##### Table of Contents



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 October 3, 2004
Commission File Number 0-16852 KOMAG, INCORPORATED  Incorporated in the State of Delaware
I.R.S. Employer Identification Number 94-2914864
1710 Automation Parkway, San Jose, California 95131
Telephone: (408) 576-2000 Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes
[X] No [   ] Indicate by check mark whether the Registrant is an accelerated
filer (as defined in Exchange Act rule 12b-2). Yes [ X ] No
[   ] Indicate by check mark whether the Registrant has filed all reports
required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under
a plan confirmed by a court. Yes [X] No [   ] On October 3, 2004, 27,916,827 shares of the Registrants common
stock, $0.01 par value, were issued and outstanding.




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INDEX
KOMAG, INCORPORATED  
 Page No.PART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Condensed Consolidated Financial Statements (Unaudited)Condensed Consolidated Statements of Income - three and nine months ended October 3, 2004, and September 28, 2003
    
    
    3Condensed Consolidated Balance Sheets - October 3, 2004 and December 28, 2003
    
    
    4Condensed Consolidated Statements of Cash Flows - nine months ended October 3, 2004 and September 28, 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6-11Item 2.
    
    Management's Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12-32Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    32Item 4.
    
    Controls and Procedures
    
    
    32PART II.
    
    OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    33Item 2.
    
    Changes in Securities
    
    
    33Item 3.
    
    Defaults Upon Senior Securities
    
    
    33Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    33Item 5.
    
    Other Information
    
    
    33Item 6.
    
    Exhibits
    
    
    33SIGNATURES
    
    
    
    
    34EXHIBIT 31.1EXHIBIT 31.2EX-32
  2




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) KOMAG, INCORPORATED 
 CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
 Three Months
    
    Three Months
    
    Nine Months
    
    Nine MonthsEnded
    
    Ended
    
    Ended
    
    EndedOctober 3, 2004
    
    September 28, 2003
    
    October 3, 2004
    
    September 28, 2003Net sales
    
    $
    102,424
    
    

    $
    109,199
    
    
    $
    327,148
    
    
    $
    320,061Cost of sales
    
    
    79,256
    
    
    
    83,840
    
    
    
    245,422
    
    
    
    249,090Gross profit
    
    
    23,168
    
    
    
    25,359
    
    
    
    81,726
    
    
    
    70,971Operating expenses:Research, development, and engineering
    
    
    9,720
    
    
    
    10,778
    
    
    
    30,385
    
    
    
    31,089Selling, general, and administrative
    
    
    3,923
    
    
    
    4,717
    
    
    
    13,185
    
    
    
    13,317Gain on disposal of assets
    
    
    (230
    )
    
    
    (792
    )
    
    
    (630
    )
    
    
    (1,870
    )13,413
    
    
    
    14,703
    
    
    
    42,940
    
    
    
    42,536Operating income
    
    
    9,755
    
    
    
    10,656
    
    
    
    38,786
    
    
    
    28,435Other income (expense):Interest income
    
    
    342
    
    
    
    103
    
    
    
    851
    
    
    
    343Interest expense
    
    
    (437
    )
    
    
    (3,351
    )
    
    
    (2,744
    )
    
    
    (10,095
    )Other, net
    
    
    (75
    )
    
    
    83
    
    
    
    (142
    )
    
    
    307(170
    )
    
    
    (3,165
    )
    
    
    (2,035
    )
    
    
    (9,445
    )Income before income taxes
    
    
    9,585
    
    
    
    7,491
    
    
    
    36,751
    
    
    
    18,990Provision for (benefit from) income taxes
    
    
    321
    
    
    
    (2,452
    )
    
    
    1,146
    
    
    
    (607
    )Net income
    
    $
    9,264
    
    
    $
    9,943
    
    
    $
    35,605
    
    
    $
    19,597Basic net income per share
    
    $
    0.33
    
    
    $
    0.42
    
    
    $
    1.31
    
    
    $
    0.84Diluted net income per share
    
    $
    0.33
    
    
    $
    0.40
    
    
    $
    1.27
    
    
    $
    0.81Number of shares used in basic per share computations
    
    
    27,792
    
    
    
    23,558
    
    
    
    27,200
    
    
    
    23,457Number of shares used in diluted per share computations
    
    
    28,285
    
    
    
    24,860
    
    
    
    28,036
    
    
    
    24,252
 See notes to condensed consolidated financial statements. 3




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KOMAG, INCORPORATED 
 CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 October 3, 2004
    
    December 28, 2003ASSETSCurrent assetsCash and cash equivalents
    
    $
    91,133
    
    
    $
    70,058Accounts receivable (less allowances of $1,159 and $1,064 respectively)
    
    
    62,872
    
    
    
    60,628Inventories
    
    
    36,398
    
    
    
    25,501Prepaid expenses and deposits
    
    
    2,528
    
    
    
    2,756Total current assets
    
    
    192,931
    
    
    
    158,943Property, plant, and equipment, net
    
    
    205,689
    
    
    
    184,536Intangible assets, net
    
    
    2,123
    
    
    
    4,257Other assets
    
    
    3,015
    
    
    
    71$
    403,758
    
    
    $
    347,807LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilitiesCurrent portion of long-term debt
    
    $
    
    
    
    $
    20,247Trade accounts payable
    
    
    35,422
    

    
    
    40,117Accrued expenses and other liabilities
    
    
    16,720
    
    
    
    25,054Total current liabilities
    
    
    52,142
    
    
    
    85,418Long-term debt
    
    
    80,500
    
    
    
    95,801Total liabilities
    
    
    132,642
    
    
    
    181,219Stockholders equityCommon stock, $0.01 par value per share:Authorized - 50,000 sharesIssued and outstanding - 27,917 and 23,753 shares, respectively
    
    
    279
    
    
    
    238Additional paid-in capital
    
    
    241,210
    
    
    
    172,457Deferred stock-based compensation
    
    
    (99
    )
    
    
    (228
    )Retained earnings (accumulated deficit)
    
    
    29,726
    
    
    
    (5,879
    )Total stockholders equity
    
    
    271,116
    
    
    
    166,588$
    403,758
    
    
    $
    347,807
 See notes to condensed consolidated financial statements. 4




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KOMAG, INCORPORATED 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 Nine Months
    
    Nine MonthsEnded
    
    EndedOctober 3, 2004
    
    September 28, 2003Operating ActivitiesNet income
    
    $
    35,605
    
    
    $
    19,597Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation and amortization of property, plant, and equipment
    
    
    27,499
    
    
    
    29,998Amortization and adjustments of intangible assets
    
    
    2,422
    
    
    
    2,809Stock-based compensation
    
    
    555
    
    
    
    1,697Non-cash interest charges
    
    
    398
    
    
    
    5,001Gain on disposal of assets
    
    
    (630
    )
    
    
    (1,870
    )Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (2,244
    )
    
    
    (15,447
    )Inventories
    
    
    (10,897
    )
    
    
    (6,480
    )Prepaid expenses and deposits
    
    
    (492
    )
    
    
    (593
    )Trade accounts payable
    
    
    (4,322
    )
    
    
    1,798Accrued expenses and other liabilities
    
    
    (7,987
    )
    
    
    5,509Net cash provided by operating activities
    
    
    39,907
    
    
    
    42,019Investing ActivitiesAcquisition of property, plant, and equipment
    
    
    (49,312
    )
    
