WD Media 10Q 2007 Q1 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 April 2, 2006
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. Yesþ Noo

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filerþ Accelerated filero Non-accelerated filero

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yeso Noþ

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEEDING FIVE YEARS

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. Yesþ Noo

On April 2, 2006, 30,729,574 shares of the Registrant’s common stock, $0.01 par value, were issued and outstanding.

INDEX
KOMAG, INCORPORATED


	Page
PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)		4
Condensed Consolidated Statements of Income — three months ended April 2, 2006 and April 3, 2005		4
Condensed Consolidated Balance Sheets — April 2, 2006 and January 1, 2006		5
Condensed Consolidated Statements of Cash Flows — three months ended April 2, 2006 and April 3, 2005.		6
Notes to Condensed Consolidated Financial Statements (Unaudited)		7-14
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		15-21
Item 3. Quantitative and Qualitative Disclosures about Market Risk		21
Item 4. Controls and Procedures		23

PART II. OTHER INFORMATION
Item 1A. Risk Factors		24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		38
Item 6. Exhibits		39

SIGNATURES		40
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of the United States (US) federal securities laws that involve risks and uncertainties. Certain statements contained in this report are not purely historical including, without limitation, statements regarding our expectations, beliefs, intentions, anticipations, commitments, or strategies regarding the future that are forward-looking. These statements include those discussed in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations, including “Results of Operations,” “Critical Accounting Policies,” and “Liquidity and Capital Resources,” and elsewhere in this report. These statements include statements concerning product development, product acceptance, product demand, shipping volumes, projected revenues, international revenues, pricing pressures, sales returns, gross profit, expenses, reserves, taxes, net income, capital spending, and liquidity requirements.

In this report, the words “may,” “could,” “would,” “might,” “will,” “should,” “plan,” forecast,” “anticipate,” “believe,” “expect,” “intend,” “estimate,” “predict,” “potential,” “continue,” “future,” “moving toward” or the negative of these terms or other similar expressions also identify forward-looking statements. Our actual results could differ materially from those forward-looking statements contained in this report as a result of a number of risk factors, including, but not limited to, those set forth in the section entitled “Risk Factors” and elsewhere in this report. You should carefully consider these risks, in addition to the other information in this report and in our other filings with the Securities and Exchange Commission (SEC). All forward-looking statements and reasons why results may differ included in this report are made as of the date of this report, and we assume no obligation to update any such forward-looking statement or reason why such results might differ.

PART I. FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

KOMAG, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)


	Three Months Ended
	April 2, 2006			April 3, 2005
Net sales	$	208,512		$	140,275
Cost of sales		149,419			105,212

Gross profit		59,093			35,063
Operating expenses:
Research, development, and engineering		15,075			11,155
Selling, general, and administrative		8,024			5,535
Gain on disposal of assets		(60	)		(389	)

		23,039			16,301

Operating income		36,054			18,762
Other income (expense):
Interest income		2,071			750
Interest expense		(441	)		(441	)
Other income (expense), net		(476	)		(28	)

		1,154			281


Income before income taxes		37,208			19,043
Provision for income taxes		971			516

Net income	$	36,237		$	18,527


Basic net income per share	$	1.22		$	0.66


Diluted net income per share	$	1.09		$	0.59


Number of shares used in basic per share computations		29,685			28,261


Number of shares used in diluted per share computations		33,499			32,313

See accompanying notes to condensed consolidated financial statements.

KOMAG, INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)


	April 2, 2006			January 1, 2006
ASSETS

Current assets
Cash and cash equivalents	$	105,989		$	99,984
Short-term investments		85,000			105,050
Accounts receivable (less allowances of $1,978 and $2,866, respectively)		119,462			116,217
Inventories		72,517			54,000
Prepaid expenses and deposits		1,418			1,846

Total current assets		384,386			377,097
Property, plant, and equipment, net		439,247			351,046
Other assets		3,291			3,308

	$	826,924		$	731,451


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities
Trade accounts payable	$	143,557		$	97,901
Customer advances		122,540			102,898
Accrued expenses and other liabilities		16,880			28,585

Total current liabilities		282,977			229,384
Long-term debt		80,500			80,500
Deferred rent		2,694			2,562

Total liabilities		366,171			312,446

Stockholders’ equity
Common stock, $0.01 par value per share:
Authorized - 50,000 shares
Issued and outstanding - 30,730 and 30,092 shares, respectively		307			301
Additional paid-in capital		263,741			267,920
Deferred stock-based compensation		—			(9,695	)
Accumulated other comprehensive loss		(645	)		(634	)
Retained earnings		197,350			161,113

Total stockholders’ equity		460,753			419,005

	$	826,924		$	731,451

See accompanying notes to condensed consolidated financial statements.

KOMAG, INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	Three Months Ended
	April 2, 2006			April 3, 2005
Operating Activities
Net income	$	36,237		$	18,527
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of property, plant, and equipment		14,476			10,100
Tax provision charged to additional paid-in capital		810			297
Amortization and adjustments of intangible assets		44			942
Stock-based compensation		3,536			841
Deferred rent		132			640
Non-cash interest charges		38			38
Gain on disposal of assets		(60	)		(389	)
Changes in operating assets and liabilities:
Accounts receivable, net		(3,245	)		(6,442	)
Inventories		(18,517	)		(6,167	)
Prepaid expenses and deposits		428			984
Trade accounts payable		16,767			12,771
Customer advances		19,642			—
Accrued expenses and other liabilities		(11,555	)		(5,733	)

Net cash provided by operating activities		58,733			26,409

Investing Activities
Acquisition of property, plant, and equipment		(73,988	)		(16,615	)
Purchases of short-term investments		(36,850	)		(67,150	)
Proceeds from sales and maturities of short-term investments		56,900			60,150
Proceeds from disposal of property, plant, and equipment		99			443
Other		(65	)		—

Net cash used in investing activities		(53,904	)		(23,172	)

Financing Activities
Repurchase of common stock		(1,049	)		—
Proceeds from sale of common stock		2,225			2,164

Net cash provided by financing activities		1,176			2,164

Increase in cash and cash equivalents		6,005			5,401
Cash and cash equivalents at beginning of period		99,984			26,410

Cash and cash equivalents at end of period	$	105,989		$	31,811

See accompanying notes to condensed consolidated financial statements.

KOMAG, INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

APRIL 2, 2006

Note 1. Basis of Presentation and Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements include the accounts of Komag, Incorporated (the Company), a Delaware corporation, and its wholly-owned subsidiaries. These financial statements have been prepared in accordance with United States of America (US) generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US generally accepted accounting principles. While the financial information furnished is unaudited, in the opinion of management, all normal recurring adjustments considered necessary for a fair presentation of the condensed consolidated financial position, operating results, and cash flows for the periods presented, have been included. Operating results for the three months ended April 2, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended January 1, 2006, which are included in the Company’s Annual Report on Form 10-K.

Use of Estimates in the Preparation of Financial Statements:The preparation of financial statements in conformity with accounting principles generally accepted in the US requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fiscal Year:The Company uses a 52-53 week fiscal year ending on the Sunday closest to December 31. The Company’s 2006 fiscal year will include 52 weeks. The three-month reporting periods included in this report include 13 weeks.

Cash and Cash Equivalents:The Company considers as a cash equivalent any bank deposit, money market investment, and any highly-liquid investment that has an original maturity at the date of purchase of three months or less.

Short-Term Investments:The Company invests its excess cash in high-quality, short-term debt instruments and auction rate preferred securities. At April 2, 2006, all short-term investments are designated as available for sale. Interest and dividends on the investments are included in interest income. The costs of the Company’s investments approximate fair value; accordingly, there were no realized gains or losses.

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


	April 2, 2006		January 1, 2006
Raw materials	$	58,885	$	39,230
Work in process		7,811		6,489
Finished goods		5,821		8,281

	$	72,517	$	54,000

Computation of Net Income Per Share:The Company determines net income per share in accordance with Statement of Financial Accounting Standards (SFAS) No. 128,Earnings per Share.

Basic net income per common share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income 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 net income per share by application of the treasury stock method. The dilutive effect of outstanding contingently convertible debt is reflected in diluted net income per share by application of the if-converted method. Interest expense related to the contingently convertible debt is an adjustment to net income for the diluted net income per share calculations.

The following table sets forth the computation of net income per share. The table is in thousands, except per share amounts.


