##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|           |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|           |  | For the fiscal year ended January 1,
    2006                                               
|           |  | or                                                                                          
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|           |  | For the transition period
    from           to                                             

Commission file number 0-16852

Komag, Incorporated


(Exact name of registrant as specified in its
charter)


|                                                                    |  |                                         
|------------------------------------------------------------------- |  | ----------------------------------------
|                                                                   
|                                                                   
|                                                                   
|                                                                   
|Delaware                                                            |  | 94-2914864                              
|(State or other jurisdiction of
     incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

1710 Automation Parkway, San Jose, California 95131

(Address of Principal Executive Offices,
including Zip Code)


Registrants telephone number, including area code:

(408) 576-2000


Securities registered pursuant to Section 12(b) of the
Act:

|                    |  |                                          
|------------------- |  | -----------------------------------------
|Title of Each Class |  | Name of Each Exchange on Which Registered
|                    |  |                                          
|None                |  | None                                     

Securities registered pursuant to Section 12(g) of the
Act:

Common Stock, $0.01 par value


Indicate by check mark if the Registrant is a
well-known seasoned issuer, as defined in Rule 405 of the
Securities
Act.    Yes o         No þ

Indicate by check mark if the Registrant is not
required to file reports pursuant to Section 13 or
Section 15(d) of the
Act.    Yes o         No þ

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 þ         No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of the registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment of this
Form 10-K.    o

Indicate by check mark whether the Registrant is
a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer
and large accelerated filer in Rule 12b-2 of the
Exchange Act. (Check one):

Large accelerated
filer þ         Accelerated
filer o         Non-accelerated
filer o


Indicate by check mark whether the Registrant is
a shell company (as defined in Exchange Act rule 12b-2 of the
Act).    Yes þ         No o

On July 3, 2005, which was the last business
day of the Registrants most recently completed second
quarter, the aggregate market value of voting stock held by
non-affiliates of the Registrant was approximately $839,974,346
based on the closing sale price of $28.29 for shares of the
Registrants common stock as reported by the Nasdaq
National Market. Shares of Common Stock held by each executive
officer and director of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a
conclusive determination for other purposes.

On February 22, 2006, 30,165,875 shares
of the Registrants Common Stock, $0.01 par value,
were outstanding.

APPLICABLE ONLY TO REGISTRANTS INVOLVED IN
BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE
YEARS:

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

Documents Incorporated by Reference

Designated portions of the following document are
incorporated by reference into this Report on Form 10-K
where indicated: Komag, Incorporated Proxy Statement for the
Annual Meeting of Stockholders to be held on May 24, 2006,
Part III.



---






---



##### 










KOMAG, INCORPORATED

TABLE OF CONTENTS TO ANNUAL REPORT ON FORM 10-K

|                |  |                                                                                                                       |  |      |    |  |  | 
|--------------- |  | --------------------------------------------------------------------------------------------------------------------- |  | ---- | -- |  |  | 
|                |  |                                                                                                                       |  | Page
|                |  |                                                                                                                       |  |     
|               
|               
|               
|               
|Item 1.         |  | Business                                                                                                              |  |      | 3  | 
|               
|               
|               
|               
|Item 1A.        |  | Risk Factors                                                                                                          |  |      | 11 | 
|               
|               
|               
|               
|Item 1B.        |  | Unresolved Staff Comments                                                                                             |  |      | 23 | 
|               
|               
|               
|               
|Item 2.         |  | Properties                                                                                                            |  |      | 23 | 
|               
|               
|               
|               
|Item 3.         |  | Legal Proceedings                                                                                                     |  |      | 23 | 
|               
|               
|               
|               
|Item 4.         |  | Submission of Matters to a
    Vote of Security Holders                                                               |  |      | 23 | 
|               
|               
|               
|               
|Item 5.         |  | Market for Registrants
    Common Equity, Related Stockholder Matters, and Issuer Purchases
    of Equity Securities |  |      | 25 | 
|               
|               
|               
|               
|Item 6.         |  | Selected Consolidated
    Financial Data                                                                              |  |      | 26 | 
|               
|               
|               
|               
|Item 7.         |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                             |  |      | 27 | 
|               
|               
|               
|               
|Item 7A.        |  | Quantitative and Qualitative
    Disclosures about Market Risk                                                        |  |      | 35 | 
|               
|               
|               
|               
|Item 8.         |  | Consolidated Financial
    Statements and Supplementary Data                                                          |  |      | 37 | 
|               
|               
|               
|               
|Item 9.         |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                              |  |      | 61 | 
|               
|               
|               
|               
|Item 9A.        |  | Controls and Procedures                                                                                               |  |      | 61 | 
|               
|               
|               
|               
|Item 9B.        |  | Other Information                                                                                                     |  |      | 62 | 
|               
|               
|               
|               
|Item 10.        |  | Directors and Executive
    Officers                                                                                  |  |      | 62 | 
|               
|               
|               
|               
|Item 11.        |  | Executive Compensation                                                                                                |  |      | 62 | 
|               
|               
|               
|               
|Item 12.        |  | Security Ownership of
    Certain Beneficial Owners and Management, and Related
    Stockholder Matters               |  |      | 62 | 
|               
|               
|               
|               
|Item 13.        |  | Certain Relationships and
    Related Transactions                                                                    |  |      | 62 | 
|               
|               
|               
|               
|Item 14.        |  | Principal Accountant Fees
    and Services                                                                            |  |      | 62 | 
|               
|               
|               
|               
|Item 15.        |  | Exhibits and Financial
    Statement Schedules                                                                        |  |      | 62 | 
|EXHIBIT 10.4.1 
|EXHIBIT 10.7   
|EXHIBIT 10.7.1 
|EXHIBIT 10.10.1
|EXHIBIT 10.13  
|EXHIBIT 21     
|EXHIBIT 23.1   
|EXHIBIT 31.1   
|EXHIBIT 31.2   
|EXHIBIT 32.1   



2



---



##### Table of Contents



PART I

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking
statements within the meaning of the U.S. federal
securities laws that involve risks and uncertainties. Certain
statements contained in this report are not purely historical,
including, without limitation, statements regarding our
expectations, beliefs, intentions, anticipations, commitments,
or strategies regarding the future that are forward-looking.
These statements include those discussed in Item 7,
Managements Discussion and Analysis of Financial Condition
and Results of Operations, including Results of
Operations, Critical Accounting Policies, and
Liquidity and Capital Resources, and elsewhere in
this report. These statements include statements concerning
product development, product acceptance, product demand,
shipping volumes, projected revenues, international revenues,
pricing pressures, sales returns, gross profit, expenses,
reserves, taxes, net income, capital spending, and liquidity
requirements.

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






|        |         
|------- | --------
|Item 1. | Business

General

We design, manufacture, and market thin-film media (disks),
which are incorporated into disk drives. As a result of our
market leadership and significant research and development
efforts, we believe that we have developed a thorough
understanding of the market needs in the disk drive market, and
offer a broad portfolio of advanced solutions to address those
needs. Our customers include Hitachi Global Storage Technologies
(HGST), Maxtor Corporation (Maxtor), Seagate Technology
(Seagate), and Western Digital Corporation (Western Digital),
which are the worlds four largest disk drive
manufacturers. In December 2005, two of our major customers,
Seagate and Maxtor, announced that they entered into a
definitive agreement under which Seagate will acquire Maxtor.
The transaction is expected to be completed in the second half
of 2006, subject to obtaining shareholder approvals and
customary regulatory approvals. Until the closing, Seagate and
Maxtor will continue to operate as separate businesses. Upon
closing of the proposed merger, we anticipate that the combined
Seagate-Maxtor company will be the largest disk drive
manufacturer in the industry.

Disks, such as the ones we manufacture, are the primary storage
medium for digital data. Technology advances have greatly
increased the storage capacity of individual disks, lowering the
per gigabyte (GB) cost of storage. The lower cost of
storage has facilitated the adoption of disk drives into a broad
range of new applications, providing new areas of market growth
for disks and disk drives. High-volume, high-growth applications
for disk drives include personal computers (PC), high-end server
(enterprise) storage systems, communications
infrastructure, and consumer electronics appliances, which is
currently the fastest growing market segment. The increase in
storage capacity used in existing and new applications is
expected to generate increased demand for disk drives and higher
demand for disks such as those we sell.

Komag was incorporated in Delaware in October 1986. Our
principal executive offices are located at 1710 Automation
Parkway, San Jose, California 95131, and our telephone
number at that location is (408) 576-2000. Our Internet
address is www.komag.com. Our annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on
Form 8-K, amendments to those reports and other SEC filings
are available free of charge through our website as soon as
reasonably practicable after such reports are electronically
filed

3



---



##### Table of Contents





Industry Background

Increasing demand for digital data storage and low-cost,
high-performance disk drives has resulted in increasing demand
for disks. TrendFocus estimates that disk drive shipments from
2005 to 2010 are expected to grow at a compounded annual growth
rate of approximately 14%. We believe there are a number of key
factors driving this demand. These factors include:



| |   |                                                                                                                                                                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased demand for PCs with high storage capacities driven by
    consumer multi-media, broadband, and wireless applications,
    increased business usage, and an increased number of computers
    in developing economies;                                                           
|
| |  | increased demand for enterprise storage driven by a broader
    deployment of applications, which require significant storage
    capacity, such as enterprise software, data warehousing, data
    recovery, and data security operations; and                                           
|
| |  | increased demand for new consumer electronic applications, which
    require significant digital data storage capability, including
    digital video and audio recorders, video game platforms,
    emerging high-definition television applications, and global
    positioning systems.