    
    (14,655
    )Proceeds from disposal of property, plant, and equipment
    
    
    1,290
    
    
    
    1,930Other
    
    
    (256
    )
    
    
    (271
    )Net cash used in investing activities
    
    
    (48,278
    )
    
    
    (12,996
    )Financing ActivitiesPayment of debt
    
    
    (116,341
    )
    
    
    (5,312
    )Proceeds from the issuance of long-term debt
    
    
    77,419
    
    
    
    Proceeds from sale of common stock, net of issuance costs
    
    
    68,368
    
    
    
    429Net cash provided by (used in) financing activities
    
    
    29,446
    
    
    
    (4,883
    )Increase in cash and cash equivalents
    
    
    21,075
    
    
    
    24,140Cash and cash equivalents at beginning of period
    
    
    70,058
    
    
    
    23,520Cash and cash equivalents at end of period
    
    $
    91,133
    
    
    $
    47,660
 See notes to condensed consolidated financial statements 5




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##### Table of Contents



KOMAG, INCORPORATED 
 
 Note 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America. In the opinion
of management, all normal recurring adjustments considered necessary for a fair
presentation of the condensed consolidated financial position, operating
results, and cash flows for the periods presented, have been included.
Operating results for the nine months ended October 3, 2004 are not necessarily
indicative of the results that may be expected for the year ending January 2,
2005. Fiscal Year:The Company uses a 52-53 week fiscal year ending on the
Sunday closest to December 31. Because the Companys 2004 fiscal year will
include 53 weeks, its three-month reporting periods ended April 4, 2004, July
4, 2004, and October 3, 2004 included 14 weeks, 13 weeks, and 13 weeks,
respectively. The fourth quarter of 2004 will include 13 weeks. The Companys
three-month reporting periods ended March 30, 2003, June 29, 2003, and
September 28, 2003 each included 13 weeks. Inventories:Inventories are stated at the lower of cost (first-in,
first-out method) or market, and consist of the following (in thousands): October 3, 2004
    
    December 28, 2003Raw materials
    
    $
    16,771
    
    
    $
    13,525Work in process
    
    
    12,770
    
    
    
    6,134Finished goods
    
    
    6,857
    
    
    
    5,842$
    36,398
    
    
    $
    25,501
 Stock-Based Compensation:The Company uses the intrinsic value method to
account for employee stock-based compensation. The intrinsic value method is in
accordance with the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Accordingly, compensation cost is recorded on the date of grant to the extent
that the fair value of the underlying share of common stock exceeds the
exercise price for a stock option or the purchase price for a share of common
stock. In accordance with Financial Accounting Standards Board (FASB) Statement
of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure  an Amendment of SFAS No. 123,
the Company provides pro forma disclosure of the effect on net income and
earnings per share had the fair value method, as prescribed by SFAS No. 123,
been used. 6




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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. The table is in thousands, except per share data. Three Months Ended
    
    Nine Months EndedOctober 3, 2004
    
    September 28, 2003
    
    October 3, 2004
    
    September 28, 2003Net income, as reported
    
    $
    9,264
    
    
    $
    9,943
    
    
    $
    35,605
    
    
    $
    19,597Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects of zero
    
    
    185
    
    
    
    297
    
    
    
    555
    
    
    
    1,697Deduct: Stock-based compensation
expense determined under the fair value
method for all awards, net of
related tax effects of zero
    
    
    (887
    )
    
    
    (1,333
    )
    
    
    (2,799
    )
    
    
    (3,346
    )Pro forma net income
    
    $
    8,562
    
    
    $
    8,907
    
    
    $
    33,361
    
    
    $
    17,948Net income per share:Basic  as reported
    
    $
    0.33
    
    
    $
    0.42
    
    
    $
    1.31
    
    
    $
    0.84Diluted  as reported
    
    $
    0.33
    
    
    $
    0.40
    
    
    $
    1.27
    
    
    $
    0.81Basic  pro forma
    
    $
    0.31
    
    
    $
    0.38
    
    
    $
    1.23
    
    
    $
    0.77Diluted  pro forma
    
    $
    0.30
    
    
    $
    0.36
    
    
    $
    1.19
    
    
    $
    0.74
 For pro forma disclosure purposes, the Company used the Black-Scholes
option pricing model to estimate the fair value of each option and stock
purchase right grant on the date of grant. The following assumptions were used to estimate the fair value of option
grants in the first, second, and third quarters of 2004, and the first and
third quarters of 2003 (there were no grants in the second quarter of 2003):
risk-free interest rates of 2.46%, 3.70%, and 3.09%, respectively, for 2004,
and 2.68% and 2.54%, respectively, for 2003; volatility factors of the expected
market price of the Companys common stock of 82.6%, 82.7%, and 78.28%,
respectively, for 2004, and 87.1% and 85.5%, respectively, for 2003; and a
weighted-average expected option life of 4.0 years for all periods presented.
The weighted-average fair value of options granted was $11.58, $8.34, and
$6.32, respectively, in the first, second, and third quarters of 2004, and
$4.34 and $8.28, respectively, in the first and third quarters of 2003. The following assumptions were used to estimate the fair value of employee
purchase rights under the Amended and Restated 2002 Employee Stock Purchase
Plan (ESPP) for the first, second, and third quarters of 2004 and 2003:
risk-free interest rates of 1.00%, 1.49%, and 1.52%, respectively, for 2004,
and 1.18%, 1.18%, and 0.99%, respectively, for 2003; volatility factors of
73.5%, 70.9%, and 67.4%, respectively, for 2004, and 62.2%, 62.2%, and 51.8%,
respectively, for 2003; and weighted-average expected purchase rights lives of
six months for all periods presented. The weighted-average fair value of those
purchase rights granted was $4.64, $4.71, and $3.62, respectively, in the
first, second, and third quarters of 2004, and $2.07 in the first, second, and
third quarters of 2003. Because the Company does not pay dividends, there was no dividend yield
included in the pro forma disclosure calculation. 7




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Net Income Per Share:The Company determines net income per share in
accordance with SFAS No. 128, Earnings per Share. Basic net income per common share is computed by dividing income available
to common stockholders by the weighted-average number of shares of common stock
outstanding during the period. Diluted net income per share is computed by
dividing income available to common stockholders by the weighted-average number
of shares and dilutive potential shares of common stock outstanding during the
period. The dilutive effect of outstanding options and stock purchase rights is
reflected in diluted net income per share by application of the treasury stock
method. The following table reflects the computation of net income per share. The
table is in thousands, except per share amounts. Three Months Ended
    
    Nine Months EndedOctober 3, 2004
    
    September 28, 2003
    
    October 3, 2004
    
    September 28, 2003Numerator: Net income
    
    $
    9,264
    
    
    $
    9,943
    
    
    $
    35,605
    
    
    $
    19,597Denominator for basic income per share -
weighted average shares
    
    
    27,792
    
    
    
    23,558
    
    
    
    27,200
    
    
    
    23,457Effect of dilutive securities:Stock purchase rights
    
    
    4
    
    
    
    440
    
    
    
    12
    
    
    
    424Stock options
    
    
    288
    
    
    
    490
    
    
    
    468
    
    
    
    287Warrants
    
    
    201
    
    
    
    372
    
    
    
    356
    
    
    