	Three Months Ended
	April 2, 2006		April 3, 2005
Numerator for basic net income per share:
Net income as reported	$	36,237	$	18,527


Numerator for diluted net income per share:
Net income as reported	$	36,237	$	18,527
Interest adjustment related to contigently convertible debt		441		441

	$	36,678	$	18,968


Denominator for basic net income per share:
Weighted average shares outstanding		29,685		28,261


Denominator for diluted net income per share:
Weighted average shares		29,685		28,261
Effect of dilutive securities:
Contingently convertible shares under convertible debt		3,049		3,049
Stock options		473		522
Warrants		—		460
Stock purchase rights		292		21

		33,499		32,313


Basic net income per share	$	1.22	$	0.66


Diluted net income per share	$	1.09	$	0.59

Recent Accounting Pronouncements:In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151,Inventory Costs(SFAS 151).SFAS 151 clarifies the accounting for inventory when there are amounts of idle facility expense, freight, handling costs, and wasted materials. Under existing generally accepted accounting principles, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be “so abnormal” as to require treatment as current period charges rather than recorded as adjustments to the value of the inventory. SFAS 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal.” In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company adopted this pronouncement beginning in fiscal year 2006. The adoption of SFAS 151 had no material effect on the Company’s financial position or results of operations.

In May 2005, the FASB issued SFAS No. 154,Accounting Changes and Error Corrections(SFAS 154). SFAS 154 replaces APB No. 20 and FASB Statement No. 3. SFAS 154 provides guidance on the accounting for

and reporting of accounting changes and error corrections. It establishes retrospective application as the required method for reporting a change in accounting principle. SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS 154. The Company adopted this pronouncement beginning in fiscal year 2006. The adoption of SFAS 154 had no material effect on the Company’s financial position or results of operations.

Note 2. Stock-Based Compensation

Change in Accounting Principle

Effective January 2, 2006, the Company adopted SFAS No. 123R,Share-Based Payment(SFAS 123R) using the modified prospective method, in which compensation cost is recognized based on the requirements of SFAS 123R for (a) all share-based payments granted or modified after the effective date and (b) for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date.

As permitted under SFAS No. 123,Accounting for Stock-Based Compensation(SFAS 123), the Company elected to follow Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(APB 25), and related interpretations in accounting for stock-based awards to employees through January 1, 2006. Accordingly, compensation cost for stock options and stock purchase rights was measured as the excess, if any, of the market price of the Company’s common stock at the date of grant over the exercise price. Stock-based compensation expense related to stock options issued and stock purchase rights amounted to approximately $3.5 million and $0.8 million for the three months ended April 2, 2006 and April 3, 2005, respectively.

The Company elected to amortize stock-based compensation for awards outstanding and unvested on its adoption of SFAS 123R as well as for awards granted on or after its adoption of SFAS 123R on a ratable basis over the requisite service (vesting) period for the entire award. The vesting period for stock options has generally been four years and the vesting for stock purchase rights generally has been three years.

Plan Description

The 2002 Qualified Stock Plan (the 2002 Stock Plan) provides for the grant of incentive stock options to the Company’s employees, and for the grant of non-statutory stock options, stock purchase rights, stock appreciation rights, performance shares and performance units to the Company’s employees, directors, and consultants. The term for stock options granted may not exceed 10 years.

As of April 2, 2006, the Company had authorized a total of 4,242,054 shares of its common stock for issuance under the 2002 Stock Plan. As of April 2, 2006, the Company had a net balance of 838,701 shares of the Company’s common stock reserved for issuance under the 2002 Stock Plan. Of the 838,701 shares reserved for future issuance under the 2002 Stock Plan, 29,833 shares are for stock purchase rights deferred under a deferred compensation plan, 679,812 shares are for the exercise of outstanding stock options, and 129,056 shares are for

future grants of stock options and stock purchase rights.

Summary of Assumptions and Activity

The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model that uses the assumptions noted below. There were no option grants in the first three months of 2006. The following assumptions were used to estimate the fair value of option grants in the first three months of 2005: risk-free interest rate of 4.04%, expected volatility of the market price of the Company’s common stock of 71.8%, no dividend yield, and a weighted-average expected life of 4.0 years. The weighted-average fair value of options granted during the first three months of 2005 was $11.43 per share.

The following table sets forth a summary of option activity for the first quarter of 2006:


						Weighted-average
						Remaining		Aggregate
				Weighted-average		Contractual		Intrinsic
	Shares			Exercise Price		Term		Value
				(per share)		(years)
Outstanding at January 1, 2006		868,853		$	12.99
Granted		—			—
Exercised		(188,434	)	$	11.79
Cancelled		(607	)	$	13.41

Outstanding at April 2, 2006		679,812		$	13.33		7.58	$	23,297,419


Exercisable at April 2, 2006		295,224		$	12.12		7.39	$	10,474,866

The total intrinsic value of options exercised during the three months ended April 2, 2006 and April 3, 2005 was $6.6 million and $1.9 million, respectively. Upon the exercise of options, the Company issues new common stock from its authorized shares.

The following table sets forth a summary of the Company’s stock purchase rights for the three months ended April 2, 2006:


				Weighted-average
				Grant Date
	Shares			Fair Value
				(per share)
Outstanding at January 1, 2006		573,201		$	22.34

Granted		473,374			46.76
Vested		(145,437	)		20.65
Cancelled		(1,814	)		30.98


Outstanding at April 2, 2006		899,324		$	35.45

In the first three months of 2006, the Company recorded $1.6 million of stock-based compensation expense related to stock purchase rights. The cumulative effect of adopting SFAS 123R related to applying an estimated forfeiture rate to unvested stock purchase rights outstanding on the date of adoption was a $0.2 million credit, which was credited to cost of sales, research, development, and engineering expenses, and selling, general, and administrative expenses. The Company determines the fair value of stock purchase rights based on the Nasdaq closing stock price on the date of grant. Compensation expense related to stock purchase rights is amortized on a ratable basis over the vesting period of 36 months.

As of April 2, 2006, there was approximately $33.8 million of total unrecognized compensation cost related to employee and director stock-based compensation arrangements. The cost is expected to be recognized on a ratable basis over the remaining vesting period of the stock-based awards which have a weighted average remaining vesting period of 1.37 years. The total fair value of stock-based awards vested during the quarter ended April 2, 2006 was approximately $3.8 million.

As a result of adopting SFAS 123R on January 2, 2006, the Company’s income before provision for income taxes, and net income for the three months ended April 2, 2006, were approximately $1.0 million and $0.9 million lower, respectively, than if it had continued to account for share-based compensation under APB Opinion No. 25. Basic and diluted net income per share for the three months ended April 2, 2006 were approximately $0.02 and $0.03 lower, respectively, due to the adoption of SFAS 123R.

During the first quarter of 2006, the Company announced the anticipated retirement of its Chief Executive Officer (CEO) later in 2006. Certain agreements were entered into with the CEO as a result of the anticipated retirement. The agreements were filed as exhibits to the Form 10-K filed for the year ended January 1, 2006. Under the agreements, the vesting of certain stock options and stock purchase rights will be accelerated in connection with the CEO’s retirement. The Company recorded an additional $1.0 million of stock-based compensation expense in the first quarter of 2006 related to the modification of the CEO’s stock options and stock purchase rights.

In accordance with SFAS No. 123Accounting for Stock-Based Compensation(SFAS 123), and SFAS No. 148Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of SFAS 123, prior to

fiscal 2006, the Company provided pro forma disclosure of the effect on net income and earnings per share had the fair value method, as prescribed by SFAS 123, been used.

The following table reflects the effect on the Company’s net income and income per share had the fair value method been applied to all outstanding and unvested awards for the first quarter of 2005. The table is in thousands, except per share data.


	Three
	Months
	Ended
	April 3, 2005

Net income, as reported	$	18,527
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		841
Deduct: Stock-based compensation expense determined under the fair value method for all awards, net of related tax effects		(1,566	)

Pro forma net income	$	17,802


Net income per share:
Basic — as reported	$	0.66

Diluted — as reported	$	0.59

Basic — pro forma	$	0.63

Diluted — pro forma	$	0.56

Note 3. Concentration of Customer, Supplier, and Geographic Risk

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


	Three Months Ended
	April 2, 2006			April 3, 2005

Western Digital Corporation		35	%		19	%
Hitachi Global Storage Technologies (1)		22	%		25	%
Maxtor Corporation		21	%		35	%
Seagate Technology		18	%		16	%


(1)		Includes sales to Hitachi Global Storage Technologies’ contract manufacturer, Excelstor

The Company relies on a limited number of suppliers for some of the materials and equipment used in its manufacturing processes, including aluminum blanks, aluminum substrates, nickel plating solutions, polishing and texturing supplies, and sputtering target materials. Kobe Steel, Ltd. is the Company’s sole supplier of aluminum blanks, which is a fundamental component in producing disks. The Company also relies on a single supplier,

Heraeus Incorporated, for a substantial quantity of its sputtering target requirements, and on OMG Fidelity, Incorporated for supplies of nickel plating solutions.

A majority of the Company’s long-lived assets is located at its Malaysian manufacturing facilities. These assets totaled $407.1 million as of April 2, 2006, and $319.6 million as of January 1, 2006. The majority of the Company’s sales is delivered to manufacturing facilities located in Asia.

