002 were incorporated into disk drives for the desktop personal computer market. Because of this concentration in a single market, which we expect to continue, our business is tightly linked to the success of the personal computer market. Historically, demand for personal computers has been seasonal and cyclical. Due to the high fixed costs of our business, fluctuations in demand resulting from this seasonality and cyclicality can lead to disproportionate changes in the results of our operations. If cancellations or reductions in demand for our products occur in the future, our business, financial condition, and results of operations could be seriously harmed.

Delays and cancellations of our customer orders may cause us to under-utilize our production capacity, which could significantly reduce our gross margins and result in significant losses.

Our business is characterized by high fixed costs. If there is a decrease in demand for our products, our production capacity could be underutilized, and, as a result, we may experience:

	•		equipment write-offs;

	•		restructuring charges;

	•		operating losses;

	•		reduced average selling prices for our products;

	•		increased unit costs; and

	•		employee layoffs.

The occurrence of one or more of the above would negatively impact our gross margins.

There is a high concentration of customers in the disk drive market, and we receive a large percentage of our revenues from only a few customers, the loss of any of which would adversely affect our sales.

Our customers are disk drive manufacturers. Given the relatively small number of disk drive manufacturers, we expect that we will continue to depend on a limited number of customers. This high customer concentration is due to the following factors:

	•		the high-volume requirements of the dominant disk drive manufacturers;

	•		a tendency of our customers to rely on a few suppliers because of the close interrelationship between media performance and disk drive performance;

	•		the complexity of integrating components from a variety of suppliers; and

	•		the increases in storage densities that have led to decreases in the platter count per drive, which lower platter counts, result in disk drive manufacturers with captive disk manufacturing operations having excess capacity; consequently, they rely less on independent sources of media, such as our company.

In the first half of 2003, 43% of our net sales were to Western Digital and 37% were to Maxtor. During fiscal 2002, 62% of our net sales were to Western Digital and 30% were to Maxtor. During fiscal 2001, 59% of our net sales were to Western Digital and 27% were to Maxtor. If any one of our significant customers reduce their media requirements or develop or expand capacity to produce thin-film disks for internal use, our sales will be reduced and, as a result, our business, financial condition and operating results could suffer.

If we are unable to perform successfully in the highly competitive and increasingly concentrated thin-film media industry, we may not be able to gain additional market share or we may lose our existing market share, and our operating results would be harmed.

The market for our products is highly competitive, and we expect competition to continue in the future. Competitors in the thin-film disk industry fall mainly into two groups: Asian-based manufacturers and captive manufacturers. Our Asian-based competitors include Fuji Electric, Trace Storage, Hoya and Showa Denko. The U.S. captive manufacturers include the disk media operations of Seagate Technology, IBM and Maxtor. In late 2002, IBM entered into a joint venture with Hitachi. The joint venture, named Hitachi Global Storage Technology, includes Hitachi’s and IBM’s disk drive operations and a portion of IBM’s disk media operations, and evidences the increasing concentration and economies of scale in our industry. Many of these competitors have greater financial resources than we have, which could allow them to adjust to fluctuating market conditions better than us. Further, they may have greater technical and manufacturing resources, more extensive name recognition, more marketing power, a broader array of product lines, and preferred vendor status. 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.

Price competition may force us to lower our prices, causing our revenues and gross margins to suffer.

We face significant price competition in the disk media industry. Continued high levels of competition have continued to put downward pressure on prices per unit. Additionally, the average selling price of disk drives rapidly declines over its commercial life as a result of technological enhancements, productivity improvements, and industry supply increases. We may be forced to continue 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 assure you that we will be able to compete successfully in this kind of price competitive environment. Lower prices would reduce our ability to generate revenue, and our gross margin would suffer. If we fail to mitigate the effect of these pressures through reducing the cost of our products or changing our product mix, our revenues and gross margins could be adversely affected.

Price declines are further affected by the imbalance between demand and supply that has intensified competition in the industry. For most of 2002, as in the last several years, media supply exceeded media demand. As independent suppliers like us struggled to utilize their capacity, the excess media supply caused average selling prices for disk products to decline. Pricing pressure on component suppliers has also been compounded by high consumer demand for inexpensive personal computers and consumer devices. In the fourth quarter of 2002 and the first two quarters of 2003, media supply and demand began to come into balance, and disk prices began to stabilize, but there is no certainty that this will continue. We expect supply and demand factors and industry-wide competition to continue to put pressure on our profit margin.