    84Denominator for dilutive income per share
    
    
    28,285
    
    
    
    24,860
    
    
    
    28,036
    
    
    
    24,252Basic net income per share
    
    $
    0.33
    
    
    $
    0.42
    
    
    $
    1.31
    
    
    $
    0.84Diluted net income per share
    
    $
    0.33
    
    
    $
    0.40
    
    
    $
    1.27
    
    
    $
    0.81
 Incremental common shares attributable to outstanding common stock options
(assuming proceeds would be used to purchase treasury stock) of 774,414 and
241,959 for the three-month and nine-month periods ended October 3, 2004,
respectively, and 5,597 and 105,457 for the three-month and nine-month periods
ended September 28, 2003, respectively, were not included in the diluted net
income per share computation because the effect would have been anti-dilutive. The Companys Convertible Subordinated Notes (see Note 6) will be convertible,
under certain circumstances, into approximately 3.0 million shares of the
Companys common stock. These shares have been excluded from the earnings per
share calculation in accordance with SFAS No. 128. In October 2004, the
Emerging Issues Task Force (EITF) reached a consensus on Issue No. 04-08
Accounting Issues Related to Certain Features of Contingently Convertible Debt
and the Effect on Diluted Earnings per Share. This consensus, which is
expected to be effective during the fourth quarter of 2004, will require the
Company to include these additional 3.0 million shares in the calculation of
diluted earnings per share. If EITF 04-08 had gone into effect in the third
quarter of 2004, the Companys reported diluted earnings per share would have
been reduced by approximately $0.02. 8




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##### Table of Contents



Note 2. Major Customers The following table reflects the percentage of the Companys revenue by
major customer: Three Months Ended
    
    Nine Months EndedOctober 3, 2004
    
    September 28, 2003
    
    October 3, 2004
    
    September 28, 2003Maxtor Corporation
    
    
    48
    %
    
    
    36
    %
    
    
    48
    %
    
    
    36
    %Hitachi Global Storage Technologies
    
    
    36
    %
    
    
    25
    %
    
    
    29
    %
    
    
    15
    %Western Digital Corporation
    
    
    8
    %
    
    
    36
    %
    
    
    12
    %
    
    
    41
    %
 Note 3. Income Taxes The Companys wholly-owned thin-film media operation, Komag USA (Malaysia)
Sdn. (KMS), received an eight-year extension of its tax holiday for its first
plant site in Malaysia. The extension provides a tax holiday through June
2011. The extended tax holiday applies to income generated by sales of disk
products using new technologies. KMS has also been granted additional tax
holidays for its second, third, and fourth plant sites in Malaysia. These tax
holidays expire between December 2006 and 2008. A substantial majority of the
Companys income is generated by sales of disk products covered by these tax
holidays. The Companys estimated annual effective income tax rate for 2004 is 3%,
and includes taxes on income generated by sales of product no longer covered
under the tax holiday at the Companys first Malaysian plant site, and other
tax expenses related to the Companys U.S. and international operations. In the third quarter of 2003, the Company received approval from the
Malaysian Ministry of Finance for the exemption of withholding tax on royalty
payments made by its Malaysian operations to its subsidiary in the Netherlands.
The exemption is for a period of five years effective retroactively from
January 2002 through December 2006. Because the withholding taxes on the
royalty and interest payments were no longer payable, the Company reversed its
related accrual in the third quarter of 2003, and recorded an income tax
benefit of $2.5 million associated with the reversal. The third quarter of
2003 income tax provision without the $2.5 million tax benefit was less than
$0.1 million. For the first nine months of 2003, we recorded a net income tax benefit of
$0.6 million, which reflected the $2.5 million tax benefit related to
withholding taxes which are no longer payable, as discussed above, net of $1.9
million of foreign withholding taxes and foreign income taxes. In the first and third quarters of 2004, the Company utilized $1.6 million
and $1.1 million, respectively, of Malaysian capital allowances and net
operating loss carry-forwards ($0.5 million and $0.3 million tax-effected,
respectively). Upon emergence from chapter 11 bankruptcy on June 30, 2002, the
Company provided a full valuation allowance against all tax assets; therefore,
upon utilization of the capital allowance and net operating loss carry-forwards
in the first and third quarters of 2004, the Company made a $0.8 million
reduction to intangible assets. The $0.8 million reduction was allocated to
reduce the Companys volume purchase agreement (VPA) with Western Digital
Corporation (Western Digital) by $0.5 million and developed technology by $0.3
million. 9




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The use of the Companys net operating losses and tax credit
carry-forwards generated by the predecessor company (the Company prior to
emergence from chapter 11 bankruptcy) will be accounted for first as a credit
to intangible assets when they are utilized, and then to additional paid-in
capital after the intangible assets have been reduced to zero. Note 4. Intangible Assets As of October 3, 2004, intangible assets included three items. A VPA of
$7.7 million (less accumulated amortization of $5.1 million and tax-related
adjustments of $1.5 million) is included in intangible assets. The VPA is
being amortized on a straight-line basis and has a remaining useful life of six
months. In addition, developed technology of $3.1 million (less accumulated
amortization of $2.0 million and tax-related adjustments of $0.8 million) is
included in intangible assets. The developed technology is being amortized on a
straight-line basis and has a remaining useful life of fifteen months. Lastly,
patent costs of $0.9 million (less accumulated amortization of $0.2 million)
are included in intangible assets. Amortization and adjustments of intangible assets in the third quarter and
first nine months of 2004 was $0.8 million and $2.4 million, respectively, and
was $0.9 million and $2.8 million, respectively, in the third quarter and
first nine months of 2003. Note 5. Accrued Expenses and Other Liabilities The following table summarizes accrued expenses and other liabilities (in
thousands): October 3, 2004
    
    December 28, 2003Accrued compensation and benefits
    
    $
    13,372
    
    
    $
    20,608Other liabilities
    
    
    3,348
    
    
    
    4,446$
    16,720
    
    
    $
    25,054
 Note 6. Debt and Equity Offerings On January 28, 2004, the Company announced the closing of its offering of
$80.5 million of 2.0% Convertible Subordinated Notes (the Notes). 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 the Companys common stock based on
an initial effective conversion price of $26.40. Holders of the Notes may
convert the Notes into shares of the Companys common stock prior to maturity
if: 1) the sale price of the Companys common stock equals or exceeds $31.68
for at least 20 trading days in any 30 consecutive trading day period within
any fiscal quarter of the Company; 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) specified corporate transactions (as described in
the offering prospectus for the notes) occur. As of October 3, 2004, none of
the preceding conditions had been 10




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met; therefore, the debt was not convertible.
The Company may redeem the Notes on or after February 6, 2007, at specified
declining redemption premiums. Holders of the Notes may require the Company 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. In connection with the issuance of the Notes, the Company
incurred $3.1 million of loan fees. The loan fees, which are included in other
assets on the condensed consolidated balance sheet, are being amortized on a
straight-line basis over the 20-year life of the Notes. On October 3, 2004,
unamortized loan fees were $3.0 million. On January 28, 2004, the Company sold 3,525,000 shares of its common stock
at $20.00 per share. The proceeds from the sale of the common stock, net of
$4.1 million of issuance costs, were $66.4 million. The combined net proceeds from the issuance of the Notes and the common
stock were $143.8 million. In February 2004, the Company used the proceeds from the January 2004 debt
and equity offerings to repay in full $116.3 million of previously outstanding
Senior Secured Notes and certain other promissory notes. The previously
outstanding debt bore a weighted-average interest rate of 9.5%. There was no
gain or loss recognized on the repayment of the debt. Additionally, the
Company terminated an unused credit facility in January 2004. Note 7. Asset Purchase In February 2004, the Company purchased a Malaysian substrate
manufacturing facility for $10.0 million from Trace Storage Technology
Corporation (Trace). The purchase included land, building, and equipment. The
Company is manufacturing aluminum ground substrates and plated and polished
substrates in this factory for its own use. Additionally, the Company is
selling a portion of the output to Trace under a supply agreement entered into
in connection with the purchase. 11