Disk drives are the primary devices used for storing, managing,
and protecting the digital data associated with most of these
applications. According to Trendfocus, HGST, Maxtor, Seagate,
and Western Digital accounted for approximately 75% of total
disk drive units shipped worldwide in 2005.

Due to the significant challenges raised by the need to
continually innovate and improve manufacturing and operational
efficiencies, the disk drive industry has undergone significant
consolidation. We believe that consolidation, like the proposed
Seagate-Maxtor merger, could continue in our industry as the
technological challenges and associated levels of required
investment grow, increasing the competitive necessity of
large-scale operations.

Disk Market

Disks are enabling components in disk drives. The technical
advances by disk suppliers, along with those of other component
suppliers, have improved the performance and storage capacity of
disk drives, and dramatically lowered the cost per GB stored.
Disk suppliers help drive technology innovation in disk drives
by increasing storage capacities per square inch of disk
surface, referred to as areal density, and improving
reliability. For example, todays areal densities allow for
up to approximately 160 GB of storage per 3 1/2-inch disk. We
expect that current technologies, including synthetic
anti-ferromagnetically coupled layers (SAF), will soon lead to
increases in areal densities of up to approximately 200 GB of
storage per 3 1/2-inch disk. We believe that perpendicular
magnetic recording (PMR), will further increase areal density.
Advanced products with over 200 GB per platter storage capacity,
utilizing PMR technology, are in the development stage for
delivery over the next two years. Initial shipments of PMR media
began in the industry in certain smaller form factor disks in
2005.

There are significant barriers to entry to the disk market. To
succeed, we believe disk suppliers must have strong
relationships with the leading disk drive manufacturers, the
engineering expertise to enable technology leadership, and the
economies of scale to achieve efficient low-cost operations and
meet customer timing and volume requirements.

We believe that after several years of relatively stable supply
and demand conditions for disks, the supply of disks became very
tight in 2005. We believe that the tightness in supply is a
result of growing end-market

4



---



##### Table of Contents





Competitive Strengths

We are a leading independent supplier of disks and the only
independent disk supplier headquartered in the United States
(U.S.). We believe that our leadership position is attributable
to our ability to simultaneously drive technological advances
and manufacture high-performance, low-cost products. Our major
competitive strengths include the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Leading Independent Disk Supplier. We believe that we
    have developed a deep understanding of market needs in the disk
    drive market and offer a broad portfolio of advanced solutions
    to address those needs. Additionally, we believe the scale of
    our manufacturing and our technology development programs
    provide us with competitive advantages in maintaining and
    growing our market share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Technology Leadership. We have been in the thin-film
    media business for over 20 years, during which time we have
    invested heavily in research and development. Our research,
    development, and engineering team has 446 employees in the U.S.
    and Malaysia, and is focused on developing next- generation
    products and efficient manufacturing processes. As a recent
    example of our success in technology innovation, 36% of our 2005
    fourth quarter shipments were 100 GB and greater disks.
    Additionally, we believe we are currently a leader in developing
    next-generation technologies, such as PMR, to allow us to stay
    at the forefront of technology development in the disk industry.
    We believe our research and development strategy allows us to
    design and manufacture high volumes of advanced disks for our
    customers.                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Strong Relationships with Top-Tier Disk Drive
    Manufacturers. We believe that we have developed strong
    relationships with many of the leading disk drive manufacturers,
    including HGST, Maxtor, Seagate, and Western Digital. In
    December 2005, two of our major customers, Seagate and Maxtor,
    announced that they had entered into a definitive agreement
    under which Seagate will acquire Maxtor. The acquisition is
    expected to be completed in the second half of 2006. Our
    San Jose, California headquarters and research and
    development operations are in close proximity to the design
    centers of many of the worlds largest disk drive
    manufacturers. Our ability to have our design teams work in such
    close proximity to our customers has, in part, facilitated the
    strong and collaborative customer relationships that we have
    established with these large disk drive manufacturers. We devote
    significant time working with our customers to produce disks
    that are highly specialized and customized for our
    customers particular technological requirements, and these
    close relationships provide added insight into our
    customers product and technology roadmaps.
|
| |  | Low-Cost Efficient Manufacturing Operations. We believe
    our manufacturing costs are among the lowest in our industry.
    Our manufacturing operations, all of which are located in
    Malaysia, are located in the same region as the manufacturing
    operations of many of the worlds largest disk drive
    manufacturers. We believe the location of our manufacturing
    operations, together with our experience in the industry and our
    economies of scale, provide us with timing and cost advantages
    in delivering consistently high-quality products to our
    customers in high volumes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Broad Range of Disk Products to Address Large and Emerging
    Markets. We provide a broad range of disk products that are
    incorporated into disk drives for desktop, enterprise, and
    consumer electronics applications. Our primary market focus has
    been 3 1/2-inch disks for the desktop and consumer electronic
    applications, which TrendFocus estimated represented
    approximately 62% of the total disk drive market during the
    fourth quarter of 2005, and the majority of the highest volume
    business of our largest customers. As our customers pursue
    applications and products in other promising growth areas, such
    as the enterprise server, mobile and small form factor consumer
    electronics storage markets, we                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

5



---



##### Table of Contents



| |  |                                                                                                                                                                   
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | believe we are well positioned to meet their needs based on our
    ability to produce a wide range of products with varying areal
    densities and form factors.

Strategy

Our primary goal is to maintain our position as a leading
independent provider of disks. The key elements of our strategy
are as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Maintain Technology Leadership. We intend to maintain and
    extend our technology leadership in the disk market by
    continuing to invest in leading-edge research and development.
    We intend to continue to focus our technology development
    efforts primarily on large and emerging market opportunities,
    such as high-density storage for PCs, enterprise storage
    systems, communications infrastructure and consumer electronics
    appliances. We currently manufacture 80 GB and 100 GB and
    above 3 1/2-inch disks, and expect to ship 160GB disks in early
    2006. We are currently sampling and qualifying PMR media, and
    expect to ship PMR disks for enterprise applications in 2006.
    Additionally, we are pursuing new technologies, such as discrete
    track recording (DTR), in an effort to achieve technological
    advantages over our competitors.                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Continue Improving Manufacturing Efficiency and Reducing
    Production Costs. We intend to continue to improve the
    efficiency and quality of our manufacturing operations in
    Malaysia where we believe we can achieve lower costs than other
    disk manufacturers. We believe that our advanced manufacturing
    operations allow us to accelerate delivery of high volumes of
    reasonably priced disks, which enable our customers to rapidly
    introduce new products. As a leading independent disk supplier,
    we believe our highly experienced operations personnel can
    continue to drive yield improvements and reduce costs faster
    than our competitors. We believe our strategy of improving our
    manufacturing efficiency while reducing costs contributes to our
    customers success and will help grow our market share.                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Leverage Collaborative Relationships with Disk Drive
    Manufacturers. We believe that we have established strong
    relationships with our customers, enabling us to participate in
    establishing technological and design requirements for new
    products. We believe that close technical collaboration with our
    customers and their other component suppliers during the design
    of our customers new disk drives facilitates integration
    of our disks, improves our ability to achieve cost-effective,
    high-volume manufacturing rapidly, and enhances the likelihood
    that we will remain a significant supplier of disks for
    high-performance disk drive products.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | Maintain a Strong Customer Base. Our customers include
    HGST, Maxtor, Seagate, and Western Digital, which, according to
    TrendFocus, together represented 75% of all global disk drive
    sales during 2005. We continue to target additional high-volume
    disk drive manufacturers and believe that our combination of
    high-performance products and competitive pricing will enable us
    to further diversify our customer mix. In combination with
    offering a broad product mix to address multiple storage
    markets, we believe this strategy will reduce our dependence on
    the success of any one customer or market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | Balance Capacity Growth with Customer Demand. Our
    strategy is to balance, in a cost-effective manner, our
    investments in new capacity with the expected growth in demand
    for our products. In 2005, and continuing into 2006, we began
    expansions to our facilities to increase our capacity. Our
    expansion plans are based on strategic supply agreements with
    several of our customers. As part of these agreements, we have
    made certain commitments to increase capacity, and our customers
    have agreed to purchase certain amounts of disks. Additionally,
    our customers have agreed to make certain prepayments for media
    to help mitigate the cash impact of the capital spending
    required for us to increase our capacity. We believe that these
    arrangements with our customers are the correct strategy to
    allow for prudent capacity increases to meet the continuing
    growing demand for disks, as disk drives further expand
    penetration into multiple growing consumer applications. We
    expect to fund the capital spending for the capacity expansions
    of both our finished disks, as well as substrates, from cash
    generated from operations, as well as from the prepayment
    arrangements.

6



---



##### Table of Contents



Technology

We believe our technological strength has allowed us to achieve
and maintain our position as a leading independent supplier to
the thin-film media market. Our technological strength stems
from the depth of our understanding of materials science and the
interplay between disks, heads, and other disk drive components.
Our disk manufacturing expertise is evidenced by our history of
delivering reliable products in high volume.

We manufacture and sell thin-film magnetic media on rigid disk
platters for use in disk drives. These drives are used to
record, store, retrieve and protect digital information. Inside
a disk drive, the disk rotates at speeds of up to 15,000 rpm.
The head scans across the disk as it spins, magnetically
recording or reading information. The location on the disk where
each bit of magnetic code is stored is extremely small and
precisely placed. The tolerances of the disks and recording
heads are extremely demanding and the interaction between these
components is one of the most critical design aspects in an
advanced disk drive.