We have historically made and, in the future, expect to continue to make acquisitions, and acquisitions could disrupt our operations and harm our operating results.

The continuing growth of our business is dependent on; 1) market growth; 2) our ability to develop and introduce, on a timely basis, new products to our customers; and 3) our ability to manufacture continuously, in high volume, high-quality advanced products to meet our customers needs. Additionally, achieving low product cost through careful monitoring of yield, materials, and operating supplies consumed, and achieving high-volume production in our low-cost manufacturing locations is critical to our ability to maintain profitability. Through acquisitions of other companies and technologies, we may be able to address the need to develop new products, enhance our ability to achieve low product costs, and facilitate increased units sales and/or revenue growth. Acquisitions involve numerous risks, including the following:

	•		difficulties in integrating the operations, technologies, products and personnel of the acquired companies;

	•		diversion of management’s attention from normal daily operations of the business;

	•		potential difficulties in completing projects associated with in-process research and development;

	•		difficulties in entering markets in which we have no or limited direct prior experience and where competitors in such markets have stronger market positions;

	•		initial dependence on unfamiliar supply chains or relatively small supply partners;

	•		insufficient revenues to offset increased expenses associated with acquisitions; and

	•		the potential loss of key employees of the acquired companies.

Acquisitions may also cause us to:

	•		issue common 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 our future acquisitions 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 all pre-acquisition due diligence will have identified all possible issues that might arise with respect to such products or integration into our company.

If we are not able to fund our business with cash generated by operations or raise future capital, we may be forced to reduce or suspend operations.

The disk media business has historically been capital-intensive, and we believe that in order to remain competitive, we will likely continue to have to make investments for capital expenditures, working capital, and research and development. If we cannot generate sufficient cash flows from operations, or raise additional funds required by our business to remain competitive, we may be forced to reduce or suspend operations.

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.

With short product life cycles and rapid technological change, we must frequently qualify new products, based on criteria such as quality, storage capacity, performance, and price. We must also be able to achieve rapidly high-volume production and sales. Hard disk drive programs have increasingly become “bimodal” in that a few programs are high-volume and the remaining programs are relatively small in terms of volume. As a result, supply and demand balance can change quickly from customer to customer and from program to program.

Further, qualifying thin-film disks for incorporation into new disk drive products requires us to work extensively with the customer and the customer’s other suppliers to meet product specifications. Therefore, customers often require a significant number of product presentations and demonstrations, as well as substantial interaction with our senior management, before making a purchasing decision. Accordingly, our products typically have a lengthy sales cycle, which can range from six to twelve months. 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 our share of the program ultimately will result in high-volume production. To the extent we expend significant resources to qualify products without realizing sales, our operations will suffer.

If our customers cancel orders, they may not be required to pay any penalties, and our sales could suffer.

Our sales are generally made pursuant to purchase orders that are subject to cancellation, modification, or rescheduling without significant penalties. 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.

Our customers’ internal disk operations may limit our ability to sell our product.

Disk drive manufacturers such as Seagate, IBM, Maxtor, and Hitachi Global Storage Technology have large internal media manufacturing operations. In 2002, Seagate, IBM, and Hitachi internally produced more than 89% of their media requirements, and Maxtor internally produced approximately 45%

of its media requirements. We compete directly with these internal operations, when we market our products to these disk drive companies, and indirectly, when we sell our disks to customers who must compete with vertically-integrated disk drive manufacturers. Vertically-integrated companies have the ability to keep their disk-making operations fully utilized, thus lowering their costs of production. This cost advantage contributes to the pressure on us and other independent media manufacturers to sell disks at prices so low that historically we have been unprofitable, and we cannot be sure we can maintain profitability. Vertically-integrated companies are also able to achieve a large scale that supports the development resources necessary to advance technology rapidly. We may not have sufficient resources to be able to compete effectively with these companies. If we are unable to absorb development costs through scale, and because of continued downward price pressures, our business, financial condition, and operations could suffer.

Because we depend on a limited number of suppliers, if our suppliers experience capacity constraints or production failures, our production and operating results could be harmed.

We rely on a limited number of suppliers for some of the materials and equipment used in our manufacturing processes, including aluminum substrates, nickel plating solutions, polishing and texturing supplies, and sputtering target materials. For example, Kobe Steel, Ltd. is our primary supplier of aluminum substrates, a fundamental component in producing our disks. The supplier base has been further weakened by the poor financial condition of the industry, and some suppliers have exited the business. 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. Due to the significant growth in demand for our disk products in the fourth quarter of 2002, our sales were actually somewhat constrained in the fourth quarter of 2002 due to the need to acquire substrates from sources other than our traditional internal and external suppliers. If our sources of materials and supplies were unavailable for a significant period of time, our production and operating results could be adversely affected.