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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. 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. The Companys business is subject to a number of risks and uncertainties.
While this discussion represents our current judgment on the future direction
of our business, these risks and uncertainties could cause actual results to
differ materially from any future performance suggested herein. Some of the
important factors that may influence possible differences are continued
competitive factors, technological developments, pricing pressures, changes in
customer demand, and general economic conditions, as well as those discussed
below in Risk Factors. We undertake no obligation to update forward-looking
statements to reflect events or circumstances occurring after the date of such
statements. Readers should review Risk Factors below, as well as other
documents filed by the Company with the Securities and Exchange Commission from
time to time. Results of Operations Overview 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 do not have to
increase our fixed cost structure in proportion to increases in demand and
resultant capacity utilization. Conversely, our financial results deteriorate
rapidly when the disk market worsens and our production volume decreases. 12




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Because our 2004 fiscal year will include 53 weeks, our three-month and
nine-month reporting periods ended October 3, 2004, included 13 weeks and 40
weeks, respectively. Our three-month and nine-month reporting periods ended
September 28, 2003, included 13 weeks and 39 weeks, respectively. Net Sales In the third quarter of 2004, consolidated net sales of $102.4 million
were 6.2% lower compared to $109.2 million in the third quarter of 2003.
Finished unit sales volume decreased to 16.6 million units in the third quarter
of 2004 from 17.5 million units in the third quarter of 2003. Further, our
finished unit average selling price decreased by 2.3% in the third quarter of
2004 compared to the third quarter of 2003. The decrease reflected the sale of
end-of-life products in the third quarter of 2004 at prices that were lower
than our current generation products. Excluding the sale of end-of-life
products, our average selling price increased 1.0% in the third quarter of 2004
compared to the third quarter of 2003, due to a higher mix of 80 GB products. In the third quarter of 2004, other disk sales (which generally include
single-sided disks, aluminum substrate disks, plated disks, textured disks, and
polished disks) were $11.1 million, a 9.0% decrease compared to $10.1 million
in the third quarter of 2003. In the third quarter of 2004, sales of 80 GB and greater per platter disks
increased to 93% of net sales, compared to 34% in the third quarter of 2003.
The increase reflected the continued customer migration to higher storage
densities. All of our customers completed the transition from 40 GB to 80 GB
programs in the first quarter of 2004. In the third quarter of 2004, sales to Maxtor Corporation (Maxtor),
Hitachi Global Storage Technologies (HGST) and Western Digital accounted for
48%, 36%, and 8%, respectively, of our revenue. In the third quarter of 2003,
sales to Maxtor, HGST, and Western Digital accounted for 36%, 25%, and 36%,
respectively, of our revenue. Finished disk shipments for desktop and consumer applications together
represented 94% of our third quarter of 2004 unit shipment volume compared to
93% in the third quarter of 2003. The remaining finished disk shipments (6% in
the third quarter of 2004 and 7% in the third quarter of 2003) were disks for
high-end server (enterprise) drives. Consolidated net sales in the first nine months of 2004 increased to
$327.2 million, a $7.1 million increase compared to $320.1 million in the first
nine months of 2003. The increase was primarily driven by a 2.5% increase in
our finished unit average selling price in the first nine months of 2004
compared to the first nine months of 2003. The higher average selling price
reflected a higher mix of 80 GB products. Our sales volume increased by 0.8%,
to 50.9 million units in the first nine months of 2004 compared to 50.5 million
units in the first nine months of 2003. Other disk sales in the first nine months of 2004 were $34.1 million,
compared to $36.3 million in the first nine months of 2003 due to a reduction
in textured disk sales partially offset by increasing
aluminum substrates and polished disk sales. 13




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In the fourth quarter of 2004, we expect revenue to increase 10% to 15%,
compared to the third quarter of 2004, due to the normal seasonal strength.
Our sales are concentrated among a few customers. We expect to continue to
derive a substantial portion of our sales from Maxtor, HGST, and Western
Digital. Gross Profit For the third quarter of 2004, our overall gross profit percentage was
22.6%, a 0.6 percentage point decline compared to a gross profit percentage of
23.2% for the third quarter of 2003. A decrease in our finished unit average
selling price (as discussed above), accounted for a 1.8 percentage point
decrease in our gross profit. A sale of previously written down product and
lower overall manufacturing spending (primarily lower incentive compensation)
partially offset the decline in our average selling price. For the first nine months of 2004, we achieved a gross profit percentage
of 25.0% compared to a gross profit percentage of 22.2% for the first nine
months of 2003, a 2.8 point increase. The increase in the finished unit
average selling prices (as discussed above), accounted for an increase of
approximately 1.8 points in the gross profit percentage for the first nine
months of 2004. The remainder of the improvement in the gross profit percentage
was primarily due to lower provisions for incentive compensation and lower
amortization of deferred stock compensation charges in the first nine months of
2004. We expect to maintain our variable cost per unit at levels similar to the
first nine months of 2004 while continuing to advance our technology. Our fixed
cost per unit is dependent on the production levels we achieve. In the fourth
quarter of 2004, we expect higher unit production and shipments, which we
expect will result in lower fixed cost per unit. Research, Development, and Engineering Expenses Research, development, and engineering (R&D) expenses of $9.7 million in
the third quarter of 2004 were $1.1 million lower compared to the $10.8 million
in the third quarter of 2003. The decrease primarily reflected lower incentive
compensation expense in the third quarter of 2004 compared to the third quarter
of 2003. R&D expenses of $30.4 million in the first nine months of 2004 were $0.7
million lower than the $31.1 million in the first nine months of 2003. The
decrease primarily reflected lower incentive compensation expense, partially
offset by a $1.4 million non-recurring payroll-related charge. Selling, General, and Administrative Expenses Selling, general, and administrative (SG&A) expenses of $3.9 million in
the third quarter of 2004
were $0.8 million lower compared to the $4.7 million incurred in the third
quarter of 2003, which is primarily due to a decrease in incentive compensation
charges. 14