The primary factors governing the density of storage achievable
on a disks surface are:



| |   |                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the minimum distance at which read/write heads can reliably pass
    over the surface of the disk to detect a change in magnetic
    polarity when reading from the disk, which is called flying
    height (measured in microinches, or millionths of an inch);
|
| |  | the strength of the magnetic field required to change the
    polarity of a bit of data on the magnetic layer of a disk when
    writing, which is called coercivity; and                                                                                       
|
| |  | the ability of the head to discriminate a signal from background
    media noise, which is called the signal-to-noise ratio (SNR).                                                                                                                              

As flying height is reduced, the head can read and write smaller
bits. The higher the coercivity of the media is, the smaller the
width of the bit that can be stored. SNR is determined by the
choice of magnetic materials and the method for depositing those
materials on the disks surface, as well as the recording
head used.

Our plating, polishing, and texturing processes produce a
uniform disk surface that is smooth at an atomic level. This
smoothness permits the read/write heads to fly over the disk
surface at a distance of 0.3 to 0.4 microinches (millionths
of an inch). Disks must be made in a clean environment to limit
surface defects. Even a small number of defects, a fraction of a
micron in diameter, could cause the recording head-disk
interface to fail. The magnetic alloys deposited on the surfaces
of our disks have high coercivity, low noise, and other
desirable magnetic characteristics.

Finally, a protective layer of diamond-hard carbon and a layer
of lubricant, each of which is controlled to a tolerance of a
few angstroms, is applied to the disk surface to prevent wear.
The continued improvement in these and other factors has
resulted in rapid advancement in the amount of data a disk is
capable of storing.

In order to manufacture the best possible disks and achieve the
high yields we desire, we require excellent raw materials,
including highly-polished substrates. Our polished substrates,
in conjunction with our automatic optical inspection systems and
the latest disk buff process, provide us with high yields. At
the same time, we have developed our polishing, texturing, final
test, and packaging technology to achieve low costs for the
materials and operating supplies needed to make our disks.
Finally, our multi-layer sputter process, with nanometer-thin
(one nanometer equals one billionth of a meter) structures,
provides magnetic stability, mechanical durability, and
corrosion resistance, which we believe are at the forefront of
our industry. To improve durability and corrosion resistance, we
have developed and qualified advanced diamond-like carbon films
specifically for each of our sputter tools. Each method enables
production of carbon films as thin as one-tenth of a microinch
with extraordinary hardness and durability.

Research, Development, and Engineering

Our research, development, and engineering efforts focus on
emphasizing key technology advancements in disk functionality,
reliability, quality and manufacturing efficiency. We believe
that improving yields and

7



---



##### Table of Contents





We often partner with our customers and other disk drive
component makers in areas of technology development such as
magnetic recording heads. We believe our advanced longitudinal
disks that feature SAF-coupled layers to enhance thermal
stability will support a recording density of at least 160 GB
per 3 1/2-inch diameter disk. Further, we expect initial 3
1/2-inch PM media to have a capability of approximately 240
GB per disk. We expect these disks will be produced using
current production equipment, which suggests a limited need to
replace equipment to keep pace with technology improvement
during the next few years.

As of January 1, 2006, our worldwide research, development,
and engineering program employed 446 people.

Products and Customers

We sell our disks primarily to disk drive manufacturers for
incorporation into disk drives. Disk drives, in turn, are sold
to computer or consumer appliance manufacturers that incorporate
the disk drives into their systems, or are sold directly to
consumers. We work closely with our customers as they design new
high-performance disk drives, and generally customize our
products according to their specifications.

Our products offer a range of coercivities, glide height
capabilities and other parameters to meet specific customer
requirements. Finished disk sales of 3 1/2-inch (95mm) 80 GB and
100 GB and above disks for desktop and high capacity consumer
application, together represented 94% of our fourth quarter of
2005 unit shipment volume. Our remaining shipments in the
fourth quarter of 2005 were smaller form factor disks for
enterprise storage applications.

We manufacture substrates primarily for our own use in finished
disks. By doing so, we reduce our dependence on third-party
suppliers of substrates. If we have substrate capacity in excess
of our finished disk requirements, we have sold, and may
continue to sell, our substrates to third parties. By selling
our substrates to third parties, we better-utilize our
factories, reduce our overall cost per disk, and enhance
customer relationships with disk drive manufacturers.

For the year ended January 1, 2006, our principal
customers, HGST, Maxtor, Seagate, and Western Digital, together
accounted for approximately 93% of our net sales. We have
entered into supply agreements with Maxtor, Seagate and Western
Digital. As part of these agreements, Komag has made certain
commitments to increase capacity and our customers have agreed
to purchase certain amounts of media. In addition, our customers
have agreed to make certain prepayments for media to help
mitigate the cash impact of the capital spending required for
Komag to increase capacity.

Upon the closing of the proposed acquisition of Maxtor by
Seagate, we expect Seagate to become the successor to the
strategic supply agreement between Maxtor and Komag. We
anticipate that after the closing of the merger, based on our
current agreements with Seagate and Maxtor, we will continue to
work with Seagate to supply Seagate the total combined volume of
disks specified under each of our separate agreements with
Seagate and Maxtor.

We believe that these arrangements with our customers are the
right strategy to allow for prudent capacity increases to meet
the continuing growing demand for media, as disk drives further
expand penetration into multiple growing consumer applications.

Competition

The market for our products is highly competitive, with
manufacturers competing for a limited number of major customers.
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. The captive disk
manufacturers that produce thin-film media internally for their
own use include HGST, Maxtor, and Seagate. Many of these
competitors have greater financial resources, greater technical
and manufacturing

8



---



##### Table of Contents





We believe that some of the principal factors used by customers
to distinguish among disk manufacturers include consistent time
to market, advanced technology, consistent high quality products
produced in high volume at low cost and responsiveness to
customer preferences and demands. We believe that our products
are competitive with respect to each of these factors in the
markets that we currently serve.

Manufacturing

We have four manufacturing facilities located in Penang,
Sarawak, and Johor, Malaysia. These facilities have
approximately 1,303,000 square feet, a large portion of
which contains Class 100 or better clean room environments.
These facilities currently have a production capacity of
approximately 31 million finished disks a quarter. We are
in the process of further expanding our capacity at our existing
manufacturing sites in Malaysia. We expect to increase our total
capacity to approximately 43 million disks per quarter by
the end of 2006.

Our strategy is to balance, in a cost-effective manner, our
investments in new capacity with the expected growth in demand
for our products.

Maintaining low product cost is critical to our ability to
sustain profitability. The cost of our products is sensitive to
many factors, including production volume, yield, materials and
operating supplies consumed, and manufacturing location. Our
processes have required substantial investment in equipment and
factory buildings. This investment leads to a high fixed cost
structure, making our costs sensitive to changes in production
volume. Over the last several years, we have successfully
reduced the per-unit manufacturing costs of our disks. We
believe that our production volumes, yield, and the low cost of
our Malaysian manufacturing facilities affords us a comparable
or better cost structure compared to others within the industry.

We believe our manufacturing expertise in thin-film media is
evidenced by our history of delivering reliable state of the art
products in high volumes. By using our proprietary processes and
techniques, we have produced advanced disk products that
generally exhibit uniform performance characteristics. These
uniform performance characteristics enhance the reliability of
the disk drive products manufactured by our customers. In
addition, these characteristics can raise production yields on
our customers manufacturing lines, which is an important
cost consideration for them. Manufacturing costs are highly
dependent on our ability to effectively use our installed
physical capacity to produce large volumes of products at
acceptable yields. To improve yields and capacity utilization,
we have adopted formal continuous improvement programs at each
of our manufacturing facilities.

Manufacturing of our disks is a complex, multi-step process that
converts aluminum substrates into finished data storage media
ready for use in a disk drive. The process requires the
deposition of extremely thin, uniform layers of metallic film
onto a disk substrate. To achieve this, we use a vacuum
deposition, or sputtering, method similar to that used to coat
semiconductor wafers. The basic process consists of many
interrelated steps that can be grouped into five major
categories:



| |   |                                                                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Sizing and Grinding of the Substrate. A raw aluminum
    blank substrate is sized by precisely cutting the inner and
    outer diameter of the blank. A mechanical grinding process is
    then utilized to provide a relatively flat surface on the
    substrate prior to nickel alloy plating.                                       
|
| |  | Nickel Alloy Plating and Polishing of the Substrate.
    Through a series of chemical baths, aluminum substrates are
    plated with a uniform nickel phosphorus layer in order to
    provide support for the magnetic layer. Next, this layer is
    polished to produce surface characteristics required for
    magnetic deposition.
|
| |  | Texturing and Cleaning. During these process steps, a
    precisely controlled, fine texture is applied to the polished
    disk surface to allow the read/write heads of the disk drives to
    fly at low and constant levels and then the disks are cleaned in
    preparation for the sputtering process.                           