Note 4. Accrued Expenses and Other Liabilities

The following table (in thousands) summarizes accrued expenses and other liabilities balances at April 2, 2006 and January 1, 2006:


	April 2, 2006		January 1, 2006

Accrued compensation and benefits	$	14,384	$	24,986
Other liabilities		2,496		3,599

	$	16,880	$	28,585

Note 5. Customer Advances

The Company entered into supply agreements, including certain amendments to these agreements, with three major customers in 2005, and another major customer in the first quarter of 2006. Each agreement requires that the Company supply, and the customer purchase, certain specified media volumes, and that the Company supply media from existing and new production capacity to meet such purchase requirements, subject to certain exceptions. Under the supply agreements, the customers are required to pay certain advances covering future purchases of media from the Company. The customer advances, which totaled $122.5 million and $102.9 million as of April 2, 2006 and January 1, 2006, respectively, are to be repaid to the customers via a credit of a specified dollar amount per disk on future sales.

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. Condensed 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, including but not limited to: our belief that we are a leading independent supplier of disks; our belief that we have developed a deep understanding of market needs in the disk drive market; our belief that our manufacturing and technology development programs provide us with competitive advantages in maintaining and growing our market share; our belief that we have developed strong relationships with many of the leading disk drive manufacturers; our belief that our manufacturing operations, together with our experience in the industry and our economies of scale, provide us with timing and cost advantages in delivering consistently high-quality products to our customers in high volumes; our plan to continue to generate cash from our operations for the remainder of 2006; our expectation that our revenues will increase by 5% to 10% in the second quarter of 2006 compared to the first quarter of 2006; our belief that we will continue to investigate areas where we can expand our presence in the disk market; our expectation that we will continue to generate cash from operations; our expectation that we will fund our expansion with cash from operations and customer advances; our expectation that we will expand our disk manufacturing capacity to 35 million disks a quarter by the second quarter of 2006, and to 43 million disks a quarter by the end of 2006; and our belief that the estimates and judgments made regarding future events in connection with the preparation of our financial statements are reasonable. 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 and costs per unit, our ability to estimate revenues, shipping volumes, pricing pressures, returns, reserves, demand for our disks, selling, general, and administrative expenses, taxes, research, development, and engineering expenses, spending on property, plant, and equipment, expected sales of disks and the market for disk drives generally and certain customers specifically, and our beliefs regarding our liquidity needs.

Forward-looking statements are estimates reflecting the best judgment of our senior management, and they involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Our 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 in the Risk Factors section below. We undertake no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of such statements. Readers should review the Risk Factors section below, as well as other documents filed from time to time by us with the SEC.

Results of Operations

Overview

Komag, Incorporated was incorporated in Delaware in 1983. We are headquartered in San Jose, California. All of our manufacturing facilities are in Malaysia.

We design, manufacture, and market thin-film media (disks), which are incorporated into disk drives. Disks, such as the ones we manufacture, serve as a primary storage medium for digital data. Our net sales are driven by the level of demand for disks by disk drive manufacturers and the average selling prices of our disks. Demand for our disks is dependent on unit growth in the disk drive market, the growth of storage capacity in disk drives, which affects the number of disks needed per drive, and the number of disks our customers purchase from external suppliers. Average selling prices are dependent on overall supply and demand for disks and our product mix.

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 generally 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 and our production volume were to decrease.

Due to continuing strong customer demand and supply agreements entered into with each of our four major customers in 2005 and 2006, we increased our capacity to approximately 32 million disks a quarter by the end of the first quarter of 2006. We are currently in the process of expanding our capacity to 35 million disks a quarter, which we plan to achieve in the second quarter of 2006. We expect to expand further our capacity and exit the fourth quarter of 2006 with a capacity of 43 million disks a quarter. If we are unable to utilize our expanded capacity, we may be unable to increase or sustain our gross margins.

A majority of our revenue, expense, and capital purchasing activities is transacted in US dollars. However, a large portion of our payroll, certain manufacturing and operating expenses, and inventory and capital purchases is transacted in the Malaysian ringgit (ringgit). In July 2005, Malaysia removed its currency peg to the US dollar in favor of a managed float system. Changes in exchange rates could adversely affect the amount we spend on our payroll, certain manufacturing and operating expenses, and raw materials and capital purchases.

The following discussion compares the results of operations for the first quarter ended April 2, 2006, to the results of operations for the first quarter ended April 3, 2005. To facilitate an understanding of this discussion, we have provided the following table. The table (in thousands) reflects income statement components for the first quarters of 2006 and 2005, and also reflects income statement components as a percentage of net sales.


	Three Months Ended
	April 2, 2006					April 3, 2005

Net sales	$	208,512		100.0	%	$	140,275		100.0	%
Cost of sales		149,419		71.7	%		105,212		75.0	%

Gross profit		59,093		28.3	%		35,063		25.0	%

Research, development, and engineering expense		15,075		7.2	%		11,155		8.0	%
Selling, general, and administrative expense		8,024		3.8	%		5,535		3.9	%
Gain on disposal of assets		(60	)	(0.0	%)		(389	)	(0.3	%)
Interest income		(2,071	)	(1.0	%)		(750	)	(0.5	%)
Interest expense		441		0.2	%		441		0.3	%
Other expense, net		476		0.2	%		28		0.0	%
Provision for income taxes		971		0.5	%		516		0.4	%

Net income	$	36,237		17.4	%	$	18,527		13.2	%

Net Sales

Consolidated net sales in the first quarter of 2006 were $208.5 million, a 48.6% increase compared to $140.3 million in the first quarter of 2005. Our finished unit sales volume increased to 31.9 million units in the first quarter of 2006 from 22.2 million in the first quarter of 2005. The increase in consolidated net sales primarily reflected the increase in our sales volume due to higher demand in the industry. Our average selling price increased slightly in the first quarter of 2006 compared to the first quarter of 2005.

Other disk sales, which generally include single-side disks, aluminum substrate disks, plated disks, textured disks, and polished disks, were $25.8 million in the first quarter of 2006, compared to $17.4 million in the first quarter of 2005. The increase reflected higher sales of textured disks and polished disks. The increase in other disk sales was related to higher customer demand. Disk substrate sales vary from period to period based on customer requirements.

Finished disk shipments for desktop and consumer applications together represented 93% of our unit shipment volume in the first quarter of 2006 compared to 94% in the first quarter of 2005. The remaining finished disk shipments in the first quarter of 2006 and 2005 were for enterprise drives. Sales of 100GB and above per platter disks increased to 31% of net sales in the first quarter of 2006, compared to 18% in the first quarter of 2005.

In the first quarter of 2006, sales to Western Digital Corporation (Western Digital), Hitachi Global Storage Technologies (HGST) (including sales to HGST’s contract manufacturer, Excelstor), Maxtor Corporation (Maxtor), and Seagate Technology (Seagate), accounted for 35%, 22%, 21%, and 18%, respectively, of our total net sales. In the first quarter of 2005, sales to Western Digital, HGST, Maxtor, and Seagate accounted for 19%, 25%, 35%, and

16%, respectively, of our total net sales. Our sales are concentrated among a few customers. We expect to continue to derive a substantial portion of our sales from these customers, and from a small number of other customers. In December 2005, Seagate and Maxtor announced that they entered into a definitive agreement under which Seagate will acquire Maxtor. The transaction is expected to be completed as early as May 2006.

We entered into supply agreements, including certain amendments to these agreements, with Western Digital, Maxtor and Seagate in 2005, and with HGST in the first quarter of 2006. Each agreement requires that we supply, and the customer purchase, certain specified media volumes, and that we supply media from existing and new production capacity to meet such purchase requirements, subject to certain exceptions. Under the supply agreements, these customers are required to pay certain advances covering future purchases of media from the Company. The customer advances, which totaled $122.5 million and $102.9 million as of April 2, 2006 and January 1, 2006, respectively, are to be repaid to the customers via a credit of a specified dollar amount per disk on future sales.

Based on continuing strong market demand, we expect total net sales for the second quarter to increase by 5% to 10% from the first quarter of 2006. This level of total net sales reflects current continuing strong demand for finished disks, as well as demand for our substrates.

Gross Profit

Our gross profit percentage increased 3.3 percentage points to 28.3% for the first quarter of 2006, compared to 25.0% for the first quarter of 2005. In the first quarter of 2006, there was a positive gross profit impact of 2.5 percentage points due to a higher average selling price and a 0.8 percentage point increase due to lower costs per unit.

Research, Development, and Engineering Expenses

Research, development and engineering (R&D) expenses in the first quarter of 2006 were $15.1 million compared to $11.2 million in the first quarter of 2005. The increase primarily reflects higher headcount and related compensation expense.

Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses of $8.0 million in the first quarter of 2006 were $2.5 million higher than the $5.5 million incurred in the first quarter of 2005. The increase primarily reflected higher stock compensation expense of $1.5 million, higher incentive compensation of $0.5 million, and higher headcount and related compensation expense of $0.5 million. The higher stock compensation is primarily due to an additional $1.0 million of stock-based compensation expense in the first quarter of 2006 related to the modification of stock options and stock purchase rights for our Chief Executive Officer (CEO). During the first quarter of 2006, we announced the anticipated retirement of our CEO later in 2006. Certain agreements were entered into with the CEO as a result of the anticipated retirement. The agreements were filed as exhibits to the Form 10-K filed for the year ended January 1, 2006. Under the agreements, the vesting of certain stock options and stock purchase rights will be accelerated in connection with the CEO’s retirement.