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SG&A expenses of $13.2 million in the first nine months of 2004 were
relatively flat compared to the $13.3 million incurred in the first nine months
of 2003. Lower incentive compensation and deferred compensation expense were
offset by higher payroll and consulting fees. Interest Expense Interest expense in the third quarter of 2004 was $0.4 million, and
represented interest on the $80.5 million, 2% Convertible Subordinated Notes,
which were issued on January 28, 2004. Interest expense in the first nine
months of 2004 was $2.7 million, and included $1.6 million of interest on the
Senior Secured Notes and certain promissory notes, and $1.1 million of interest
expense on the new Notes. We recorded $3.4 million of interest expense in the third quarter of 2003
and $10.1 million in the first nine months of 2003. Interest expense in both
periods primarily represented interest on the Senior Secured Notes, the Junior
Secured Notes, and certain promissory notes. The Senior Secured Notes and promissory notes were redeemed in full,
including accrued interest, in February 2004. The Junior Secured Notes were
redeemed in full, including accrued interest, in the fourth quarter of 2003.
There were no gains or losses on the redemptions, and there were no unamortized
debt issuance costs. Income Taxes Our wholly-owned thin-film media operation, Komag USA (Malaysia) Sdn.
(KMS), received an eight-year extension of its tax holiday for its first plant
site in Malaysia. The extension provides a tax holiday through June 2011. The
extended tax holiday applies to income generated by sales of disk products
using new technologies. KMS has also been granted additional tax holidays for
its second, third, and fourth plant sites in Malaysia. These tax holidays
expire between December 2006 and 2008. A substantial majority of our income is
generated by sales of disk products covered by these tax holidays. Our estimated annual effective income tax rate for 2004 is 3% and includes
taxes on income generated by sales of product no longer covered under the tax
holiday at our first Malaysian plant site and other tax expenses related to our
U.S. and international operations. In the third quarter of 2003, we received approval from the Malaysian
Ministry of Finance for the exemption of withholding tax on royalty payments
made by our Malaysian operations to our subsidiary in the Netherlands. The
exemption is for a period of five years effective retroactively from January
2002 through December 2006. As a result, we recorded an income tax benefit of
$2.5 million in the third quarter of 2003 related to withholding taxes we
previously accrued which are no longer payable. The third quarter of 2003
income tax provision without the $2.5 million tax benefit was less than $0.1
million. For the first nine months of 2003, we recorded an income tax benefit of
$0.6 million, which includes the $2.5 million tax benefit described above, net
of $1.9 million of foreign withholding taxes and foreign income taxes. 15




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In the first and third quarters of 2004, we utilized $1.6 million and $1.1
million, respectively, of Malaysian capital allowances and net operating loss
carry-forwards ($0.5 million and $0.3 million tax-effected, respectively). Upon
emergence from chapter 11 bankruptcy on June 30, 2002, we provided a full
valuation allowance against all tax assets; therefore, upon utilization of the
capital allowance and net operating loss carry-forwards in the first and third
quarters of 2004, we made a $0.8 million reduction to intangible assets. The
$0.8 million reduction was allocated to reduce our volume purchase agreement
(VPA) with Western Digital Corporation (Western Digital) by $0.5 million and
developed technology by $0.3 million. The use of the Companys net operating losses and tax credit
carry-forwards generated by the predecessor company (the Company prior to
emergence from chapter 11 bankruptcy) will be accounted for first as a credit
to intangible assets when they are utilized, and then to additional paid-in
capital after the intangible assets have been reduced to zero. Critical Accounting Policies In the ordinary course of business, we have made a number of estimates and
assumptions relating to the reporting of results of operations and financial
condition in the preparation of our consolidated financial statements in
conformity with accounting principles generally accepted in the United States
of America. Actual results could differ significantly from those estimates if
our assumptions are incorrect. We believe that the following discussion
addresses our most critical accounting policies. These policies are most
important to the portrayal of our financial condition and results and require
managements most difficult, subjective and complex judgments, often as a
result of the need to make estimates about the effect of matters that are
inherently uncertain. Allowance for Sales Returns We estimate our allowance for sales returns based on historical data as
well as current knowledge of product quality. 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 historically been, which could result in significant changes in
future returns. Since estimated sales returns are recorded as a reduction in revenues, any
significant difference between our estimated and actual experience or changes
in our estimate would be reflected in our reported revenues in the period we
determine that difference. There were no significant changes from prior quarter estimates during the
first nine months of 2004. Impairment of Long-lived Assets Long-lived assets are evaluated for impairment whenever events or changes
in circumstances indicate that these assets may be impaired or the estimated
useful lives are no longer appropriate. We 16




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consider the primary indicators of impairment to include significant
decreases in unit volumes, unit prices or significant increases in production
costs. We review our long-lived assets for impairment based on estimated future
undiscounted cash flows attributable to the assets. In the event that these
cash flows are not expected to be sufficient to recover the recorded value of
the assets, the assets are written down to their estimated fair values
utilizing discounted estimates of future cash flows. The discount rate used is
based on the estimated incremental borrowing rate at the date of the event that
triggers the impairment. There were no impairments of long-lived assets during the first nine
months of 2004. 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. In the third quarter of 2004, we sold $1.4 million of inventory that had
been written down to zero in the second quarter of 2004. This resulted in a
positive impact of 1.3 percentage points on our gross margin in the third
quarter of 2004. Liquidity and Capital Resources Cash and cash equivalents of $91.1 million at the end of the third quarter
of 2004 increased by $21.1 million from the end of the 2003 fiscal year. The
increase primarily reflected the receipt of $77.4 million and $66.4 million in
net proceeds from our January 2004 debt and equity public offerings,
respectively, and a $39.9 million increase resulting from consolidated
operating activities, offset by $116.3 million in debt repayments, and $49.3
million of spending on property, plant, and equipment. Consolidated operating activities generated $39.9 million in cash in the
first nine months of 2004. The primary components of this change include the
following:  
    
    net income of $35.6 million, plus non-cash charges of $30.2 million;
    
    an accounts receivable increase of $2.2 million primarily related to the timing of sales;
    
    an inventory increase of $10.9 million, due to the timing of
production and sales of product to certain customers;
    
    an accounts payable decrease of $4.3 million, which
primarily reflected a reduction in accounts payable days
outstanding; and
    
    an accrued compensation and benefits decrease of $7.2
million, which primarily reflected payments of the 2003 incentive
compensation plan in early 2004. Our total capital spending in the first nine months of 2004 was $49.3
million, which included capital expenditures for our capacity expansion as well
as the $10.0 million purchase price for the acquisition of the Trace substrate
facility and equipment. Current non-cancelable capital commitments as 17




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of October 3, 2004 totaled $0.4 million. For the remainder of 2004, we
plan to spend approximately $13.0 million on property, plant, and equipment for
projects designed to improve yield and productivity, as well as to improve
equipment capability for the manufacture of advanced products. On January 28, 2004, we completed the offering of 4.0 million shares of
our common stock at $20.00 per share, of which selling security holders sold
0.5 million shares, and $80.5 million of 2.0% Convertible Subordinated Notes
(the Notes). 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 the Companys common
stock based on an initial effective conversion price of $26.40. Holders of the
Notes may convert the Notes into shares of the Companys common stock prior to
maturity if: 1) the sale price of the Companys common stock equals or exceeds
$31.68 for at least 20 trading days in any 30 consecutive trading day period
within any fiscal quarter of the Company; 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) specified corporate transactions (as
described in the offering prospectus for the notes) occur. The Company may
redeem the Notes on or after February 6, 2007, at specified declining
redemption premiums. Holders of the Notes may require the Company 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. On February 26, 2004, we used $116.3 million of the $143.8 million in net
proceeds from the offerings to redeem in full the Senior Secured Notes and
certain promissory notes, including accrued interest. We lease our research and administrative facility in San Jose, California
under an operating lease. We also lease, and have sublet, another building in
San Jose. Both of these leases expire in 2007, and have renewal options for
five years. Additionally, we lease certain equipment under operating leases.
These leases expire on various dates through 2008. We have no capital leases. 18