9



---



##### Table of Contents





| |   |                                                                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Sputtering and Lube. By a technically demanding vacuum
    deposition process, magnetic layers are successively deposited
    on the disk and a hard protective overcoat is applied. After
    sputtering, a microscopic layer of lubrication is applied to the
    disks surface to improve durability and reduce surface
    friction.
|
| |  | Glide Test and Certification. In robotically-controlled
    test cells, disks are tested for glide height and surface
    defects, and then certified for magnetic properties. Based on
    these test results, disks are graded against our customers
    specific performance requirements.                                           

Most of the critical process steps are conducted in
Class 100 or better clean room environments. Throughout the
process, disks are handled by highly automated equipment to
reduce contamination and enhance process precision. Minute
impurities in materials, particulate contamination or other
production problems can reduce production yields and, in extreme
cases, cause production to be suspended for prolonged periods.

Environmental Regulation

We are subject to a variety of environmental and other
regulations in connection with our operations and believe that
we have obtained all necessary permits for our operations. We
use various industrial hazardous materials, including
metal-plating solutions, in our manufacturing processes. Wastes
from our manufacturing processes are either stored in areas with
secondary containment before removal to a disposal site, or
processed on-site and discharged to the industrial sewer system
in accordance with state and federal regulations.

We have, from time to time, upgraded our wastewater treatment
facilities to improve the performance and consistency of our
wastewater processing. Our Penang and Sarawak manufacturing
facilities are ISO 14001-certified. ISO 14001 is a
voluntary set of standards that provides companies with a
structure for managing the potential environmental impact of
their operations. In order to obtain ISO certification, we
developed and implemented a formal program to ensure that our
manufacturing operations are consistent with minimizing
hazardous waste, preventing pollution of air and water, and
protecting the environment.

Nonetheless, industrial wastewater discharges from our
facilities may, in the future, be subject to more stringent
regulations. If we fail to comply with present or future
regulations, part or all of our operations would be suspended or
terminated. These regulations could restrict our ability to
expand at our present locations or could require us to acquire
costly equipment or incur other significant expenses.

Patents and Proprietary Information

We hold, and have applied for, U.S. and foreign patents and have
entered into cross-licenses with certain of our customers. While
these patents could present obstacles to the introduction of new
products by competitors and possibly result in royalty-bearing
licenses from third parties, we believe that our success does
not generally depend on the ownership of intellectual property
rights but rather on our innovative skills, technical
competence, manufacturing execution, and marketing abilities.
Accordingly, we do not expect that the patents we hold or apply
for will constitute any assurance of our future success.

We regard elements of our equipment designs and processes as
proprietary and confidential and rely upon employee and vendor
nondisclosure agreements and a system of internal safeguards for
protection. In spite of these steps for protecting proprietary
and confidential information, there is a risk that competitors
may obtain and use such information. Further, the laws of
certain foreign countries in which we do business may provide a
lesser degree of protection to our proprietary and confidential
information than that provided by the laws of the
U.S. Moreover, from time to time, we receive proprietary
and confidential information from vendors, customers, and
partners, the use and disclosure of which are governed by
nondisclosure agreements. Through internal communication and the
monitoring of use and disclosure of such information, we comply
with our obligations regarding use and nondisclosure. However,
despite these efforts, there is a risk that we may use or
disclose this information in violation of our obligations of
nondisclosure.

We have occasionally received, and may receive in the future,
communications from third parties asserting violation of
intellectual rights alleged to cover certain of our products or
manufacturing processes or

10



---



##### Table of Contents





Employees

As of January 1, 2006, on a worldwide basis, we had 7,121
employees. Of the total, 6,141 were full-time employees and 980
were employed on a temporary basis, 6,526 were employed in
manufacturing, 446 were employed in research, development, and
engineering, and 149 were employed in sales, administrative, and
management positions, and 6,728 were employed in Malaysia and
393 were employed in the U.S.

We believe that our future success will depend in large part on
our ability to continue to attract, retain, and motivate
highly-skilled and dedicated employees. We have no employees who
are represented by a labor union, and we have never experienced
a work stoppage.




Item 1A.     Risk
Factors

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

Risks Related to Our Business



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

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

The effect of these cycles on suppliers has been magnified by
disk drive manufacturers practice of ordering components,
including disks, in excess of their needs during periods of
rapid growth, thereby increasing the severity of the drop in the
demand for components during periods of reduced growth or
contraction. Further, downturns in the disk drive market may
cause disk drive manufacturers to delay or cancel projects,
reduce their production, or reduce or cancel orders for our
products. This, in turn, may lead to longer sales cycles, delays
in payment and collection, pricing pressures, and unused
capacity, causing us to realize lower revenues and margins and
causing our operating results to suffer. For example, in the
fourth quarter of fiscal year 2003, disk drive manufacturers
appear to have overbuilt product, which resulted in an excess
supply of disk drives that was not fully corrected until
approximately the third quarter of fiscal year 2004.

Due to these factors, forecasts may not be achieved, either
because expected sales do not occur or because they occur at
lower prices or on terms that are less favorable to us. This
increases the chance that our

11



---



##### Table of Contents







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

We are in the process of significantly increasing the scope of
our manufacturing operations in Malaysia. We currently have a
manufacturing capacity of approximately 31 million units
per quarter and plan to increase our capacity to approximately
43 million units per quarter by the end of 2006. We are
expanding our capacity as a result of commitments we have made
to certain customers pursuant to strategic supply agreements. In
the event we do not increase our capacity as planned on a timely
basis, we could lose significant future orders from major
customers. In the event we are successful in expanding our
manufacturing capacity as planned, there can be no assurance we
will receive sufficient orders to utilize fully our additional
capacity. In addition, the high utilization of our expanded
capacity is dependent on our obtaining sufficient operating
supplies and raw materials from our limited and sole-source
suppliers to accommodate the increased capacity. We do not have
binding commitments from these limited and sole-source suppliers
to provide sufficient supplies and raw materials to fully
utilize the additional capacity.

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



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

We sell most of our products to a limited number of customers.
Our customers are disk drive manufacturers. Because of our small
customer base, the loss of any one significant customer could
have a materially adverse impact on our business operations. A
relatively small number of disk drive manufacturers dominates
the disk drive market. According to TrendFocus, four of these
manufacturers (HGST, Maxtor, Seagate, and Western Digital)
accounted for approximately 75% of worldwide hard disk drive
sales in 2005. In addition, we anticipate that Seagates
proposed acquisition of Maxtor would make the combined
Seagate-Maxtor company the largest disk drive manufacturer in
the industry. We expect that the success of our business will
continue to depend on a limited number of customers. In 2005,
32% of our net sales were to Maxtor, 24% were to Western Digital
, 21% were to HGST, and 16% were to Seagate. In 2004, 47% of our
net sales were to Maxtor, 14% were to Western Digital, 29% were
to HGST, and 4% were to Seagate. If the combined Seagate-Maxtor
company or any one of our other significant customers reduces
its disk requirements, cancels existing orders, develops or
expands capacity to produce its own disks, or requires us to
reduce our prices before we are able to reduce costs, and we are
unable to replace these orders with sales to new customers, our
sales would be reduced and our business, financial condition,
and operating results would suffer. Our ability to maintain
strong relationships with our significant customers is essential
to our future performance. Any further mergers, acquisitions,
consolidations, or other significant transactions involving our
significant customers may adversely affect our business and
operating results.

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

12



---



##### Table of Contents





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

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

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



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

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



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

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

13



---



##### Table of Contents



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



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

The market for our products is highly competitive, and we expect
competition to continue in the future. Competitors in the
thin-film media industry fall primarily into two groups:
Asian-based independent disk manufacturers, and captive disk
manufacturers. Our major Asian-based independent competitors
include Fuji Electric, Hoya, and Showa Denko. The captive disk
manufacturers who produce thin-film media internally for their
own use include HGST, Maxtor, and Seagate. Many of these
competitors have greater financial resources than we have, which
could allow them to adjust to fluctuating market conditions
better than we. Further, they may have greater technical and
manufacturing resources, more marketing power, and a broader
array of products. To the extent our competitors continue to
consolidate and achieve greater economies of scale, we will face
additional competitive challenges. Our competitors may also
lower their product prices to gain market share, develop new
technology which would significantly reduce the cost of their
products, or offer more products than we do and therefore enter
into agreements with customers to supply their products as part
of a larger supply agreement. Price declines are also affected
by any imbalances between demand and supply. For most of 2002,
as in the several years prior, disk supply exceeded demand. As
independent suppliers like us struggled to utilize their
capacity, the excess disk supply caused average selling prices
for disks to decline. Supply and demand conditions have improved
since 2002, resulting in a more stable pricing environment.
Supply and demand factors and industry-wide competition could
adjust in the future and force disk prices down, which, in turn,
would put pressure on our gross margin. 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 be assured that we will be able to compete
successfully in this kind of price competitive environment. If
we are not able to compete successfully in the future, we would
not be able to gain additional market share for our products, or
we may lose our existing market share, and our operating results
could be harmed.



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

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

14



---



##### Table of Contents





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

Our business is characterized by high fixed overhead costs,
including expensive plant facilities and production equipment.
Our per-unit costs and our gross profit are significantly
affected by the number of units we produce and the amount of our
production capacity that we utilize. We are in the process of
significantly expanding our production capacity to approximately
43 million units per quarter by the end of 2006 from
approximately 30 million units per quarter at the end of
2005. We have in the past, and may in the future, experience
periods of underutilized capacity. For example, in the third
quarter of 2004, we completed the installation of additional
equipment, which increased our production capacity from
approximately 20 million disks a quarter to approximately
24 million disks a quarter. Our finished disk shipments
were below this capacity level in the third quarter and fourth
quarter of 2004. If our capacity utilization decreases for any
reason, including lack of customer demand or cancellation or
delay of customer orders, we could experience significantly
higher unit production costs, lower margins, and potentially
significant losses, as occurred for several years prior to 2003.
Underutilization of our production capacity could also result in
equipment write-offs, restructuring charges, and employee
layoffs. If our production capacity is underutilized for any
reason, our financial results and our business would be severely
harmed.



| |                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------
| | Changes in the accounting treatment of stock-based awards
    will adversely affect our reported results of operations.