Interest Expense

Interest expense reflected interest on our $80.5 million, 2% convertible subordinated notes, which were issued on January 28, 2004.

Other income (expense), net

Other income (expense), net primarily consists of foreign currency gains and losses.

Tax provision

Our tax provision for the three months ended April 2, 2006 is based on our annual effective tax rate of 2.6% in accordance with SFAS No. 109,Accounting for Income Taxes.We currently have separate tax holidays at our different manufacturing facilities located in Malaysia which continue through 2006 and a new ten year tax holiday begins in January 2007 through 2016 which covers all of our manufacturing facilities in Malaysia.

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 US generally accepted accounting principles. We regularly evaluate our estimates, including those related to our net sales, allowance for inventories, commitments and contingencies, income taxes, and asset impairments. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. 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. We have not experienced material differences between our estimated reserves for sales returns and actual results. It is possible that the failure rate on products sold could be higher than it has been historically, which could result in significant changes in future returns. Since estimated sales returns are recorded as a reduction in net sales, any significant difference between our estimated and actual experience or changes in our estimate would be reflected in our reported net sales in the period we determine that difference. There were no significant changes from the prior quarter estimates in the first three months of 2006.

Inventory Obsolescence

Our policy is to provide for inventory obsolescence based upon an estimated obsolescence percentage

applied to the inventory based on age, historical trends, and requirements to support forecasted sales. In addition, and as necessary, we may provide additional charges for future known or anticipated events. There were no significant changes from the prior quarter estimates in the first three months of 2006.

Liquidity and Capital Resources

As of April 2, 2006, we had $191.0 million in cash, cash equivalents, and short-term investments, which reflected a $14.0 million decrease during the quarter. This decrease primarily reflected $74.0 million of spending on property, plant, and equipment, offset by a $58.7 million increase resulting from consolidated operating activities, and $1.2 million in net proceeds from sales of common stock under our stock incentive plans.

In July 2005, Malaysia removed its currency peg to the US dollar in favor of a managed float system. As of April 2, 2006, we held approximately $36.0 million (Malaysian ringgit 132.1 million) of cash and cash equivalents that were denominated in Malaysian ringgit.

Consolidated operating activities generated $58.7 million in cash in the first three months of 2006. The primary components of this amount include the following:

	•		net income of $36.2 million, net of non-cash depreciation and amortization of property, plant and equipment of $14.5 million and other net non-cash charges of $4.5 million;

	•		an accounts receivable increase of $3.2 million, which reflected an increase in sales during the first quarter of 2006 compared to fourth quarter of 2005;

	•		an inventory increase of $18.5 million, which primarily reflected increased inventory to support increased production and sales volumes;

	•		an accounts payable increase of $16.8 million, which primarily reflected increased inventory and higher capital spending; and

	•		an accrued expenses and other liabilities increase of $8.1 million, which primarily reflected a net increase in customer advances, offset by payments of incentive compensation accruals.

Our total capital spending in the first three months of 2006 was $102.9 million (on an accrual basis), and included capital expenditures to increase our substrate and finished disk capacity, to improve our equipment capability for the manufacture of advanced products, and for projects designed to improve yield and productivity. For the remainder of 2006, we plan to spend approximately $200.0 million on property, plant, and equipment in order to increase our finished disk and related substrate capacity and continue to ramp new production processes. We expect to fund this capital spending with cash from operations and customer advances.

We have $80.5 million of 2% Convertible Subordinated Notes (the Notes) outstanding. The Notes mature on February 1, 2024, bear interest at 2.0%, and require semiannual interest payments beginning on August 1, 2004. The Notes will be convertible, under certain circumstances, into shares of our common stock based on an initial effective conversion price of $26.40. Holders of the Notes may convert the Notes into shares of our common stock prior to maturity if: 1) the sale price of our common stock equals or exceeds $31.68 for at least 20 trading days in any 30 consecutive trading day period within any of our fiscal quarters; 2) the trading price of the Notes falls below a specified threshold prior to February 19, 2019; 3) the Notes have been called for redemption; or 4) certain

specified corporate transactions (as described in the offering prospectus for the Notes) occur. As of April 2, 2006, the Notes were convertible. We may redeem the Notes on or after February 6, 2007, at specified declining redemption premiums. Holders of the Notes may require us to purchase the Notes on February 1, 2011, 2014, or 2019, or upon the occurrence of a fundamental change, at a purchase price equal to 100% of the principal amount of the Notes, plus accrued and unpaid interest. There are no financial covenants, guarantees, or collateral associated with the Notes.

We have a Malaysian ringgit 12.5 million (approximately $3.4 million) bank guarantee. There is no expiration date on the bank guarantee. No interest will be charged on the bank guarantee, but there is a commission of 0.05% on the amount of bank guarantee utilized. As of April 2, 2006, there were no liabilities outstanding related to this bank guarantee.

We lease our research and administrative facility in San Jose, California under an operating lease, which expires in 2014. Additionally, we lease certain equipment under operating leases. These leases expire on various dates through 2008. We have no capital leases.

We currently anticipate that existing cash and cash equivalents, and cash generated from operations, will be adequate to meet our cash needs for at least the next 12 months.

As of April 2, 2006, our long-term debt obligations, operating lease obligations, and unconditional purchase obligations were as follows (in thousands):


	Remainder
	of
	2006		2007		2008		2009		2010		Thereafter		Total
Long-Term Debt Obligations	$	—	$	—	$	—	$	—	$	—	$	80,500	$	80,500
Operating Lease Obligations		2,078		2,203		2,051		3,154		3,146		13,241		25,873
Unconditional Purchase Obligations (1)		6,594		1,225		1,184		1,184		1,184		2,075		13,446

Total Contractual Cash Obligations	$	8,672	$	3,428	$	3,235	$	4,338	$	4,330	$	95,816	$	119,819


(1)		Unconditional purchase obligations are defined as agreements to purchase goods or services that are enforceable and legally binding, and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable pricing provisions; and the approximate timing of the transactions. The amounts are based on our contractual commitments.

As of April 2, 2006, we had approximately $5.6 million of non-cancelable capital commitments. This amount is included in the table above under Unconditional Purchase Obligations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET 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 and auction rate preferred securities (which the Company rolls over every three months or less), which

are accounted for as cash equivalents or short-term investments, depending on the period of time from the purchase date to the maturity date.

We are exposed to foreign currency exchange rate risk. A majority of our revenue, expense, and capital purchasing activities is transacted in US dollars. However, a large portion of our payroll, certain manufacturing and operating expenses, and inventory and capital purchases is transacted in the Malaysian ringgit (ringgit). For approximately the last seven years, the exchange rate between the ringgit and the US dollar has been pegged at 3.8 ringgits to one US dollar by the Malaysian government. In July 2005, Malaysia removed its currency peg to the US dollar in favor of a managed float system. Changes in exchange rates could adversely affect the amount we spend on our payroll, certain manufacturing and operating expenses, and raw materials and capital purchases. In the first three months of 2006, our spending on payroll, manufacturing and operating expenses, and raw materials and capital purchases that were denominated in ringgit was approximately $89.5 million. Additionally, in the first three months of 2006, we paid approximately $23.4 million denominated in Malaysian ringgit to a Malaysian supplier for raw materials purchases, based on a cost plus a percentage arrangement. The Malaysian supplier incurs certain costs denominated in ringgit; therefore, any change in the valuation of the ringgit could impact the cost per unit we pay for such raw materials. As of April 2, 2006, we held approximately $36.0 million (Malaysian ringgit 132.1 million) of cash and cash equivalents that were denominated in Malaysian ringgit. We currently do not hedge the exposure to fluctuations in the Malaysian ringgit.

In September 2005, we began to hedge some of our foreign currency risk related to anticipated equipment purchases denominated in Japanese yen by entering into foreign exchange forward contracts that generally have maturities of 12 months or less. The Company has designated these foreign exchange forward contracts as a cash flow hedge in accordance with SFAS No. 133. The derivatives associated with our hedging activities are marked to market at fair value and any resulting liability is recorded in other liabilities and any resulting asset is recorded to prepaid and other current assets in the Condensed Consolidated Balance Sheets. The effective portion of gains or losses resulting from changes in fair value is initially reported as a component of accumulated other comprehensive income (loss), net of any tax effects, in stockholders’ equity and subsequently reclassified into depreciation expense in the periods in which the related equipment purchase is depreciated after the forecasted transaction actually occurs. The ineffective portion of gains or losses resulting from changes in fair value is reported in interest and other income, net in the Consolidated Statements of Operations. Our hedging programs reduce, but do not entirely eliminate, the impact of currency exchange rate movements.

As of April 2, 2006, we had foreign exchange contracts to purchase approximately $3.5 million of Japanese yen. The fair value of our forward contracts was recorded as a $0.2 million other current liability as of April 2, 2006.