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At October 3, 2004, our long-term debt obligations, operating lease
obligations, and unconditional purchase obligations, were as follows (in
thousands): Remainderof2004
    
    2005
    
    2006
    
    2007
    
    2008
    
    Thereafter
    
    TotalLong-Term Debt Obligations
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    80,500
    
    
    $
    80,500Operating Lease Obligations (1)
    
    
    886
    
    
    
    3,740
    
    
    
    3,344
    
    
    
    415
    
    
    
    5
    
    
    
    
    
    
    
    8,390Unconditional Purchase
Obligations (2)
    
    
    741
    
    
    
    1,504
    
    
    
    137
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,382Total Contractual Cash Obligations
    
    $
    1,627
    
    
    $
    5,244
    
    
    $
    3,481
    
    
    $
    415
    
    
    $
    5
    
    
    $
    80,500
    
    
    $
    91,272
  (1)
    
    These represent gross operating lease obligations, and are
not reduced by sublease income.(2)
    
    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; however, it is
possible we may negotiate lower payments if we choose to exit these
contracts earlier. Based on current operating forecasts, we estimate that the cash balance
and cash from operations will be adequate to support our continuing operations,
capital spending plan, and interest payments for at least the next twelve
months. Other In January 2004, we issued $80.5 million of 2.0% subordinated notes
convertible into common stock. In October 2004, the Emerging Issues Task Force
(EITF) reached a consensus on Issue No. 04-08 Accounting Issues Related to
Certain Features of Contingently Convertible Debt and the Effect on Diluted
Earnings per Share. This consensus, which is expected to be effective during
the fourth quarter of 2004, will require us to include an additional 3.0
million shares of our common stock in the calculation of diluted earnings per
share. If EITF 04-08 had gone into effect in the third quarter of 2004, our
reported diluted earnings per share would have been reduced by approximately
$0.02. 19




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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, and the value of our stock could decline. You should also
refer to the other information set forth in this report and incorporated herein
by reference, including our condensed consolidated financial statements and
the related notes. Further, thisForm 10-Qcontains forward-looking
statements. Actual results may differ significantly from the results
contemplated by our forward-looking statements. Risks Related to Our Business We had a history of operating losses and emerged from chapter 11 bankruptcy in
2002. Despite operating profitability during each of our seven most recent
fiscal quarters, we cannot assure you that we will be able to maintain or
improve our profitability in the future. In 2001, after defaulting on our debt obligations, we filed a voluntary
petition for relief under chapter 11 of the United States Bankruptcy Code. We
emerged from chapter 11 bankruptcy in June 2002. Although we have been
profitable in our most recent seven quarters, we have a history of losses. Due
to the factors discussed below in this Risk Factors section, including the very
competitive, capital intensive and historically cyclical nature of the disk and
disk drive markets on which our business is dependent, we cannot assure you
that we will be able to sustain or improve our profitability in the future. 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, particularly the desktop personal
computer market. We believe that a substantial majority of our finished unit
sales are incorporated into disk drives manufactured by our customers for the
desktop personal computer market. Because of this concentration in a single
market, which we expect to continue, our business is tightly linked to the
success of the personal computer market. The personal computer 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. The effect of these cycles on
suppliers, including disk manufacturers, 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. Accordingly, downturns in the desktop personal computer 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. 20




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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 margin are significantly affected by the number of units we produce and
the amount of our production capacity that we utilize. In the third quarter of
2004, we completed the installation of additional equipment, which increased
our production capacity to approximately 24 million disks a quarter. We are
currently operating below this capacity level. If we are unable to utilize our
expanded capacity, we may be unable to increase or sustain our gross margins.
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. Underutilization of our production capacity
could also result in equipment write-offs, restructuring charges and employee
layoffs. For example, from our 1997 fiscal year to the third quarter of our
2002 fiscal year, our gross margin was severely adversely affected by the
underutilization of our capacity. If our production capacity is underutilized
for any reason, our financial results and our business would be severely
harmed. We receive a large percentage of our net sales from only a few disk drive
manufacturing customers, the loss of any of which would adversely affect our
sales. Our customers are disk drive manufacturers. A relatively small number of
disk drive manufacturers dominates the disk drive market. In the first nine
months of 2004, four of these manufacturers (HGST, Maxtor, Western Digital,
and Seagate) accounted for approximately three-fourths of worldwide hard disk
drive sales. Accordingly, we expect that the success of our business will
continue to depend on a limited number of customers who have comparatively
strong bargaining power in negotiating contracts with us. In the first nine months of 2004, 48% of our net sales were to Maxtor, 29%
were to HGST, and 12% were to Western Digital. In fiscal year 2003, 37% of our
net sales were to Maxtor, 17% were to HGST, and 38% were to Western Digital.
If any one of our significant customers reduces its disk requirements or
develops or expands capacity to produce its own disks, and we are unable to
replace these orders with sales to new customers, our sales would be reduced
and our business would suffer. Price competition may force us to lower our prices, causing our gross margin to
suffer. We face significant price competition in the disk industry. High levels of
competition have historically put downward pressure on prices per unit.
Additionally, the average selling price of disks and disk drives rapidly
declines over their commercial life as a result of technological enhancements,
productivity improvements and industry supply increases. We may be forced to
lower our prices or add new products and features at lower prices to remain
competitive, and we may otherwise be unable to introduce new products at higher
prices. We cannot assure you that we will be able to compete successfully in
this kind of price competitive environment. Lower prices would reduce our
ability to generate sales, and our gross margin would suffer. If we fail to
mitigate the effect of these pressures through increased sales volume or 21




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changing our product mix, our net sales and gross margin could be adversely
affected. 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. Pricing pressure on component suppliers was also compounded by high
consumer demand for inexpensive personal computers and consumer devices.
Supply and demand conditions have improved since 2002, resulting in a more
stable pricing environment. Supply and demand factors and industry-wide
competition could continue to adjust and force disk prices down, which, in
turn, would put pressure on our gross margin. 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. 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. If future demand for our products exceeds the production capability of our
existing facilities, we may be required to invest significant capital
expenditures to increase capacity or else risk losing market share. We believe that we have limited capability to expand further our
production capacity using our existing facilities to meet incremental increases
in future demand for our disk products. If demand for our products were to
exceed significantly these capacity levels, we may not be able to satisfy this
increased demand. To increase our production capacity to meet significant
increases in demand for our disks, we would be required to expand our existing
facilities, construct new facilities, or acquire entities with additional
production capacities. These alternatives would require significant capital
investments by us and would require us to seek additional equity or debt
financing. There can be no assurance that such financing would be available to
us when needed on acceptable terms, or at all. If we were unable to expand
capacity on a timely basis to meet increases in demand, we could lose market
opportunities for sales, and our market share could decline. Further, we cannot
assure you that the increased demand for our disk products would continue for a
sufficient period of time to recoup our capital investments associated with
increasing our production capacity. 22