In December 2004, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 123R, Share-Based Payment(SFAS 123R). SFAS 123R is a revision of
SFAS No. 123, Accounting for Stock-Based
Compensation(SFAS 123). SFAS 123R became
effective for Komag beginning in the first quarter of 2006.
SFAS 123R requires all share-based payments to employees to
be recognized in the financial statements based on their fair
values and does not permit pro forma disclosure as an
alternative to financial statement recognition. The adoption of
the SFAS 123R fair value method will have an adverse impact
on our reported results of operations because the stock-based
compensation expense will be charged directly against our
reported earnings.



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

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



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

Our manufacturing operations are consolidated in Malaysia. As a
result, technology developed at our U.S.-based research and
development center must be first implemented for high-volume
production at our Malaysian facilities. Therefore, we rely
heavily on electronic communications between our
U.S. headquarters and our Malaysian facilities to transfer
specifications and procedures, diagnose operational issues, and
meet

15



---



##### Table of Contents





Additionally, because a large portion of our payroll, certain
manufacturing and operating expenses, and inventory and capital
purchases is transacted in the Malaysian ringgit (ringgit), we
are particularly sensitive to any change in the foreign currency
exchange rate for the ringgit. For approximately seven years,
the exchange rate between the ringgit and the U.S. dollar
was pegged at 3.8 ringgits to one U.S. dollar by the
Malaysian government. On July 21, 2005, Malaysia removed
its currency peg to the U.S. dollar in favor of a managed
float system. The change in exchange rates could adversely
affect the amount we spend on our payroll, certain manufacturing
and operating expenses, and raw materials and capital purchases.
In 2005, our spending on payroll, manufacturing, and operating
expenses, and raw materials and capital purchases that were
denominated in ringgit was approximately $232.7 million.
Additionally, in 2005, we paid approximately $78.6 million
U.S. dollars to a Malaysian supplier for raw materials
purchases, based on a cost plus a percentage arrangement. This
Malaysian supplier incurs certain costs that are denominated in
ringgit; therefore, any change in the valuation of the ringgit
could materially impact the cost per unit we pay for such raw
materials. Furthermore, our ability to transfer funds from our
Malaysian operations to the U.S. is subject to Malaysian
rules and regulations.

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



| |   |                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------
| |  | compliance with changing legal and regulatory requirements of
    foreign jurisdictions;                      
|
| |  | fluctuations in tariffs or other trade barriers;                                                              
|
| |  | difficulties in staffing and managing foreign operations;                                                     
|
| |  | political, social, and economic instability;                                                                  
|
| |  | increased exposure to threats and acts of terrorism;                                                          
|
| |  | exposure to taxes in multiple jurisdictions;                                                                  
|
| |  | local infrastructure problems or failures including but not
    limited to loss of power and water supply; and
|
| |  | transportation delays and interruptions.                                                                      

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



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

We must frequently qualify new products with our disk drive
manufacturing customers, based on criteria such as quality,
storage capacity, performance, and price. Qualifying disks for
incorporation into new disk drive products requires us to work
extensively with our customer and the customers other
suppliers to meet product specifications. Therefore, customers
often require a significant number of product presentations and
demonstrations, as well as substantial interaction with our
senior management, before making a purchasing decision.
Accordingly, our products typically have a lengthy sales cycle,
which can range from six to twelve months or longer. During this
time, we may expend substantial financial resources and
management time and effort, while having no assurances that a
sale will result, or that disk drive programs ultimately will
result in

16



---



##### Table of Contents







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

The disk industry is subject to rapid technological change, and
if we are unable to anticipate and develop products and
production technologies on a timely basis, our competitive
position could be harmed. Customization has increased the risk
of product obsolescence, and as a result, supply chain
management, including just-in-time delivery, has become a
standard industry practice. In order to sustain customer
relationships and sustain profitability, we must be able to
develop new products and technologies in a timely fashion in
order to help customers reduce their time-to-market performance,
and continue to maintain operational excellence that supports
high-volume manufacturing ramps and tight inventory management
throughout the supply chain. The success of any new product
introduction is dependent on a number of factors, including
market acceptance, our ability to manage the risks associated
with product transitions, and the risk that a new product will
have quality problems or other defects in the early stages of
introduction that were not anticipated in the design of such
product. Accordingly, we have invested, and intend to continue
to invest heavily, in our research and development program. If
we cannot respond to this rapidly changing environment or fail
to meet our customers demanding product and qualification
requirements, we will not be able to compete effectively. As a
result, we would not be able to maximize the use of our
production facilities, and our profitability would be negatively
impacted.



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

Our products primarily serve the 3 1/2-inch disk drive market
where product performance, consistent quality, price, and
availability are of great competitive importance. The continuing
need for high-capacity disk drives requires disks with higher
storage capacity. Higher storage capacity on the surface of a
disk is achieved by increasing its areal density. Areal density
continues to increase rapidly, requiring significant improvement
in every aspect of disk design. These advances require
substantial on-going process and technology development. New
process technologies, including SAF and 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 transfer those advanced technologies at high yields
to our Malaysian operations, or if technologies that we have
chosen not to develop prove to be viable competitive
alternatives, we would not be able to compete effectively. As a
result, we would lose market share and face increased price
competition from other manufacturers, and our operating results
would suffer.



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

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

17



---



##### Table of Contents







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

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



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

Our protection of our intellectual property is limited. It is
commonplace to protect technology through patents and other
forms of intellectual property rights in technically
sophisticated fields. We may not receive patents for our pending
or future patent applications, and any patents that we own or
that are issued to us may be invalidated, circumvented or
challenged. In the disk and disk drive industries, companies and
individuals have initiated actions against others in the
industry to enforce intellectual property rights. Although we
attempt to protect our intellectual property rights through
patents, copyrights, trade secrets, and other measures, we may
not be able to protect adequately our technology. In addition,
we may not be able to discover significant infringements of our
technology or successfully enforce our rights to our technology
if we discover infringing uses by others, and such infringements
could have a negative impact on our ability to compete
effectively. Competitors may be able to develop similar
technology and also may have or may develop intellectual
property rights and enforce those rights to prevent us from
using such technologies, or demand royalty payments from us in
return for using such technologies. Either of these events may
affect our production, which could materially reduce our
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. We may have to litigate to enforce
patents issued or licensed to us, to protect trade secrets or
know-how owned by us or to determine the enforceability, scope
and validity of our proprietary rights and the proprietary
rights of others. Enforcing or defending our proprietary rights
could be expensive and might not bring us timely and effective
relief. In certain cases, we may not be able to negotiate
necessary licenses on commercially reasonable terms, or at all.
Also, if we have to defend such claims, we could incur
significant expenses and our managements attention could
be diverted from our core business. Further, we may not be able
to anticipate claims by others that we infringe on their
technology or successfully defend ourselves against such claims.
Any litigation resulting from such claims could have a material
adverse effect on our business and financial results.



| |                                                                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Historical quarterly results may not accurately predict
    our performance due to a number of uncertainties and market
    factors, and as a result it is difficult to predict our future
    results.

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



| |   |                                                       
| | - | ------------------------------------------------------
| |  | timing of significant orders, or order cancellations; 
|
| |  | changes in our product mix and average selling prices;

18



---



##### Table of Contents





| |   |                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | modified, adjusted, or rescheduled shipments;                                                                                                                                                                                                                                                                 
|
| |  | actions by our competitors, including announcements of new
    products or technological innovations;                                                                                                                                                                                                         
|
| |  | availability of disks versus demand for disks;                                                                                                                                                                                                                                                                
|
| |  | the cyclical nature of the disk drive industry;                                                                                                                                                                                                                                                               
|
| |  | our ability to develop and implement new and efficient
    manufacturing process technologies;                                                                                                                                                                                                                
|
| |  | increases in our production and engineering costs associated
    with initial design and production of new product programs;                                                                                                                                                                                  
|
| |  | our ability to execute future product development and production
    ramps effectively;                                                                                                                                                                                                                       
|
| |  | fluctuations in exchange rates, particularly between the
    U.S. dollar and the Malaysian ringgit;                                                                                                                                                                                                           
|
| |  | the ability of our process equipment to meet more stringent
    future product requirements;                                                                                                                                                                                                                  
|
| |  | our ability to introduce new products that achieve
    cost-effective high-volume production in a timely manner, timing
    of product announcements, and market acceptance of new products;                                                                                                                  
|
| |  | the availability of our production capacity, and the extent to
    which we can use that capacity;                                                                                                                                                                                                            
|
| |  | changes in our manufacturing efficiencies, in particular product
    yields and input costs for direct materials, operating supplies
    and other running costs;                                                                                                                                             
|
| |  | prolonged disruptions of operations at any of our facilities for
    any reason;                                                                                                                                                                                                                              
|
| |  | changes in the cost of or limitations on availability of labor;                                                                                                                                                                                                                                               
|
| |  | structural changes within the disk industry, including
    combinations, failures, and joint venture arrangements; and                                                                                                                                                                                        
|
| |  | changes in tax regulations in foreign jurisdictions that could
    potentially reduce our tax incentives in areas such as Malaysian
    capital allowances, tax holidays, and exemptions on withholding
    tax on royalty payments made by our Malaysian operations to our
    subsidiary in the Netherlands.