The counterparty to these forward contracts is a creditworthy multinational commercial bank. The risks of counterparty nonperformance associated with these contracts are not considered to be material.

Notwithstanding our efforts to mitigate some foreign currency exchange rate risks, there can be no assurances that our mitigating activities will adequately protect us against the risks associated with foreign currency fluctuations.

We have $80.5 million in convertible subordinated notes outstanding. These notes bear interest at 2% and mature in February 2024. A hypothetical 100 basis point increase in interest rates would result in approximately $0.8 million of additional interest expense each year.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of April 2, 2006, our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), has conducted an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a — 15(b) of the Exchange Act. Based on that evaluation, the CEO and CFO concluded that our disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely manner.

Internal Control over Financial Reporting

Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:

	•		pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;

	•		provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and

	•		provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and that the degree of compliance with the policies or procedures may deteriorate.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting during our first fiscal quarter ended April 2, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

Our management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected.

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

These risks and uncertainties are not the only ones facing our company. Additional risks and uncertainties that we are unaware of or currently deem immaterial may also become important factors that may harm our business. If any of the following risks actually occur, or other unexpected events occur, our business, financial condition or results of operations could be materially adversely affected, the value of our stock could decline, and investors may lose part or all of their investment. Further, thisForm 10-Q contains forward-looking statements, and actual results may differ significantly from the results contemplated by our forward-looking statements.

Risks Related to Our Business

Our business is concentrated in the disk drive market, so downturns in the disk drive manufacturing market and related markets may decrease our revenues and margins.

The market for our products depends on economic conditions affecting the disk drive manufacturing and related markets. Our products are incorporated into disk drives manufactured by our customers for the desktop personal computer market as well as the enterprise storage systems market and consumer electronic device market. Because of the concentration of our products in the disk drive market, which we expect to continue, our business is linked to the success of this market. The disk drive market has historically been seasonal and cyclical, and has experienced periods of oversupply and reduced production levels, resulting in significantly reduced demand for disks and pricing pressures. Historically, it has been very difficult to achieve and maintain profitability and revenue growth in the disk drive industry because the average selling price of a disk drive rapidly declines over its commercial life as a result of technological enhancement, productivity improvement and increases in supply. In addition, intense price competition among personal computer manufacturers also tends to cause the average selling price of a disk drive to decline even further.

The effect of these cycles on suppliers historically has been magnified by disk drive manufacturers’ practice of ordering components, including disks, in excess of their needs during periods of rapid growth, thereby increasing the severity of the drop in the demand for components during periods of reduced growth or contraction. Further, downturns in the disk drive market may cause disk drive manufacturers to delay or cancel projects, reduce their production, or reduce or cancel orders for our products. This, in turn, may lead to longer sales cycles, delays in

payment and collection, pricing pressures, and unused capacity, causing us to realize lower revenues and margins and causing our operating results to suffer. For example, in the fourth quarter of fiscal year 2003, disk drive manufacturers appear to have overbuilt product, which resulted in an excess supply of disk drives that was not fully corrected until approximately the third quarter of fiscal year 2004.

Due to these factors, forecasts may not be achieved, either because expected sales do not occur or because they occur at lower prices or on terms that are less favorable to us. This increases the chance that our revenues and margins could be lower than the expectations of investors and analysts, which could make our stock price more volatile.

We are in the process of significantly increasing the scope of our manufacturing operations in Malaysia, and if we fail to successfully manage and integrate our expanding operations, we may be unable to exploit potential market opportunities, which would materially and adversely affect our business.

We are in the process of significantly increasing the scope of our manufacturing operations in Malaysia. In the first quarter of 2006, we had a manufacturing capacity of approximately 32 million units per quarter and expect to increase our capacity to approximately 43 million units per quarter by the end of 2006. We are expanding our capacity as a result of commitments we have made to each of our four major customers pursuant to strategic supply agreements. In the event we do not increase our capacity as planned on a timely basis, we could lose significant future orders from major customers. In the event we are successful in expanding our manufacturing capacity as planned, there can be no assurance we will receive sufficient orders to utilize fully our additional capacity. In addition, the high utilization of our expanded capacity is dependent on our obtaining sufficient operating supplies and raw materials from our limited and sole-source suppliers to accommodate the increased capacity. We do not have binding commitments from these limited and sole-source suppliers to provide sufficient supplies and raw materials to fully utilize the additional capacity.

Addressing the challenges of our capacity expansion requires, and will continue to require, substantial management attention and financial resources. In the event that our expansion efforts require additional funding, or if we have insufficient resources to fund our expansion efforts, we may need to seek additional capital, which may not be available on favorable terms, or at all. If we are unable to successfully develop and integrate our expanded manufacturing operations in Malaysia in a timely and effective manner, our business could be materially and adversely affected.

We receive a large percentage of our net sales from only a few disk drive manufacturing customers, the loss of any of which would adversely affect our sales.

We sell most of our products to a limited number of customers. Our customers are disk drive manufacturers. Because of our small customer base, the loss of any one significant customer could have a materially adverse impact on our business operations. A relatively small number of disk drive manufacturers dominates the disk drive market. In addition, we anticipate that Seagate’s proposed acquisition of Maxtor would make the combined Seagate-Maxtor company the largest disk drive manufacturer in the industry. We expect that the success of our business will continue to depend on a limited number of customers. In the first quarter of 2006, 35% of our total net sales were to Western Digital, 22% were to HGST, 21% were to Maxtor, and 18% were to Seagate. If the

combined Seagate-Maxtor company or any one of our other significant customers reduces its disk requirements, cancels existing orders, develops or expands capacity to produce its own disks, or requires us to reduce our prices before we are able to reduce costs, and we are unable to replace these orders with sales to new customers, our sales would be reduced and our business, financial condition, and operating results would suffer. Our ability to maintain strong relationships with our significant customers is essential to our future performance. Any further mergers, acquisitions, consolidations, or other significant transactions involving our significant customers may adversely affect our business and operating results.

In addition, if our customers cancel orders, our sales could suffer and we are generally not entitled to receive cancellation penalties to offset the loss of sales revenue. Our sales are generally made pursuant to purchase orders that are subject to cancellation, modification, or rescheduling without significant penalties. As a result, if a customer cancels, modifies, or reschedules an order, we may have already made expenditures that are not recoverable, and our profitability will suffer. Furthermore, if our current customers do not continue to place orders with us or if we are unable to obtain orders from new customers, our sales and operating results will suffer.

The proposed Seagate acquisition of Maxtor will reduce our total number of significant customers, which may result in reduced sales and thereby adversely affect our business, revenues and operating results.

In December 2005, two of our major customers, Seagate and Maxtor, announced that they entered into a definitive agreement under which Seagate will acquire Maxtor. The transaction is expected to be completed as early as May 2006, subject to obtaining shareholder approvals and customary regulatory approvals. Until the closing, Seagate and Maxtor will continue to operate as separate businesses. Upon closing of the proposed merger, we anticipate that the combined Seagate-Maxtor company will be the largest disk drive manufacturer in the industry. Since each of Seagate and Maxtor are currently two of our largest customers, the anticipated merger will reduce our total number of customers. We cannot forecast with any certainty the impact that Seagate’s proposed acquisition of Maxtor may have on our business, revenues, and operating results. We face high levels of competition for customers in the disk industry, and the merger and consolidation of two of our significant customers may further reduce our bargaining power, result in reduced demand for our products, lead to downward pricing pressure, and otherwise negatively impact our revenues. The combined Seagate-Maxtor company may have greater financial resources and greater technical and manufacturing resources than Seagate and Maxtor have as stand-alone companies.

In addition, there can be no assurance that the proposed merger will be successfully completed in a timely manner without disruption to their business operations, or that the combined company will maintain each of Seagate’s and Maxtor’s prior purchasing levels of our products. In addition, the new combined company may impose new product requirements, modifications and demands on us as they seek to maximize their post-merger operational efficiencies and economies of scale. If we fail to mitigate the effects of these risks and pressures, and successfully serve the evolving customer requirements of the combined Seagate-Maxtor company, our business and operations would be adversely affected.

Our agreements with each of our major customers require us to meet certain production volumes, and if we fail to successfully perform under these agreements, we may incur substantial costs and expenses, and our business could be materially and adversely affected.

We have entered into strategic supply agreements with each of our major customers that require us to meet certain production volume goals. Pursuant to these agreements, monies have been advanced to us to help fund the expansion of our capacity, and if we fail to meet the agreed upon volume goals, we may need to refund some of our customer advances. Even if we succeed in expanding our production capacity in a timely and effective manner as required by our contractual obligations, there can be no assurance that we will meet the product specifications or timetables required by our customers for delivery. Our inability to perform successfully and competently our obligations under our agreements may cause us to incur substantial costs and expenses, and would have an adverse effect on our business, results of operations, and financial condition.