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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 mainly 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 (Trace
Storage became part of Showa Denko in mid-2004). The captive disk manufacturers
who produce thin-film media internally for their own use include HGST, Maxtor,
and Seagate. In late 2002, IBM entered into a joint venture with Hitachi. The
joint venture, named Hitachi Global Storage Technologies (HGST), includes
Hitachis and IBMs disk drive operations and a portion of IBMs thin-film
media operations, and evidences the increasing concentration and economies of
scale in our industry. Many of these competitors have greater financial
resources than we have, which could allow them to adjust to fluctuating market
conditions better than us. Further, they may have greater technical and
manufacturing resources, more extensive name recognition, more marketing power,
a broader array of product lines and preferred vendor status. To the extent our
competitors continue to consolidate and achieve greater economies of scale, we
will face additional competitive challenges. 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. Because our products require a lengthy sales cycle with no assurance of high
volume sales, we may expend significant financial and other resources without a
return. With short product life cycles and the rapid technological change
experienced in the disk drive industry, 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. 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. 23




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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 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 blanks, a fundamental component in producing our
disks. We also rely on OMG Fidelity, Inc. and Heraeus Incorporated for supplies
of nickel plating solutions and sputtering target materials, respectively. The
supplier base has been weakened by the poor financial condition of the industry
in recent years, and some suppliers have exited the business. Our production
capacity would be limited if one or more of these materials were to become
unavailable or available in reduced quantities, or if we were unable to find
alternative suppliers. For example, due to the significant growth in demand for
our disk products in the fourth quarter of 2002, our sales were lower during
the quarter than the available market opportunity due to our inability to
acquire additional aluminum substrates. If our sources of materials and
supplies were limited or unavailable for a significant period of time, our
production, operating results, and ability to grow our business could be
adversely affected. Disk drive program life cycles are short, and disk drive programs are highly
customized. If we fail to respond to our customers demanding requirements, we
will not be able to compete effectively. 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. In general, the life
cycles of disk drive programs are short. For example, between approximately
1999 and 2002, areal density rose dramatically on an annual basis.
Additionally, disks must be more customized to each disk drive program. Short
program life cycles and customization have increased the risk of product
obsolescence, and as a result, supply chain management, including just-in-time
delivery, has become a standard industry practice. In order to sustain customer
relationships and 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. 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. Advances in disk drive technology require continually
lower flying heights and higher areal density. Until recently, areal density
was roughly doubling from year-to-year and even today continues to increase
rapidly, requiring significant improvement in every aspect of disk design.
These advances require substantial on-going process and 24




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technology development. New process technologies, including synthetic anti-ferromagnetic, or SAF and
perpendicular recording media, or PMR, must support cost-effective, high-volume
production of disks that meet these ever-advancing customer requirements for
enhanced magnetic recording performance. We may not be able to develop and
implement these technologies in a timely manner in order to compete effectively
against our competitors products or entirely new data storage technologies. In
addition, we must transfer our technology from our U.S.-based research and
development center to our Malaysian manufacturing operations. If we cannot
advance our process technologies or do not successfully implement those
advanced technologies in our Malaysian operations, or if technologies that we
have chosen not to develop prove to be viable competitive alternatives, we
would not be able to compete effectively. As a result, we would lose 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- 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 primarily manufactured from aluminum substrates,
which are the primary substrate used in desktop PC and enterprise applications.
Some disk manufacturers emphasize the use of glass as a basis for the
manufacture of their disks to primarily serve the mobile personal computer
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. All of our manufacturing operations have been consolidated in Malaysia and our
foreign operations and international sales subject us to additional risks
inherent in doing business on an international level that make it more costly
or difficult to conduct our business. 25




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As a result of our consolidation of manufacturing operations in Malaysia,
technology developed at our U.S.-based research and development center must now
be first implemented for high-volume production at our Malaysian facilities
without the benefit of being implemented at a U.S. factory. Therefore, we rely
heavily on electronic communications between our U.S. 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 U.S.
operations, the manufacture and shipment of our products would be delayed, and
our results of operations would suffer. Furthermore, our ability to transfer funds from our Malaysian operations
to the United States is subject to Malaysian rules and regulations. In 1999,
the Malaysian government repealed a regulation that restricted the amount of
dividends that a Malaysian company may pay to its stockholders. Had it not been
repealed, this regulation would have potentially limited our ability to
transfer funds to the United States from our Malaysian operations. Because a
significant percentage of our revenues is generated from our Malaysian
operations, we would be unable to finance our U.S.-based research and
development and/or repay our U.S. debt obligations if similar regulations are
enacted in the future. Additionally, there are a number of risks associated with conducting
business outside of the United States. Our sales to Asian customers, including
the foreign subsidiaries of domestic disk drive companies, account for
substantially all of our net sales. While our Asian customers assemble a
substantial portion of their disk drives in Asia, they subsequently sell these
products throughout the world. Therefore, our high concentration of Asian sales
does not accurately reflect the eventual point of consumption of the assembled
disk drives. We anticipate that international sales will continue to represent
the majority of our net sales, and as a result the success of our business is
subject to factors affecting global markets generally. We are subject to these risks to a greater extent than most companies
because, in addition to selling our products outside the United States, our
Malaysian operations account for substantially all of our net sales.
Accordingly, our operating results are subject to the risks inherent with
international operations, including, but not limited to:  
    
    compliance with changing legal and regulatory requirements of foreign jurisdictions;
    
    fluctuations in tariffs or other trade barriers;
    
    foreign currency exchange rate fluctuations, since certain
costs of our foreign manufacturing and marketing operations are
incurred in foreign currency, including purchase of certain
operating supplies and production equipment from Japanese suppliers
in Yen-denominated transactions;
    
    difficulties in staffing and managing foreign operations;
    
    political, social and economic instability;
    
    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. 26




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If we are not able to attract and retain key personnel, our operations could be
harmed. Our future success depends on the continued service of our executive
officers, our highly-skilled research, development, and engineering team, our
manufacturing team, and our key administrative, sales and marketing, and
support personnel. Acquiring talented personnel who possess the advanced skills
we require has been difficult. Our bankruptcy filing and our financial
performance in prior years increased the difficulty of attracting and retaining
skilled engineers and other knowledgeable workers. Even though we have emerged
from bankruptcy, we may have difficulty attracting and retaining key personnel.
We may not be able to attract, assimilate, or retain highly-qualified personnel
to maintain the capabilities that are necessary to compete effectively.
Further, we do not have key person life insurance on any of our key personnel.
If we are unable to retain existing or hire key personnel, our business,
financial condition, and operating results could be harmed. If we do not protect our patents and other intellectual property rights, our
revenues could suffer. It is commonplace to protect technology through patents and other forms of
intellectual property rights in technically sophisticated fields. In the disk
and disk drive industries, companies and individuals have initiated actions
against others in the industry to enforce intellectual property rights.
Although we attempt to protect our intellectual property rights through
patents, copyrights, trade secrets, and other measures, we may not be able to
protect adequately our technology. In addition, we may not be able to discover
significant infringements of our technology or successfully enforce our rights
to our technology if we discover infringing uses by others, and such
infringements could have a negative impact on our ability to compete
effectively. Competitors may be able to develop similar technology and also may
have or may develop intellectual property rights and enforce those rights to
prevent us from using such technologies, or demand royalty payments from us in
return for using such technologies. Either of these events may affect our
production, which could materially reduce our revenues and harm our operating
results. We may face intellectual property infringement claims that are costly to
resolve, may divert our managements attention, and may negatively impact our
operations. We have occasionally received, and may receive in the future,
communications from third parties that assert violation of intellectual
property rights alleged to cover certain of our products or manufacturing
processes or equipment. We evaluate on a case-by-case basis whether it would be
necessary to defend against such claims or to seek licenses to the rights
referred to in such communications. 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. 27