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



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

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



| |   |                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | difficulties in integrating the operations, technologies,
    products and personnel of the acquired companies, especially
    given the specialized nature of our technology;
|
| |  | diversion of managements attention from normal daily
    operations of the business;                                                                                         
|
| |  | potential difficulties in completing projects associated with
    in-process research and development;                                                                        

19



---



##### Table of Contents





| |   |                                                                                            
| | - | -------------------------------------------------------------------------------------------
| |  | initial dependence on unfamiliar supply chains or relatively
    small supply partners; and
|
| |  | the potential loss of key employees of the acquired companies.                             

Acquisitions may also cause us to:



| |   |                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------
| |  | issue stock that would dilute our current stockholders
    percentage ownership;                                                                  
|
| |  | assume liabilities;                                                                                                                                
|
| |  | record goodwill and non-amortizable intangible assets that will
    be subject to impairment testing and potential periodic
    impairment charges;
|
| |  | incur amortization expenses related to certain intangible assets;                                                                                  
|
| |  | incur large and immediate write-offs; or                                                                                                           
|
| |  | become subject to litigation.                                                                                                                      

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



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

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



| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | the use, storage, discharge, and disposal of hazardous materials
    used during our manufacturing process;
|
| |  | the treatment of water used in our manufacturing
    process; and                                          
|
| |  | air quality management.                                                                                    

We are required to obtain necessary permits for expanding our
facilities. We must also comply with new regulations on our
existing operations, which may result in significant costs.
Public attention has increasingly been focused on the
environmental impact of manufacturing operations that use
hazardous materials.

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



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | we could be subject to significant penalties;                                                                              
|
| |  | our ability to expand or operate in California or Malaysia could
    be restricted;                                        
|
| |  | our ability to establish additional operations in other
    locations could be restricted; or                              
|
| |  | we could be required to obtain costly equipment or incur
    significant expenses to comply with environmental regulations.

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

20



---



##### Table of Contents





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

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



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

Our 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.



| |                                                                               
| | ------------------------------------------------------------------------------
| | Terrorist attacks may adversely affect our business and
    operating results.

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



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

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

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



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

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



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | the rate of our sales growth;                                                                                                               
|
| |  | the level of our profits or losses;                                                                                                         
|
| |  | the timing and extent of our spending to expand manufacturing
    capacity, support facilities upgrades and product development
    efforts;
|
| |  | the timing and size of business or technology acquisitions;                                                                                 

21



---



##### Table of Contents





| |   |                                                                                               
| | - | ----------------------------------------------------------------------------------------------
| |  | the timing of introductions of new products and enhancements to
    our existing products; and
|
| |  | the length of product life cycles.                                                            

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



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

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

Risks Related to our Indebtedness



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

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



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

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



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

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

22



---



##### Table of Contents






Item 1B.     Unresolved
Staff Comments

None.






|        |           
|------- | ----------
|Item 2. | Properties

The following table summarizes the location, description,
current status, and size of our facilities:

|                     |  |             |                             |               |  |                 |               |             |  |  |                    |  |  |  |         | 
|-------------------- |  | ----------- | --------------------------- | ------------- |  | --------------- | ------------- | ----------- |  |  | ------------------ |  |  |  | ------- | 
|                     |  |             |                             | Current Lease |  |                 |               |            
|Location             |  | Description |                             | Term Expires  |  | Renewal Options |               | Square Feet
|                     |  |             |                             |               |  |                 |               |            
|Leased Facilities    |  |             |                             |               |  |                 |               |             |  |  |                    |  |  |  |         | 
|                    
|                    
|                    
|                    
|San Jose, California |  |             | Headquarters and R&D Center |               |  |                 | December 2014 |             |  |  | two 5-year options |  |  |  | 188,000 | 
|                    
|                    
|                    
|                    
|Owned Facilities     |  |             |                             |               |  |                 |               |             |  |  |                    |  |  |  |         | 
|                    
|                    
|                    
|                    
|Penang, Malaysia     |  |             | Manufacturing               |               |  |                 |              |             |  |  |                   |  |  |  | 785,000 | 
|                    
|                    
|                    
|                    
|Sarawak, Malaysia    |  |             | Manufacturing               |               |  |                 |              |             |  |  |                   |  |  |  | 275,000 | 
|                    
|                    
|                    
|                    
|Johor, Malaysia      |  |             | Manufacturing               |               |  |                 |              |             |  |  |                   |  |  |  | 243,000 | 

We believe that the facilities under lease or owned by us,
including the expansion activities at two of our existing
facilities, will be adequate for at least the next
12 months. For additional information regarding our
obligations under property leases, see Note 12 of Notes to
Consolidated Financial Statements, which is included in
Part II, Item 8 of this Report.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

In the normal course of business, we receive and make inquiries
with regard to possible patent infringement. Where deemed
advisable, we may seek to enter into or extend licenses or
negotiate settlements. Outcomes of such negotiations may not be
determinable at any one point in time; however, management
currently does not believe that such licenses or settlements
will materially affect our financial position or results of
operations.






|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders

No matters were submitted to our stockholders during our fourth
quarter of 2005.

Our Executive Officers

The following table sets forth the name, age, and other
information regarding our executive officers as of
February 22, 2006. No family relationship exists between
any of our directors and executive officers.

|                    |  |  |  |  |  |  |    |  |  |  |  |  |  |                                                                       
|------------------- |  |  |  |  |  |  | -- |  |  |  |  |  |  | ----------------------------------------------------------------------
|                   
|                   
|                   
|                   
|Thian Hoo Tan       |  |  |  |  |  |  | 57 |  |  |  |  |  |  | Chief Executive Officer                                               
|                   
|                   
|                   
|                   
|Timothy D. Harris   |  |  |  |  |  |  | 50 |  |  |  |  |  |  | Executive Vice President, Chief Operating Officer                     
|                   
|                   
|                   
|                   
|Ray L. Martin       |  |  |  |  |  |  | 62 |  |  |  |  |  |  | Executive Vice President, Customer Sales and
    Service              
|                   
|                   
|                   
|                   
|Peter S. Norris     |  |  |  |  |  |  | 54 |  |  |  |  |  |  | Executive Vice President, Strategic Business
    Development          
|                   
|                   
|                   
|                   
|Michael A. Russak   |  |  |  |  |  |  | 58 |  |  |  |  |  |  | Executive Vice President, Chief Technical Officer                     
|                   
|                   
|                   
|                   
|Kathleen A. Bayless |  |  |  |  |  |  | 49 |  |  |  |  |  |  | Senior Vice President, Chief Financial Officer,
    and Secretary     
|                   
|                   
|                   
|                   
|William G. Hammack  |  |  |  |  |  |  | 56 |  |  |  |  |  |  | Senior Vice President, Human Resources                                
|                   
|                   
|                   
|                   
|Paul G. Judy        |  |  |  |  |  |  | 43 |  |  |  |  |  |  | Vice President, Corporate Controller, and Chief
    Accounting Officer

Mr. Tanjoined our company in 1989, and started our
first San Jose, California, manufacturing facility in 1989,
our Penang operations in 1993, and our Sarawak operations in
1996. Mr. Tan returned to the U.S. and assumed the position
of Senior Vice President, Worldwide Operations, from 1996
through his appointment to

23



---



##### Table of Contents





Mr. Harrisjoined our company in October 2005.
Before joining our company, he worked at iolon, Inc. where he
served as Vice President of Operations from 2000 to 2004 and
Chief Operating Officer from 2004 to 2005. From 1990 to 2000,
Mr. Harris served in various management and executive
positions, at Seagate Technology, including Senior Vice
President of Worldwide Technology Operations, and Managing
Director of Malaysian Head Operations. Before joining Seagate,
Mr. Harris held manufacturing and management positions at
Conner Peripherals, Domain Technology, and Memorex.
Mr. Harris holds a Master of Business Administration degree
from Santa Clara University and a B.A. degree from the
University of California, Santa Cruz.

Mr. Martinjoined our company in 1997 as Vice
President, Product Assurance and Product Test, and became our
Senior Vice President, Customer Sales and Service in 1998. In
2001, Mr. Martin became our Executive Vice President,
Customer Sales and Service. From 1990 to 1997, he was Director
of Process and Technology at Quantum Corporation. Prior to
working at Quantum, Mr. Martin held a number of management
and engineering positions at several leading disk drive
manufacturers, including Western Digital, Seagate Technology,
and IBM. Mr. Martin holds a B.S. degree in Mechanical
Engineering from Kansas State University.

Mr. Norrisjoined our company in October 2000, as
Executive Vice President, Strategic Business Development, after
the merger with HMT. He joined HMT in 1995 as Vice President,
Finance, Chief Financial Officer and Treasurer and became its
Executive Vice President, Finance, Chief Financial Officer and
Treasurer in 1999. From 1975 to 1995, Mr. Norris worked for
General Instrument Corporation. Mr. Norris holds a B.A.
degree in Economics from Upsala College.

Dr. Russakjoined our company in October 2000, as
Chief Technical Officer and Executive Vice President of Research
and Development, after our merger with HMT. Previously,
Dr. Russak was with HMT, which he joined in 1993 as Vice
President  Research and Development. He subsequently
became Chief Technical Officer in 1998 and Executive Vice
President  Research & Development and Chief
Technical Officer in 1999. From 1985 to 1993, Dr. Russak
held several staff and management positions with IBM.
Dr. Russak holds a B.S. in Ceramic Engineering and a Ph.D.
in Materials Science from Rutgers University.