Disk drive program life cycles are short, and disk drive programs are highly customized. If we fail to respond to our customers’ demanding requirements, we will not be able to compete effectively.

Our industry has experienced rapid technological change, and if we are unable to anticipate and develop, on a timely basis, products and production technologies, our competitive position could be harmed. In general, the life cycles of recent disk drive programs have been shortening. For example, since 1999, the industry has doubled storage density annually compared to a slower pace in prior years. Additionally, media must be more customized to each disk drive program. Short program life cycles and customization have 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 achieve profitability, we must be able to develop new products and technologies in a timely fashion that can help customers reduce their time-to-market performance, and continue to maintain operational excellence that supports high-volume manufacturing ramps and tight inventory management throughout the supply chain. If we cannot respond to this rapidly changing environment or fail to meet our customers’ demanding product and qualification requirements, we will not be able to compete effectively. As a result, we would not be able to maximize the use of our production facilities and minimize our

inventory losses, and our profitability would be negatively impacted.

Downturns in the disk drive manufacturing market and related markets may decrease our revenues and margins.

The market for our products depends on economic conditions affecting the disk drive manufacturing and related markets. Downturns in these markets may cause disk drive manufacturers to delay or cancel projects, reduce their production, or reduce or cancel orders for our products. In the event of such a downturn, customers may experience financial difficulty, cease operations, or fail to budget for the purchase of our products. This, in turn, may lead to longer sales cycles, delays in payment and collection, and price pressures, causing us to realize lower revenues and margins. In particular, many of our customers and potential customers have experienced declines in their revenues and operations. In addition, the recent war in Iraq and the terrorist acts of September 11, 2001, as well as subsequent terrorist activities and threats, have created an uncertain economic environment. We cannot predict the impact of these economic uncertainties, or of any related military action on our customers or business, particularly in light of the fact that we rely heavily on overseas production and sales. We believe that, in light of these uncertainties, some businesses may curtail or eliminate spending on technology related to our products.

If we do not keep pace with rapid technological change, we will not be able to compete effectively, and our operating results could suffer.

Our thin-film disk products primarily serve the 3 1/2-inch hard disk drive market, where product performance, consistent quality, price, and availability are of great competitive importance. To succeed in an industry characterized by rapid technological developments, we must continuously advance our thin-film technology at a pace consistent with, or faster than, the pace at which our competitors are advancing their thin-film technology.

Advances in hard disk drive technology demand continually lower glide heights and higher storage densities. Over the last several years, storage density has roughly doubled each year, requiring significant improvement in every aspect of disk design. These advances require substantial on-going process and technology development. New process technologies must support cost-effective, high-volume production of thin-film disks that meet these ever-advancing customer requirements for enhanced magnetic recording performance. We may not be able to develop and implement such technologies in a timely manner in order to compete effectively against our competitors’ products and/or entirely new data storage technologies. In addition, we must transfer our technology from our U.S. research and development center to our Malaysian manufacturing operations. If we cannot advance our process technologies or do not successfully implement those advanced technologies in our Malaysian operations, or if technologies that we have chosen not to develop prove to be viable competitive alternatives, we would not be able to compete effectively. As a result, we would lose our market share and face increased price competition from other manufacturers, and our operating results would suffer.

We must continue to improve the quality of, and control contamination in, our manufacturing processes in order to be competitive.

The manufacture of our high-performance, thin-film disks requires a tightly-controlled, multi-stage process, and the use of high-quality materials. Efficient production of our products requires utilization of advanced manufacturing techniques and clean room facilities. Disk fabrication occurs in a highly controlled, clean environment to minimize particles and other yield-and quality-limiting contaminants. In spite of stringent manufacturing controls, weaknesses in process control or minute impurities in materials may cause a substantial percentage of the disks in a lot to be defective. The success of our manufacturing operations depends, in part, on our ability to maintain process control and minimize such impurities in order to maximize yield of acceptable high-quality disks. Minor variations from specifications could have a disproportionately adverse impact on our manufacturing yields. If we are not able to continue to improve on our manufacturing processes or maintain stringent quality controls, or if contamination problems arise, we will not remain competitive, and our operating results would be harmed.

If we are not able to attract and retain key personnel, our operations could be harmed.