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

We rely on a limited number of qualified suppliers for some of the materials and equipment used in our manufacturing processes, including aluminum blanks, aluminum substrates, nickel plating solutions, polishing and texturing supplies, and sputtering target materials. For example, Kobe Steel, Ltd. is our sole supplier of aluminum substrate blanks, which is a fundamental component in producing our disks. We also rely on Heraeus Incorporated, for a substantial quantity of our sputtering target requirements, and on OMG Fidelity, Inc. for supplies of nickel plating solutions. As a result of increased worldwide demand, the supply of sputtering target materials has been constrained over the past year, and has recently intensified, resulting in longer lead times and product allocation from certain target suppliers. The increasing demand for many of these materials provides our sole-source suppliers with additional bargaining power. Our production capacity would be limited if one or more of these materials were to become unavailable or available in reduced quantities, or if we were unable to find alternative suppliers. If our sources of materials and supplies were limited or unavailable for a significant period of time or the costs of such materials were to increase, our production, operating results, and ability to grow our business could be adversely affected.

We cannot be assured that we will be able to obtain adequate supplies of critical materials and equipment in a timely and economic manner, or at all. The success of our products also depends on our ability to effectively integrate materials that use leading-edge technology. If we are unable to successfully manage the integration of materials obtained from third party suppliers, our business, financial condition and operating results could suffer.

If we are unable to perform successfully in the highly competitive and increasingly concentrated disk industry, we may not be able to maintain or gain additional market share, and our operating results would be harmed.

The market for our products is highly competitive, and we expect competition to continue in the future. Competitors in the thin-film media industry fall primarily into two groups: Asian-based independent disk manufacturers, and captive disk manufacturers. Our major Asian-based independent competitors include Fuji Electric, Hoya, and Showa Denko. The captive disk manufacturers who produce thin-film media internally for their own use include HGST, Maxtor, and Seagate. Many of these competitors have greater financial resources than we have, which could allow them to adjust to fluctuating market conditions better than we. Further, they may have greater technical and manufacturing resources, more marketing power, and a broader array of products. To the extent our competitors continue to consolidate and achieve greater economies of scale, we will face additional competitive challenges. Our competitors may also lower their product prices to gain market share, develop new

technology which would significantly reduce the cost of their products, or offer more products than we do and therefore enter into agreements with customers to supply their products as part of a larger supply agreement. Price declines are also affected by any imbalances between demand and supply. For most of 2002, as in the several years prior, disk supply exceeded demand. As independent suppliers like us struggled to utilize their capacity, the excess disk supply caused average selling prices for disks to decline. Supply and demand conditions have improved since 2002, resulting in a more stable pricing environment. Supply and demand factors and industry-wide competition could adjust in the future and force disk prices down, which, in turn, would put pressure on our gross margin. We may be forced to lower our prices or add new products and features at lower prices to remain competitive, and we may otherwise be unable to introduce new products at higher prices. We cannot be assured that we will be able to compete successfully in this kind of price competitive environment. If we are not able to compete successfully in the future, we would not be able to gain additional market share for our products, or we may lose our existing market share, and our operating results could be harmed.

If we are not able to attract and retain key personnel, including a successor Chief Executive Officer for our company, our business and operations could be harmed.

Our future success depends on the continued service of our executive officers, our highly-skilled research, development and engineering team, our manufacturing team, and our key administrative, sales and marketing, and support personnel, many of whom would be extremely difficult to replace. In February 2006, our Chief Executive Officer, Thian Hoo Tan, announced his intention to retire as an officer and director of the Company later in 2006. We have started an executive search for a successor. This search has been initiated as part of our succession planning, and will include both internal and external candidates. There is no guarantee that we will find a suitable and qualified successor to Mr. Tan in a timely manner, and even if a successor is hired, we may not be able to successfully retain such person for an extended period of time, which could adversely affect our business. Acquiring and retaining talented personnel who possess the advanced skills we require has been difficult, particularly at our Malaysian manufacturing facilities where there is high growth in the marketplace We may not be able to attract, assimilate, or retain highly-qualified personnel to maintain the capabilities that are necessary to compete effectively. Further, we do not have key person life insurance on any of our key personnel. If we are unable to retain existing or hire key personnel, our business, financial condition, and operating results could be harmed.

If our production capacity is underutilized, our gross margin will be adversely affected and we could sustain significant losses.

Our business is characterized by high fixed overhead costs, including expensive plant facilities and production equipment. Our per-unit costs and our gross profit are significantly affected by the number of units we produce and the amount of our production capacity that we utilize. We are in the process of significantly expanding our production capacity to approximately 43 million units per quarter by the end of 2006 from approximately 32 million units per quarter for the first quarter of 2006. We have in the past, and may in the future, experience periods of underutilized capacity. For example, in the third quarter of 2004, we completed the installation of additional equipment, which increased our production capacity from approximately 20 million disks a quarter to approximately 24 million disks a quarter. Our finished disk shipments were below this capacity level in the third quarter and fourth quarter of 2004. If our capacity utilization decreases for any reason, including lack of customer demand or cancellation or delay of customer orders, we could experience significantly higher unit production costs, lower

margins, and potentially significant losses, as occurred for several years prior to 2003. Underutilization of our production capacity could also result in equipment write-offs, restructuring charges, and employee layoffs. If our production capacity is underutilized for any reason, our financial results and our business would be severely harmed.

Internal disk operations of disk drive manufacturers may adversely affect our ability to sell our disk products.

Disk drive manufacturers such as HGST, Maxtor, and Seagate have large internal thin-film media manufacturing operations, and are able to produce a substantial percentage of their disk requirements. We compete directly with these internal operations when we market our products to these disk drive companies, and compete indirectly when we sell our disks to customers who must compete with vertically-integrated disk drive manufacturers. Vertically-integrated companies have the opportunity to keep their disk-making operations fully utilized, thus lowering their costs of production. This cost advantage contributes to the pressure on us and other independent disk manufacturers to sell disks at lower prices and can severely affect our profitability. Vertically-integrated companies are also able to achieve a large manufacturing scale that supports the development resources necessary to advance technology rapidly. HGST previously announced that it intends to consolidate its internal thin-film media manufacturing operations in China, which could result in decreased demand for our products by HGST or increased pricing pressure. We may not have sufficient resources or manufacturing scale to be able to compete effectively with these companies as to production costs or technology development, which would negatively impact our net sales and market share.

All of our manufacturing operations are in Malaysia and our foreign operations and international sales subject us to additional risks inherent in doing business on an international level that could make it more costly and difficult to conduct our business.

Our manufacturing operations are consolidated in Malaysia. As a result, technology developed at our US-based research and development center must be first implemented for high-volume production at our Malaysian facilities. Therefore, we rely heavily on electronic communications between our US headquarters and our Malaysian facilities to transfer specifications and procedures, diagnose operational issues, and meet customer requirements. If our operations in Malaysia or overseas communications are disrupted for a prolonged period for any reason, including a failure in electronic communications with our US operations, the manufacture and shipment of our products would be delayed, and our results of operations would suffer. In addition, a tsunami, flood, earthquake, political instability, act of terrorism or other disaster or condition that adversely affects our facilities or ability to manufacture our products could significantly harm our business, financial condition and operating results.

Additionally, because a large portion of our payroll, certain manufacturing and operating expenses, and inventory and capital purchases is transacted in the Malaysian ringgit (ringgit), we are particularly sensitive to any change in the foreign currency exchange rate for the ringgit. For approximately seven years, the exchange rate between the ringgit and the US dollar was pegged at 3.8 ringgits to one US dollar by the Malaysian government. In July 2005, Malaysia removed its currency peg to the US dollar in favor of a managed float system. The change in exchange rates could adversely affect the amount we spend on our payroll, certain manufacturing and operating expenses, and raw materials and capital purchases. In the first quarter of 2006, our spending on payroll, manufacturing, and operating expenses, and raw materials and capital purchases that were denominated in ringgit was approximately $89.5 million. Additionally, in the first quarter of 2006, we paid approximately $23.4 million US

dollars to a Malaysian supplier for raw materials purchases, based on a cost plus a percentage arrangement. This Malaysian supplier incurs certain costs that are denominated in ringgit; therefore, any change in the valuation of the ringgit could materially impact the cost per unit we pay for such raw materials. Furthermore, our ability to transfer funds from our Malaysian operations to the US is subject to Malaysian rules and regulations.

There are a number of other risks associated with conducting business outside of the US. Our Malaysian operations account for substantially all of our net sales. Our sales are primarily made to Asian customers, including the foreign subsidiaries of domestic disk drive companies. Accordingly, our operating results are subject to the risks inherent with international operations, including, but not limited to:

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

	•		fluctuations in tariffs or other trade barriers;

	•		difficulties in staffing and managing foreign operations;

	•		political, social, and economic instability;

	•		increased exposure to threats and acts of terrorism;

	•		exposure to taxes in multiple jurisdictions;

	•		local infrastructure problems or failures including but not limited to loss of power and water supply; and

	•		transportation delays and interruptions.