Ms. Baylessjoined our company in 1994 as Corporate
Controller, became a Vice President in 2000, our Chief Financial
Officer in September 2002, and a Senior Vice President in 2005.
Before joining us, Ms. Bayless worked for the public
accounting firm of Ernst & Young, LLP. Ms. Bayless
holds a B.S. degree in Accounting from California State
University Fresno, and is a Certified Public Accountant.

Mr. Hammackjoined our company in June 2002, as Vice
President, Human Resources. Mr. Hammack left Komag in
January 2005 to take a position as Vice President with IDT Inc.
Mr. Hammack returned to Komag in March 2005, and became a
Senior Vice President in 2005. Before joining Komag in 2002,
Mr. Hammack served as Vice President, Human Resources at
Zambeel, Inc. from 2001 to 2002. Prior to that, he served as
Vice President, Human Resources at QRS Corporation from
1999 to 2001. From 1982 to 1999, he served as Vice President,
Human Resources at General Electric Medical Systems/ Diasonics.
Mr. Hammack holds a B.A. degree from San Diego State
University.

Mr. Judyjoined our company in 1988 as a senior
accountant, and served in various accounting and financial
reporting roles through September 1999. From March 2000 to March
2004, Mr. Judy worked for New Focus, Inc. in financial
reporting management roles, including Corporate Controller.
Mr. Judy rejoined our Company in March 2004 as Corporate
Controller and Chief Accounting Officer, and was promoted to
Vice President in October 2005. Before joining us in 1988,
Mr. Judy worked for the public accounting firm of Arthur
Andersen LLP. Mr. Judy holds a B.S. degree in Commerce from
Santa Clara University, and is a Certified Public
Accountant.

24



---



##### Table of Contents



PART II






|        |                                                                                                                      
|------- | ---------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity, Related
    Stockholder Matters, and Issuer Purchases of Equity
    Securities

The following table sets forth, for the periods indicated, the
high and low closing sale prices for our common stock, as
reported by the Nasdaq National Market.

|     |                |      |   |       |  |  |   |       | 
|---- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|     |                | High |   | Low  
|     |                |      |   |      
|2004 |                |      |   |       |  |  |   |      
|    
|    
|    
|    
|     | First Quarter  |      | $ | 24.00 |  |  | $ | 14.61 | 
|    
|    
|    
|    
|     | Second Quarter |      |   | 19.48 |  |  |   | 12.68 | 
|    
|    
|    
|    
|     | Third Quarter  |      |   | 14.08 |  |  |   | 9.75  | 
|    
|    
|    
|    
|     | Fourth Quarter |      |   | 19.21 |  |  |   | 13.96 | 
|    
|    
|    
|    
|2005 |                |      |   |       |  |  |   |      
|    
|    
|    
|    
|     | First Quarter  |      |   | 23.33 |  |  |   | 17.33 | 
|    
|    
|    
|    
|     | Second Quarter |      |   | 32.30 |  |  |   | 19.96 | 
|    
|    
|    
|    
|     | Third Quarter  |      |   | 39.95 |  |  |   | 28.33 | 
|    
|    
|    
|    
|     | Fourth Quarter |      |   | 37.62 |  |  |   | 24.93 | 

As of February 22, 2006, 30,165,875 shares of our
common stock were outstanding. These shares were held by 55
holders of record.

Dividend Policy

We have never declared cash dividends on our common stock. We
presently intend to retain all cash to repay our debt and
operate and expand our business, and do not anticipate paying
any cash dividends in the near future.

Recent Sales of Unregistered Securities

There were no sales of unregistered securities during the
quarter ended January 1, 2006.

25



---



##### Table of Contents








|        |                                     
|------- | ------------------------------------
|Item 6. | Selected Consolidated Financial Data

The following table sets forth selected consolidated financial
data and other operating information of Komag, Incorporated. The
financial data and operating information is derived from the
consolidated financial statements of Komag, Incorporated, and
should be read in conjunction with the consolidated financial
statements, related notes, and other financial information
included herein (in thousands, except per share amounts).

|                                                                             |  |                   |         |                  |  |              |         |              |  |   |         |  |  |   |         |  
|---------------------------------------------------------------------------- |  | ----------------- | ------- | ---------------- |  | ------------ | ------- | ------------ |  | - | ------- |  |  | - | ------- | -
|                                                                             |  |                  
|                                                                             |  | Successor Company |         |                 
|                                                                             |  |                   |         |                 
|                                                                             |  | Fiscal Year Ended |         |                 
|                                                                             |  |                   |         | Six Months Ended
|                                                                             |  | January 1,        |         | January 2,       |  | December 28, |         | December 29,
|                                                                             |  | 2006              |         | 2005             |  | 2003         |         | 2002        
|                                                                             |  |                   |         |                  |  |              |         |             
|                                                                             |  |                   |         |                  |  |              |         | (1)         
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Consolidated Statements of Operations
    Data                               |  |                   |         |                  |  |              |         |              |  |   |         |  |  |   |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Net sales                                                                    |  | $                 | 685,946 |                  |  | $            | 458,377 |              |  | $ | 438,292 |  |  | $ | 174,749 |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Gross profit (loss)                                                          |  |                   | 188,733 |                  |  |              | 112,117 |              |  |   | 107,422 |  |  |   | 31,740  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Restructuring/ impairment charges                                            |  |                   |        |                  |  |              |        |              |  |   |        |  |  |   | 34,763  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Operating income (loss)                                                      |  |                   | 117,932 |                  |  |              | 54,382  |              |  |   | 49,419  |  |  |   | (36,380 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Interest expense                                                             |  |                   | 1,765   |                  |  |              | 3,176   |              |  |   | 13,153  |  |  |   | 6,553   |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Other income (expense), net                                                  |  |                   | (415    | )                |  |              | (151    | )            |  |   | 250     |  |  |   | 2,150   |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Reorganization costs, net                                                    |  |                   |        |                  |  |              |        |              |  |   |        |  |  |   |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Income (loss) before cumulative effect of
    change in accounting principle |  |                   | 115,637 |                  |  |              | 51,355  |              |  |   | 36,040  |  |  |   | (41,919 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Cumulative effect of change in accounting
    principle                      |  |                   |        |                  |  |              |        |              |  |   |        |  |  |   |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Net income (loss)                                                            |  | $                 | 115,637 |                  |  | $            | 51,355  |              |  | $ | 36,040  |  |  | $ | (41,919 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Basic net income (loss) per share                                            |  | $                 | 3.99    |                  |  | $            | 1.88    |              |  | $ | 1.53    |  |  | $ | (1.84   | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Diluted net income (loss) per share                                          |  | $                 | 3.55    |                  |  | $            | 1.71    |              |  | $ | 1.47    |  |  | $ | (1.84   | )

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                             |  |                     |         |                   |  |   |          |  
|---------------------------------------------------------------------------- |  | ------------------- | ------- | ----------------- |  | - | -------- | -
|                                                                             |  |                    
|                                                                             |  | Predecessor Company
|                                                                             |  |                    
|                                                                             |  | Six Months Ended    |         | Fiscal Year Ended
|                                                                             |  | June 30,            |         | December 30,     
|                                                                             |  | 2002                |         | 2001             
|                                                                             |  |                     |         |                  
|                                                                             |  | (2) (3) (4) (7) (8) |         | (5) (6) (7) (8)  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Consolidated Statements of Operations
    Data                               |  |                     |         |                   |  |   |          |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Net sales                                                                    |  | $                   | 111,955 |                   |  | $ | 282,613  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Gross profit (loss)                                                          |  |                     | 1,558   |                   |  |   | (6,740   | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Restructuring/ impairment charges                                            |  |                     | 4,318   |                   |  |   | 57,430   |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Operating income (loss)                                                      |  |                     | (27,674 | )                 |  |   | (145,927 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Interest expense                                                             |  |                     |        |                   |  |   | 155,192  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Other income (expense), net                                                  |  |                     | 397,009 |                   |  |   | 3,771    |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Reorganization costs, net                                                    |  |                     | 6,511   |                   |  |   | 6,066    |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Income (loss) before cumulative effect of
    change in accounting principle |  |                     | 359,924 |                   |  |   | (296,395 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Cumulative effect of change in accounting
    principle                      |  |                     | (47,509 | )                 |  |   |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Net income (loss)                                                            |  | $                   | 312,415 |                   |  | $ | (296,395 | )
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Basic net income (loss) per share                                            |  |                     |        |                   |  |   |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Diluted net income (loss) per share                                          |  |                     |        |                   |  |   |         |  