Our future success depends on the continued service of our executive officers, our highly-skilled research, development and engineering team, our manufacturing team, and our key administrative, sales and marketing and support personnel. Acquiring talented personnel who possess the unique skills we require has been difficult. Our bankruptcy filing and our recent historical financial performance have increased the difficulty of attracting and retaining skilled engineers and other knowledgeable workers. We expect that it will continue to be difficult to attract and retain key personnel, even though we have emerged from bankruptcy. 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.

If we do not protect our patents and other intellectual property rights, our revenues could suffer.

It is commonplace to protect technology through patents and other forms of intellectual property rights in technically sophisticated fields. In the disk drive industry, it is common for companies and individuals to initiate actions against others in the industry to enforce intellectual property rights. Although we attempt to protect our intellectual property rights through patents, copyrights, trade secrets, and other measures, we may not be able to protect 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 rights alleged to cover certain of our products or manufacturing processes or equipment. We evaluate whether it would be necessary to defend against the claims or to seek licenses to the rights referred to in such communications. In those cases, we may not be able to negotiate necessary licenses on commercially reasonable terms, or at all. Also, if we have to defend those claims, we could incur significant expenses and our management’s attention could be diverted from our other business. Further, we may not be able to anticipate claims by others that we infringe 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 future performance, which is subject to fluctuation due to many uncertainties; consequently, it is difficult to predict future results.

Our operating results historically have fluctuated significantly on both a quarterly and annual basis. As a result, our operating results in any quarter may not reflect our future performance. We believe that our future operating results will continue to be subject to quarterly variations based on a wide variety of factors, including:

	•		timing of significant orders, or order cancellations,

	•		changes in our product mix and average selling prices;

	•		modified, adjusted or rescheduled shipments;

	•		availability of media versus demand for media;

	•		the cyclical nature of the hard disk drive industry;

	•		our ability to develop and implement new manufacturing process technologies;

	•		increases in our production and engineering costs associated with initial design and production of new product programs;

	•		the 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; and

	•		structural changes within the disk media industry, including combinations, failures, and joint venture arrangements.

We cannot forecast with certainty the impact of these and other factors on our revenues and operating results in any future period. Our expense levels are based, in part, on expectations as to future revenues. If our revenue levels are below expectations, our operating results are likely to suffer. Because

thin-film disk manufacturing requires a high level of fixed costs, our gross margins are extremely sensitive to changes in volume. At constant average selling prices, reductions in our manufacturing efficiency cause declines in our gross margins. Additionally, decreasing market demand for our products generally results in reduced average selling prices and/or low capacity utilization that, in turn, adversely affect our gross margins and operating results. Further, because we were required to implement fresh-start reporting when we emerged from chapter 11 proceedings, our historical information prior to June 30, 2002 is significantly less meaningful as a predictor of future performance.

Because we depend on our Malaysian operations, we are exposed to unavoidable risks in transmitting technology from U.S. facilities to Malaysian facilities. These risks could adversely impact our operations.

During the third quarter of 1999, we announced that all media production would be consolidated into our Malaysian factories. In the fourth quarter of 2000, we ended the manufacture of aluminum substrates in Santa Rosa, California. Currently, aluminum substrates are primarily manufactured by a Malaysian vendor. In addition, we ended production of polished disks in our Eugene, Oregon, facility in the second quarter of 2001, which we acquired as part of our merger with HMT Technology Corporation in October 2000. All polished disks are manufactured by our Malaysian factories. Further, in the second quarter of 2001, we transferred the manufacturing capacity of HMT’s Fremont, California, facility to Malaysia, and closed all of our U.S. media manufacturing operations, leaving us fully dependent on our Malaysian manufacturing operations.

Technology developed at our U.S. research and development center must now be first implemented at our Malaysian facilities without the benefit of being implemented at a U.S. factory. Therefore, we rely heavily on electronic communications between our U.S. facilities and Malaysia to transfer specifications and procedures, diagnose operational issues, and meet 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 U.S. operations, the manufacture and shipment of our products would be delayed, and our results of operations would suffer.

If we do not receive a written extension on our tax holiday for a plant site in Malaysia, we could become subject to significantly higher tax liabilities and tax expense than we have experienced in the past, and our operating results would suffer.