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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;
    
    availability of disks versus demand for disks;
    
    the cyclical nature of the disk drive industry;
    
    our ability to develop and implement new manufacturing process technologies;
    
    increases in our production and engineering costs associated
with initial design and production of new product programs;
    
    the ability of our process equipment to meet more stringent
future product requirements;
    
    our ability to introduce new products that achieve
cost-effective high-volume production in a timely manner, timing of
product announcements, and market acceptance of new products;
    
    the availability of our production capacity, and the extent
to which we can use that capacity;
    
    changes in our manufacturing efficiencies, in particular
product yields and input costs for direct materials, operating
supplies and other running costs;
    
    prolonged disruptions of operations at any of our facilities for any reason;
    
    changes in the cost of or limitations on availability of labor;
    
    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. 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 and from time to time in the future may acquire
businesses, products, equipment, or technologies that we believe 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; 28




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
    
    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. For example, in 2000, we acquired HMT Technology Corporation (HMT),
another disk manufacturer. As a result of the acquisition of HMT, we acquired
debt liabilities, real property and manufacturing facilities, and incurred
significant transaction costs related to the acquisition that raised our
ongoing operational expenses and fixed costs. We were unable to utilize our
increased capacity and generate sufficient revenues to cover the increased
costs, and have since sold a majority of all unused facilities. 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. 29




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We are required to obtain necessary permits for expanding our facilities.
We must also comply with new regulations on our existing operations, which may
result in significant costs. Public attention has increasingly been focused on
the environmental impact of manufacturing operations that use hazardous
materials. If we fail to comply with environmental regulations or fail to
obtain the necessary permits:  
    
    we could be subject to significant penalties;
    
    our ability to expand or operate in California or Malaysia could be restricted;
    
    our ability to establish additional operations in other locations could be restricted; or
    
    we could be required to obtain costly equipment or incur
significant expenses to comply with environmental regulations. Furthermore, our manufacturing processes rely on the use of hazardous
materials, and any accidental hazardous discharge could result in significant
liability and clean-up expenses, which could harm our business, financial
condition, and results of operations. Earthquakes or other natural or man-made disasters could disrupt our
operations. Our U.S. facilities are located in San Jose, California. In addition, Kobe
and other Japanese suppliers of our key manufacturing supplies and sputtering
machines are located in areas with seismic activity. Our Malaysian operations
have been subject to temporary production interruptions due to localized
flooding, disruptions in the delivery of electrical power, and, on one occasion
in 1997, by smoke generated by large, widespread fires in Indonesia. If any
natural or man-made disasters do occur, operations could be disrupted for
prolonged periods, and our business would suffer. Anti-takeover provisions in our certificate of incorporation could discourage
potential acquisition proposals or delay or prevent a change of control. We have protective provisions in place designed to provide our board of
directors with time to consider whether a hostile takeover is in our best
interests and that of our stockholders. Our certificate of incorporation
provides that we have three classes of directors. As a result, a person could
not take control of the board until the third annual meeting after the closing
of the 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. While we believe that we currently have adequate internal control over
financial reporting, we are required to evaluate the effectiveness of our
internal control over financial reporting under Section 404 of the
Sarbanes-Oxley Act of 2002 and any failure to comply with this requirement may
adversely affect our operating results. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, beginning with
our Annual Report on Form 10-K for fiscal year ending January 2, 2005, we will
be required to provide a report by our 30




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management on internal control over
financing reporting. Such report must contain, among other matters,
managements assessment of the effectiveness of our internal control over
financial reporting as of the end of our fiscal year, including a statement as
to whether or not our internal control over financial reporting is effective.
Such report must also contain a statement that our auditors have issued an
attestation report on managements assessment of our internal control over
financial reporting. We are performing the system and process documentation
and evaluation needed to comply with the requirements of Section 404. While we
anticipate being able to fully comply with the requirements of Section 404 in a
timely fashion, we cannot be certain as to the timing of completion of our
evaluation, testing and remediation actions or the impact of the same on our
operations since there is no precedent available by which to measure compliance
adequacy. If we are not able to implement the requirements of Section 404 in a
timely manner or with adequate compliance, we might be subject to sanctions or
investigation by regulatory authorities, such as the Securities and Exchange
Commission or The Nasdaq National Market. Any such action could adversely
affect our operating results and the market price of our common stock. Risks Related to our Indebtedness We are leveraged, and our debt service requirements will continue to make us
vulnerable to economic downturns. In the first quarter of 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. We used a
significant portion of the proceeds of the offerings to redeem all of our
outstanding Senior Notes. Even though we redeemed all of the outstanding Senior
Notes using the proceeds of the common stock offering and the debt offering, we
now have debt service obligations under the Convertible Subordinated Notes. As
a result, we may be required to use a substantial portion of our cash flow from
operations to meet our obligations on our Convertible Subordinated Notes,
thereby reducing the availability of cash flow to fund our business. Debt
service obligations arising from the offering of our Convertible Subordinated
Notes could limit our flexibility in planning for or reacting to changes in our
industry, and could limit our ability to borrow more money for operations and
implement our business strategy in the future. In addition, our leverage may
restrict our ability to obtain additional financing in the future. We will
continue to be more leveraged than some of our competitors, which may place us
at a competitive disadvantage because our interest and debt repayment
requirements makes us more susceptible to downturns in our business. 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 31




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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 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, which are accounted for as cash equivalents. We are exposed to foreign currency exchange rate risk. We currently do not
use derivative financial instruments to hedge such risk. A majority of our revenue, expense, and capital purchasing activities are
transacted in U.S. dollars. However, a large portion of our payroll, certain
manufacturing and operating expenses, and inventory and capital purchases are
transacted in other currencies, primarily Malaysian ringgit. Since late 1998,
the ringgit has been pegged at a conversion rate of 3.8 Malaysian ringgit to
the U.S. dollar. If the pegging is lifted in the future, we will evaluate
whether or not we will enter any hedging contracts for the Malaysian ringgit.
Payroll, manufacturing, and operating expenses, and inventory and capital
purchases recorded in Malaysian ringgit in the first nine months of 2004
totaled approximately $94.7 million. 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 Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934) as of the end of the period covered by this
quarterly report on Form 10-Q. Base on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that these disclosure controls
and procedures are effective. 32




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There were no changes in our internal control over financial reporting (as
defined in Rule 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934)
during our last fiscal quarter ended October 3, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting. 
 PART II. OTHER INFORMATION 
 ITEM 1. Legal Proceedings Not applicable. 
 ITEM 2. Changes in Securities Not applicable. 
 ITEM 3. Defaults Upon Senior Securities Not applicable. 
 ITEM 4. Submission of Matters to a Vote of Security Holders Not applicable. 
 ITEM 5. Other Information Not applicable. 
 ITEM 6. Exhibits  31.1
    
    Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200232
    
    Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 33




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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: November 5, 2004
    
    BY:
    
    /s/ Thian Hoo TanThian Hoo TanChief Executive OfficerDATE: November 5, 2004
    
    BY:
    
    /s/ Kathleen A. BaylessKathleen A. BaylessVice President, Chief Financial Officer
 34




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Exhibit Index  31.1
    
    Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 200232
    
    Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 35