If we do not effectively manage the risks associated with international operations and sales, our business, financial condition, and operating results could suffer.

Because our products require a lengthy sales cycle with no assurance of high volume sales, we may expend significant financial and other resources without a return.

We must frequently qualify new products with our disk drive manufacturing customers, based on criteria such as quality, storage capacity, performance, and price. Qualifying disks for incorporation into new disk drive products requires us to work extensively with our customer and the customer’s other suppliers to meet product specifications. Therefore, customers often require a significant number of product presentations and demonstrations, as well as substantial interaction with our senior management, before making a purchasing decision. Accordingly, our products typically have a lengthy sales cycle, which can range from six to twelve months or longer. During this time, we may expend substantial financial resources and management time and effort, while having no assurances that a sale will result, or that disk drive programs ultimately will result in high-volume production. To the extent we expend significant resources to qualify products without realizing sales, our operations will suffer.

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

The disk industry is subject to rapid technological change, and if we are unable to anticipate and develop products and production technologies on a timely basis, our competitive position could be harmed. Customization has increased the risk of product obsolescence, and as a result, supply chain management, including just-in-time delivery, has become a standard industry practice. In order to sustain customer relationships and sustain profitability, we must be able to develop new products and technologies in a timely fashion in order to help customers reduce

their time-to-market performance, and continue to maintain operational excellence that supports high-volume manufacturing ramps and tight inventory management throughout the supply chain. The success of any new product introduction is dependent on a number of factors, including market acceptance, our ability to manage the risks associated with product transitions, and the risk that a new product will have quality problems or other defects in the early stages of introduction that were not anticipated in the design of such product. Accordingly, we have invested, and intend to continue to invest heavily, in our research and development program. If we cannot respond to this rapidly changing environment or fail to meet our customers’ demanding product and qualification requirements, we will not be able to compete effectively. As a result, we would not be able to maximize the use of our production facilities, and our profitability would be negatively impacted.

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

Our products primarily serve the 3 1/2-inch disk drive market where product performance, consistent quality, price, and availability are of great competitive importance. The continuing need for high-capacity disk drives requires disks with higher storage capacity. Higher storage capacity on the surface of a disk is achieved by increasing its areal density. Areal density continues to increase rapidly, requiring significant improvement in every aspect of disk design. These advances require substantial on-going process and technology development. New process technologies, including synthetic anti-ferromagnetically coupled layers and perpendicular magnetic recording, must support cost-effective, high-volume production of disks that meet these ever-advancing customer requirements for enhanced magnetic recording performance. We may not be able to develop and implement these technologies in a timely manner in order to compete effectively against our competitors’ products or entirely new data storage technologies. In addition, we must transfer our technology from our US-based research and development center to our Malaysian manufacturing operations.

If we cannot advance our process technologies or do not successfully transfer those advanced technologies at high yields to our Malaysian operations, or if technologies that we have chosen not to develop prove to be viable competitive alternatives, we would not be able to compete effectively. As a result, we would lose market share and face increased price competition from other manufacturers, and our operating results would suffer.

If we fail to improve the quality of, and control contamination in our manufacturing processes, we will lose our ability to remain competitive.

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

An industry trend towards glass-based applications could negatively impact our ability to remain competitive.

Our finished disks are manufactured primarily from aluminum substrates, which are the primary substrate used in desktop PC, enterprise applications, and high-capacity consumer applications. Some disk manufacturers emphasize the use of glass as a basis for the manufacture of their disks to primarily serve the mobile PC market and certain other consumer applications. These applications are expected to achieve significant growth in the near future. To the extent glass-based applications were to achieve significant growth in the market place, we may lose market share if we were unable to move rapidly to produce glass-based disks to address the demand.

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

Our protection of our intellectual property is limited. It is commonplace to protect technology through patents and other forms of intellectual property rights in technically sophisticated fields. We may not receive patents for our pending or future patent applications, and any patents that we own or that are issued to us may be invalidated, circumvented or challenged. In the disk and disk drive industries, companies and individuals have initiated actions against others in the industry to enforce intellectual property rights. Although we attempt to protect our intellectual property rights through patents, copyrights, trade secrets, and other measures, we may not be able to protect adequately our technology. In addition, we may not be able to discover significant infringements of our technology or successfully enforce our rights to our technology if we discover infringing uses by others, and such infringements could have a negative impact on our ability to compete effectively. Competitors may be able to develop similar technology and also may have or may develop intellectual property rights and enforce those rights to prevent us from using such technologies, or demand royalty payments from us in return for using such technologies. Either of these events may affect our production, which could materially reduce our net sales and harm our operating results.

We may face intellectual property infringement claims that are costly to resolve, may divert our management’s attention, and may negatively impact our operations.

We have occasionally received, and may receive in the future, communications from third parties that assert violation of intellectual property rights alleged to cover certain of our products or manufacturing processes or equipment. We evaluate on a case-by-case basis whether it would be necessary to defend against such claims or to seek licenses to the rights referred to in such communications. We may have to litigate to enforce patents issued or licensed to us, to protect trade secrets or know-how owned by us or to determine the enforceability, scope and validity of our proprietary rights and the proprietary rights of others. Enforcing or defending our proprietary rights could be expensive and might not bring us timely and effective relief. In certain cases, we may not be able to negotiate necessary licenses on commercially reasonable terms, or at all. Also, if we have to defend such claims, we could incur significant expenses and our management’s attention could be diverted from our core business. Further, we may not be able to anticipate claims by others that we infringe on their technology or successfully defend ourselves against such claims. Any litigation resulting from such claims could have a material adverse effect on our business and financial results.

Historical quarterly results may not accurately predict our performance due to a number of uncertainties and

market factors, and as a result it is difficult to predict our future results.

Our operating results historically have fluctuated significantly on both a quarterly and annual basis. We believe that our future operating results will continue to be subject to quarterly variations based on a wide variety of factors, including:

	•		timing of significant orders, or order cancellations;

	•		changes in our product mix and average selling prices;

	•		modified, adjusted, or rescheduled shipments;

	•		actions by our competitors, including announcements of new products or technological innovations;

	•		availability of disks versus demand for disks;

	•		the cyclical nature of the disk drive industry;

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

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

	•		our ability to execute future product development and production ramps effectively;

	•		fluctuations in exchange rates, particularly between the US dollar and the Malaysian ringgit;

	•		the ability of our process equipment to meet more stringent future product requirements;

	•		our ability to introduce new products that achieve cost-effective high-volume production in a timely manner, timing of product announcements, and market acceptance of new products;

	•		the availability of our production capacity, and the extent to which we can use that capacity;

	•		changes in our manufacturing efficiencies, in particular product yields and input costs for direct materials, operating supplies and other running costs;

	•		prolonged disruptions of operations at any of our facilities for any reason;

	•		changes in the cost of or limitations on availability of labor;

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

	•		changes in tax regulations in foreign jurisdictions that could potentially reduce our tax incentives in areas such as Malaysian capital allowances, tax holidays, and exemptions on withholding tax on royalty payments made by our Malaysian operations to our subsidiary in the Netherlands.

We cannot forecast with certainty the impact of these and other factors on our revenues and operating results in any future period. Our expense levels are based, in part, on expectations as to future revenues. Many of our expenses are relatively fixed and difficult to reduce or modify. The fixed nature of our operating expenses will magnify any adverse effect of a decrease in revenue on our operating results. Because of these and other factors, period to period comparisons of our historical results of operations are not a good predictor of our future performance. If our future operating results are below the expectations of stock market analysts, our stock price may decline. Our ability to predict demand for our products and our financial results for current and future periods may be affected by economic conditions. This may adversely affect both our ability to adjust production volumes and expenses and our ability to provide the financial markets with forward-looking information. If our revenue levels are below expectations, our operating results are likely to suffer.

If we make unprofitable acquisitions or are unable to successfully integrate future acquisitions, our business could suffer.

We have in the past acquired, and in the future may acquire, businesses, products, equipment, or technologies that we believe will complement or expand our existing business. Acquisitions involve numerous risks, including the following:

	•		difficulties in integrating the operations, technologies, products and personnel of the acquired companies, especially given the specialized nature of our technology;

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

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

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

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

Acquisitions may also cause us to:

	•		issue stock that would dilute our current stockholders’ percentage ownership;

	•		assume liabilities;

	•		record goodwill and non-amortizable intangible assets that will be subject to impairment testing and potential periodic impairment charges;

	•		incur amortization expenses related to certain intangible assets;

	•		incur large and immediate write-offs; or

	•		become subject to litigation.

Mergers and acquisitions of high-technology companies are inherently risky, and no assurance can be given that any future acquisitions by us will be successful and will not materially adversely affect our business, operating results, or financial condition. The failure to manage and successfully integrate acquisitions we make could harm our business and operating results in a material way. Even if an acquired company has already developed and marketed products, there can be no assurance that product enhancements will be made in a timely fashion or that pre-acquisition due diligence will have identified all possible issues that might arise with respect to products or the integration of the company into our company.