Our wholly-owned thin-film media operation, Komag USA (Malaysia) SDN (KMS), had a ten-year initial tax holiday that expired in June 2003, for its first plant site in Malaysia. The Malaysian government recently provided an oral approval to extend this tax holiday for an additional eight years. We are waiting for written approval from the Malaysian government. If we do not receive written approval, we would become subject to income tax expense for that location. Therefore, we may incur significantly higher income tax liabilities and tax expense than we have experienced in the past. Significantly higher income tax liabilities and tax expense would negatively affect our operating results.

Our foreign operations and international sales subject us to additional risks inherent in doing business on an international level that make it more costly or difficult to conduct our business.

We are subject to a number of risks of conducting business outside of the U.S. Our sales to customers in Asia, including the foreign subsidiaries of domestic disk drive companies, account for substantially all of our net sales from our U.S. and Malaysian facilities. While customers assemble a substantial portion of their disk drives in Asia, they subsequently sell these products throughout the world. Therefore, our high concentration of Asian sales does not accurately reflect the eventual point of consumption of the assembled disk drives. We anticipate that international sales will continue to represent the majority of our net sales.

We are subject to these risks to a greater extent than most companies because, in addition to selling our products outside the U.S., our Malaysian operations account for substantially all of our sales. Accordingly, our operating results are subject to the risks inherent with international operations, including, but not limited to:

	•		compliance with changing legal and regulatory requirements of foreign jurisdictions;

	•		fluctuations in tariffs or other trade barriers;

	•		foreign currency exchange rate fluctuations, since certain costs of our foreign manufacturing and marketing operations are incurred in foreign currency, including purchase of certain operating supplies and production equipment from Japanese suppliers in yen-denominated transactions;

	•		difficulties in staffing and managing foreign operations;

	•		political, social and economic instability;

	•		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.

In addition, our ability to transfer funds from our Malaysian operations to the U.S. is subject to Malaysian rules and regulations. In 1999, the Malaysian government repealed a regulation that restricted the amount of dividends that a Malaysian company may pay to its stockholders. If not repealed, this regulation would have potentially limited our ability to transfer funds to the U.S. from our Malaysian operations. If similar regulations are enacted in the future, we may not be able to finance our U.S.-based research and development and/or repay our U.S. debt obligations.

Given our reliance on manufacturing facilities and suppliers in Asia, the outbreak of SARS may negatively impact our operating results.

The outbreak of severe acute respiratory syndrome (SARS) that began in China, Hong Kong, Singapore, and Vietnam could have a negative impact on our operations if its incidence rate increases. Our normal operating processes could be hindered by a number of SARS-related factors, including, but not limited to:

	•		disruptions in our manufacturing facilities in Malaysia;

	•		disruptions at our third-party suppliers located in China;

	•		disruptions in our customers’ operations in Singapore and Malaysia;

	•		reduced travel between our U.S. research and development and Malaysian manufacturing locations; and

	•		reduced travel between ourselves, customers, and suppliers.

If the number of cases rises or spreads to other areas, our sales and operating results could be harmed.

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.

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.

We rely on a continuous power supply to conduct our business, and an energy crisis in California could disrupt our operations and increase our expenses.

From time to time in the past, California has experienced energy shortages. An energy crisis could disrupt our research and development activities and increase our expenses. In the event of an acute power shortage, which occurs when power reserves for the State of California fall below 1.5%, California has, on occasion, implemented, and may in the future continue to implement, rolling blackouts throughout the

state. We currently do not have back-up generators or alternate sources of power in the event of a blackout, and our insurance does not provide coverage for any damages we or our customers may suffer as a result of any interruption in our power supply. If blackouts interrupt our power supply, we would be temporarily unable to continue operations at our California-based facilities. This could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and could result in lost revenue, any of which could substantially harm our business and results of operations.

Furthermore, the regulatory changes affecting the energy industry instituted in 1996 by the California government have caused power prices to increase. Under the revised regulatory scheme, utilities were encouraged to sell their plants, which had traditionally produced most of California’s power, to independent energy companies that were expected to compete aggressively on price. Instead, due in part to a shortage of supply, wholesale prices have increased dramatically in 2002, and continue to trend upward. If wholesale prices continue to increase, our operating expenses will likely increase, as our headquarters and research and development facilities are in California.

Earthquakes or other natural or man-made disasters could disrupt our operations.

Our U.S. facilities are located in San Jose, 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.

Anti-takeover provisions in our certificate of incorporation could discourage potential acquisition proposals or delay or prevent a change of control.

We have protective provisions in place designed to provide our board of directors with time to consider whether a hostile takeover is in our best interests and that of our stockholders. Our certificate of incorporation provides that we have 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 merger, 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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to foreign currency exchange rate risk. We currently do not use derivative financial instruments to hedge such risk.

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. We invest primarily in high-quality, short-term debt instruments.

A substantial majority of our revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, a large portion of our payroll, certain operating expenses, and capital purchases are transacted in other currencies, primarily Malaysian ringgit. Since late 1998, the ringgit has been pegged at a conversion rate of 3.8 Malaysian ringgit to the U.S. dollar. If the pegging is lifted in the future, we will evaluate whether or not we will enter any hedging contracts for the Malaysian ringgit. Expenses recorded in Malaysian ringgit in the first six months of 2003 totaled approximately $26.6 million.

We have $85.3 million in senior secured cash pay notes outstanding which bear interest at the prime rate plus 3% (such rate not to be less than 8% per annum) and mature in June 2007. A hypothetical 100 basis point increase in interest rates would result in approximately $0.9 million of additional interest expense each year.

ITEM 4. CONTROLS AND PROCEDURES

We maintain a rigorous set of disclosure controls and procedures and internal controls designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our Chief Executive Officer and our Chief Financial Officer have designed and evaluated our disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under their supervision, pursuant to Rules 13a — 15 (e) and 15d – 15(e) of the Securities Exchange Act of 1934 for the period covered on this Quarterly Report on Form 10-Q, and have determined that such disclosure controls and procedures are effective to ensure that the information required to be disclosed in our filings under periodic Securities and Exchange Commission filings is gathered, analyzed, and disclosed with adequate timeliness, accuracy, and completeness, based on an evaluation of such controls and procedures conducted as part of the end of the period covered by this report.

Subsequent to our evaluation, there were no significant changes in internal controls or other factors that could significantly affect our internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings

Not applicable.

ITEM 2. Changes in Securities

Not applicable.

ITEM 3. Defaults Upon Senior Securities

Not applicable.

ITEM 4. Submission of Matters to a Vote of Security Holders

(a)		The Company held its annual meeting of stockholders on May 20, 2003.

(b)		The meeting included a proposal to elect three Class I directors, whose names are Chris A. Eyre, David G. Takata, and Harry Van Wickle. This proposal was submitted as Item No. 1.

(c)		Other items on which stockholders voted at the meeting were:

	•		Item No. 2 — a proposal to amend the Company’s 2002 Qualified Stock Option Plan to increase the number of shares reserved for issuance by 450,000 shares, and make certain other Plan changes;

	•		Item No. 3 — a proposal to amend the Company’s 2002 Employee Stock Purchase Plan to increase the number of shares reserved for issuance by 300,000 shares; and

	•		Item No. 4 — a proposal to ratify the appointment of KPMG LLP as the Company’s independent auditors for the fiscal year ending December 28, 2003.

(d)

Shares of Common Stock voted were as follows:


	Total Vote For Each		Total Vote Withheld
	Director		From Each Director
Item No. 1
(Election of Class I Directors)
Chris A. Eyre		20,635,073		6,655
David G. Takata		20,634,683		7,045
Harry Van Wickle		20,635,073		6,655


							Broker
	For		Against		Abstain		Non-Vote
Item No. 2
(Proposal to amend the 2002 Qualified Stock Option Plan to increase the number of shares reserved for issuance by 450,000 shares, and make certain other Plan changes)		19,869,183		755,167		17,376		0
Item No. 3
(Proposal to amend the 2002 Employee Stock Purchase Plan to increase the number of shares reserved for issuance by 300,000 shares)		20,535,649		88,701		17,378		0
Item No. 4
(Ratification of independent auditors)		20,636,964		3,104		1,660		0

ITEM 5. Other Information

Not applicable.

ITEM 6. Exhibits and Reports on Form 8-K

a)		Exhibits

		31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

		31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

		32.01 Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

b)		Reports on Form 8-K

		On April 23, 2003, the Company filed Form 8-K stating that it issued a press release announcing its financial results for the first quarter ended March 30, 2003.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

KOMAG, INCORPORATED
(Registrant)


DATE:	July 31, 2003	BY:	/s/ Thian Hoo Tan


		Thian Hoo Tan Chief Executive Officer

DATE:	July 31, 2003	BY:	/s/ Kathleen A. Bayless


		Kathleen A. Bayless Vice President, Chief Financial Officer

EXHIBIT INDEX

31.01

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.02

Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.01

Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Good

WD Media (KOMG) Inactive 10-Q2004 Q2 Quarterly report

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