The nature of our operations makes us susceptible to material environmental liabilities, which could result in significant compliance and clean-up expenses and adversely affect our financial condition.

We are subject to a variety of federal, state, local, and foreign regulations relating to:

	•		the use, storage, discharge, and disposal of hazardous materials used during our manufacturing process;

	•		the treatment of water used in our manufacturing process; and

	•		air quality management.

We are required to obtain necessary permits for expanding our facilities. We must also comply with new regulations on our existing operations, which may result in significant costs. Public attention has increasingly been

focused on the environmental impact of manufacturing operations that use hazardous materials.

If we fail to comply with environmental regulations or fail to obtain the necessary permits:

	•		we could be subject to significant penalties;

	•		our ability to expand or operate in California or Malaysia could be restricted;

	•		our ability to establish additional operations in other locations could be restricted; or

	•		we could be required to obtain costly equipment or incur significant expenses to comply with environmental regulations.

Even if we are in compliance in all material respects with all present environmental regulations, it is often difficult to estimate the future impact of environmental matters, including potential liabilities. If we have to make significant capital expenditures or pay significant expense in connection with remedial actions or to continue to comply with applicable environmental laws, our business, financial condition and operating results could suffer. Furthermore, our manufacturing processes rely on the use of hazardous materials, and any accidental hazardous discharge could result in significant liability and clean-up expenses, which could harm our business, financial condition, and results of operations.

From time to time, we may have to defend lawsuits in connection with the operation of our business.

We are subject to litigation in the ordinary course of our business. If we do not prevail in any lawsuit which may occur we could be subject to significant liability for damages, our patents and other proprietary rights could be invalidated, and we could be subject to injunctions preventing us from taking certain actions. If any of the above occurs, our business and financial position could be harmed.

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

Our US facilities are located in San Jose, California. In addition, Kobe and other Japanese suppliers of our key manufacturing supplies and sputtering machines are located in areas with seismic activity. Our Malaysian operations have been subject to temporary production interruptions due to localized flooding, disruptions in the delivery of electrical power, and, on one occasion in 1997, by smoke generated by large, widespread fires in Indonesia. If any natural or man-made disasters do occur, operations could be disrupted for prolonged periods, and our business would suffer.

Terrorist attacks may adversely affect our business and operating results.

The continued threat of terrorist activity and other acts of war or hostility, including the war in Iraq, have created uncertainty in the financial and insurance markets, and have significantly increased the political, economic, and social instability in some of the geographic areas in which we operate. Acts of terrorism, either domestic or foreign, could create further uncertainties and instability. To the extent this results in disruption or delays of our manufacturing capabilities or shipments of our products, our business, operating results, and financial condition could be adversely affected.

Compliance with the rules and regulations concerning corporate governance may be costly, time-consuming, and difficult to achieve, which could harm our operating results and business.

The Sarbanes-Oxley Act (the Act), which was signed into law in October 2002, mandates that, among other things, companies maintain rigorous corporate governance measures, and imposes comprehensive reporting and disclosure requirements. The Act also imposes increased civil and criminal penalties on a corporation, its chief executive and chief financial officers, and members of its board of directors, for securities law violations. In addition, the Nasdaq National Market, on which our common stock is traded, has adopted and is considering the adoption of additional comprehensive rules and regulations relating to corporate governance. These rules, laws, and regulations have increased the scope, complexity, and cost of our corporate governance, reporting, and disclosure practices. Because compliance with these rules, laws, and regulations is costly and time-consuming, our management’s attention could be diverted from managing our day-to-day business operations, and our operating expenses could increase. In addition, because of the inherent limitations in all financial control systems, it is possible that, in the future, a material weakness may be found in our internal controls over financial reporting, which could affect our ability to insure proper financial reporting.

Further, our board members, Chief Executive Officer, and Chief Financial Officer face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers, which could harm our business.

In the future, we may need additional capital, which may not be available on favorable terms, or at all.

Our business is capital-intensive and we may need more capital in the future. Our future capital requirements will depend on many factors, including:

	•		the rate of our sales growth;

	•		the level of our profits or losses;

	•		the timing and extent of our spending to expand manufacturing capacity, support facilities upgrades and product development efforts;

	•		the timing and size of business or technology acquisitions;

	•		the timing of introductions of new products and enhancements to our existing products; and

	•		the length of product life cycles.

If we require additional capital it is uncertain whether we will be able to obtain additional financing on favorable terms, if at all. Further, if we issue equity securities in connection with additional financing, our stockholders may experience dilution and/or the new equity securities may have rights, preferences or privileges senior to those of existing holders of common stock. If we cannot raise funds on acceptable terms, if and when needed, we may not be able to develop or enhance our products and services in a timely manner, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements or may be forced to limit the number of products and services we offer, any of which could seriously harm our business.

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

We have in place protective provisions designed to provide our board of directors with time to consider whether a hostile takeover is in our and our stockholders’ best interests. Our certificate of incorporation provides for three classes of directors. As a result, a person could not take control of the board until the third annual meeting after the closing of the takeover, since a majority of our directors will not stand for election until that third annual meeting. This provision could discourage potential acquisition proposals and could delay or prevent a change in control of the company, and also could diminish the opportunities for a holder of our common stock to participate in tender offers, including offers at a price above the then-current market price for our common stock. These provisions also may inhibit fluctuations in our stock price that could result from takeover attempts.

Risks Related to our Indebtedness

We are leveraged, and our debt obligations will continue to make us vulnerable to economic downturns.

In 2004, we completed a public common stock offering of 4.0 million shares (of which 0.5 million were sold by selling stockholders) and a public $80.5 million Convertible Subordinated Notes offering. Debt service obligations arising from the offering of our Convertible Subordinated Notes could limit our ability to borrow more money for operations and implement our business strategy in the future.

Our holding company structure makes us dependent on cash flow from our subsidiaries to meet our obligations.

Most of our operations are conducted through, and most of our assets are held by, our subsidiaries. Therefore, we are dependent on the cash flow of our subsidiaries to meet our debt obligations. Our subsidiaries are separate legal entities that have no obligation to pay any amounts due under the Convertible Subordinated Notes, or to make any funds available therefore, whether by dividends, loans, or other payments. Our subsidiaries have not guaranteed the payment of the Convertible Subordinated Notes, and payments on the Convertible Subordinated Notes are required to be made only by us. Except to the extent we may ourselves be a creditor with recognized claims against our subsidiaries, subject to any limitations contained in our debt agreements, all claims of creditors and holders of preferred stock, if any, of our subsidiaries will have priority with respect to the assets of such subsidiaries over the claims of our creditors, including holders of the Convertible Subordinated Notes.

The assets of our subsidiaries may not be available to make payments on our debt obligations.

We may not have direct access to the assets of our subsidiaries unless these assets are transferred by dividend or otherwise to us. The ability of our subsidiaries to pay dividends or otherwise transfer assets to us is subject to various restrictions, including restrictions under other agreements to which we are a party under applicable law.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c) The following table provides information about the repurchase of our common stock during the quarter ended April 2, 2006:

Total

Number of

Maximum Number

Purchased

(or Approximate

as Part of

Dollar Value)

Total

Average

Publicly

of Shares

Number of

Price

Announced

that May Yet Be

Paid per

Plans or

Purchased under the

Period

Purchased (1)

Programs

Plans or Programs

January 2 to January 29

—

January 30 to February 26

22,165

46.76

—

February 27 to April 2

268

49.16

—

Total

22,433

46.76

—


(1)		Shares repurchased from certain of our officers pursuant to net share tax settlement transactions upon the vesting of shares of restricted common stock held by such officers.

ITEM 6. Exhibits

	10.1		Volume Purchase Agreement dated March 31, 2006 between Hitachi Global Storage Technologies Singapore Pte., Ltd. And Komag USA (Malaysia) Sdn., and Komag, Incorporated.*

	31.1		Rule 13a — 14 (a) Certification of Chief Executive Officer

	31.2		Rule 13a — 14 (a) Certification of Chief Financial Officer

	32		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer, furnished herewith


*		Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

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: May 3, 2006	BY:	/s/ Thian Hoo Tan


	Thian Hoo Tan
	Chief Executive Officer
	Komag, Incorporated

DATE: May 3, 2006	BY:	/s/ Kathleen A. Bayless


	Kathleen A. Bayless
	Senior Vice President, Chief Financial Officer
	Komag, Incorporated

EXHIBIT INDEX

	10.1		Volume Purchase Agreement dated March 31, 2006 between Hitachi Global Storage Technologies Singapore Pte., Ltd. And Komag USA (Malaysia) Sdn., and Komag, Incorporated.*

	31.1		Rule 13a — 14 (a) Certification of Chief Executive Officer

	31.2		Rule 13a — 14 (a) Certification of Chief Financial Officer

	32		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer, furnished herewith


*		Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.

Positive
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Constraining
Legalese
Litigous
Readability	H.S. freshman Good

WD Media (KOMG) Inactive 10-Q2007 Q1 Quarterly report

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