|                                                                              |  |                   |         |                     |  |              |         |              |  |                   |         |  |  |   |         |  |  |   |          |  
|----------------------------------------------------------------------------- |  | ----------------- | ------- | ------------------- |  | ------------ | ------- | ------------ |  | ----------------- | ------- |  |  | - | ------- |  |  | - | -------- | -
|                                                                              |  |                   |         |                    
|                                                                              |  | Successor Company |         |                    
|                                                                              |  |                   |         |                    
|                                                                              |  |                   |         |                    
|                                                                              |  | As of             |         | Predecessor Company
|                                                                              |  |                   |         |                    
|                                                                              |  | January 1,        |         | January 2,          |  | December 28, |         | December 29, |  | As of            
|                                                                              |  | 2006              |         | 2005                |  | 2003         |         | 2002         |  | December 30, 2001
|                                                                              |  |                   |         |                     |  |              |         |              |  |                  
|Consolidated Balance Sheet Data                                               |  |                   |         |                     |  |              |         |              |  |                   |         |  |  |   |         |  |  |   |          |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Property, plant, and equipment, net, and land and
    buildings held for sale |  | $                 | 351,046 |                     |  | $            | 205,642 |              |  | $                 | 184,536 |  |  | $ | 221,014 |  |  | $ | 256,856  |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Total assets                                                                  |  |                   | 731,451 |                     |  |              | 431,095 |              |  |                   | 347,807 |  |  |   | 317,200 |  |  |   | 407,850  |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Current portion of long-term debt                                             |  |                   |        |                     |  |              |        |              |  |                   | 20,247  |  |  |   | 10,229  |  |  |   |         |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Long-term debt, less current portion                                          |  |                   | 80,500  |                     |  |              | 80,500  |              |  |                   | 95,801  |  |  |   | 129,923 |  |  |   |         |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Liabilities subject to compromise                                             |  |                   |        |                     |  |              |        |              |  |                   |        |  |  |   |        |  |  |   | 516,173  |  
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Stockholders equity (deficit)                                                |  | $                 | 419,005 |                     |  | $            | 287,626 |              |  | $                 | 166,588 |  |  | $ | 127,960 |  |  | $ | (144,939 | )



---



|    |                                                                                                                                                                                                                                                                                                                        
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Results of operations for the six months ended December 29,
    2002 included a $33.9 million impairment charge related to
    the write-off of all remaining goodwill, in accordance with
    Statement of Financial Accounting Standards
    (SFAS) No. 142, Goodwill and Other Intangible Assets
    (SFAS No. 142).

26



---



##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Results of operations for the six months ended June 30,
    2002 included other income of $379.0 million associated
    with the extinguishment of liabilities subject to compromise as
    of June 30, 2002, and other income of $17.3 million to
    revalue the Companys assets and liabilities at
    June 30, 2002 to fair value as prescribed by fresh-start
    reporting under Statement of Position 90-7 (SOP 90-7),
    Financial Reporting by Entities in Reorganization Under the
    Bankruptcy Code.
|   
|(3) | Results of operations for the six months ended June 30,
    2002, included a $4.3 million restructuring/impairment
    charge in connection with the shutdown of the Companys
    research and development facility in Santa Rosa, California.                                                                                                                                                                                                                                                                    
|   
|(4) | Results of operations for the six months ended June 30,
    2002, included a $47.5 million transitional impairment loss
    under SFAS No. 142. The loss was recognized as the
    cumulative effect of a change in accounting principle in the
    Companys consolidated statement of operations.                                                                                                                                                                                                                
|   
|(5) | Results of operations for 2001 included a $45.8 million
    impairment charge related to the write-down of land and
    buildings held for sale, a $4.4 million impairment charge
    related to manufacturing equipment no longer in service, and
    restructuring charges of $7.2 million primarily related to
    lease obligations on equipment no longer in service and
    additional facility closure costs.                                                                                               
|   
|(6) | Results of operations for 2001 included a $99.1 million
    interest expense charge related to accretion to bring the
    subordinated convertible notes up to their full face value of
    $230.0 million.                                                                                                                                                                                                                                                                                                        
|   
|(7) | In accordance with SOP 90-7, we did not record interest
    expense on our outstanding debt during the chapter 11
    proceedings from August 24, 2001, through June 30,
    2002.                                                                                                                                                                                                                                                                                                                                 
|   
|(8) | Earnings per share of the Predecessor Company are not presented,
    as the amounts are not meaningful.                                                                                                                                                                                                                                                                                                                                                                                                            






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations

The following discussion should be read in conjunction with our
consolidated financial statements and the accompanying notes
included in Item 8, Consolidated Financial Statements and
Supplementary Data of this Report.

The following discussion contains predictions, estimates, and
other forward-looking statements that involve a number of risks
and uncertainties about our business, including but not limited
to: our belief that we are a leading independent supplier of
disks; our belief that we have developed a deep understanding of
market needs in the disk drive market; our belief that our
manufacturing and technology development programs provide us
with competitive advantages in maintaining and growing our
market share; our belief that we have developed strong
relationships with many of the leading disk drive manufacturers;
our belief that our manufacturing operations, together with our
experience in the industry and our economies of scale, provide
us with timing and cost advantages in delivering consistently
high-quality products to our customers in high volumes; our plan
to continue to generate cash from our operations in 2006; our
belief that we will continue to investigate areas where we can
expand our presence in the disk market; our expectation that we
will continue to generate cash from operations; our expectation
that we will fund our expansion with cash from operations and
customer advances; our expectation that we will expand our disk
manufacturing capacity to 43 million disks a quarter by the
end of 2006; and our belief that the estimates and judgments
made regarding future events in connection with the preparation
of our financial statements are reasonable. These statements may
be identified by the use of words such as expects,
anticipates, intends, plans,
and similar expressions. In addition, forward-looking statements
include, but are not limited to, statements about our beliefs,
estimates, or plans about our ability to maintain low
manufacturing and operating costs and costs per unit, our
ability to estimate revenues, shipping volumes, pricing
pressures, returns, reserves, demand for our disks, selling,
general, and administrative expenses, taxes, research,
development, and engineering expenses, spending on property,
plant, and equipment, expected sales of disks and the market for
disk drives generally and certain customers specifically, and
our beliefs regarding our liquidity needs.

Forward-looking statements are estimates reflecting the best
judgment of our senior management, and they involve a number of
risks and uncertainties that could cause actual results to
differ materially from those suggested by the forward-looking
statements. Our business is subject to a number of risks and
uncertainties. While this discussion represents our current
judgment on the future direction of our business, these risks and

27



---



##### Table of Contents





Results of Operations



| |         
| | --------
| | Overview

We design, manufacture, and market thin-film media (disks),
which are incorporated into disk drives. Our net sales are
driven by the level of demand for our 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.

To address increasing demand, we expanded our media capacity in
both 2004 and 2005, and are in the process of expanding our
capacity in 2006. We installed additional equipment at our media
manufacturing facilities to expand our media capacity from
approximately 20 million a quarter in 2003 to approximately
30 million a quarter by the end of 2005. To help balance
media capacity, we expanded our substrate capacity in the first
quarter of 2004 by purchasing a Malaysian substrate facility
from Trace Storage Technology (Trace), and have subsequently
expanded production capacity at that facility from 2004 to 2006.

As a result of continuing strong customer demand, we entered
into supply agreements in 2005 with three of our major
customers. We are currently in the process of expanding our
capacity to approximately 43 million units a quarter by the
end of 2006 to support the volume commitments in these strategic
customer agreements.

Our 2005, 2004, and 2003 fiscal years included 52 weeks,
53 weeks, and 52 weeks, respectively.

28



---



##### Table of Contents



The following discussions compare the results of operations for
the fiscal year ended January 1, 2006, to the results of
operations for the fiscal year ended January 2, 2005, and
compare the results of operations for the fiscal year ended
January 2, 2005, to the results of operations for the
fiscal year ended December 28, 2003. To facilitate an
understanding of these discussions, we have provided the
following table.

The table (in thousands) reflects our results of operations for
the 2005, 2004, and 2003 fiscal years, and also reflects
statement of operations components as a percentage of net sales.

|                                               |              |                 |         |                 |  |                   |       |      |   |   |         |         |  |  |       |      |   |   |         |         |  |  |       |      |  
|---------------------------------------------- | ------------ | --------------- | ------- | --------------- |  | ----------------- | ----- | ---- | - | - | ------- | ------- |  |  | ----- | ---- | - | - | ------- | ------- |  |  | ----- | ---- | -
|                                               |              |                
|                                               |              | Year Ended     
|                                               |              |                
|                                               |              |                 |         |                 |  |                  
|                                               |              | January 1, 2006 |         | January 2, 2005 |  | December 28, 2003
|                                               |              |                 |         |                 |  |                  
|                                               |              |                 |         |                 |  |                   |       |      |   |  
|                                              
|                                              
|                                              
|                                              
|Net sales                                      |              | $               | 685,946 |                 |  |                   | 100.0 | %    |   | $ | 458,377 |         |  |  | 100.0 | %    |   | $ | 438,292 |         |  |  | 100.0 | %   
|                                              
|                                              
|                                              
|                                              
|Cost of sales                                  |              |                 | 497,213 |                 |  |                   | 72.5  | %    |   |   | 346,260 |         |  |  | 75.5  | %    |   |   | 330,870 |         |  |  | 75.5  | %   
|                                               |              |                 |         |                 |  |                   |       |      |   |   |         |         |  |  |       |      |   |   |         |         |  |  |       |     
|                                               | Gross profit |                 |         | 188,733         |  |                   |       | 27.5 | % |   |         | 112,117 |  |  |       | 24.5 | % |   |         | 107,422 |  |  |       | 24.5 | %
|                                              
|                                              
|                                              
|                                              
|Research, development, and engineering expense |              |                 | 48,873  |                 |  |                   | 7.1   | %    |   |   | 40,783  |         |  |  | 9.0   | %    |   |   | 42,085  |         |  |  | 9.7   | %   
|                                              
|                                              
|                                              
|                                              
|Selling, general, and administrative expense   |              |                 | 23,622  |                 |  |                   | 3.4   | %    |   |   | 17,980  |         |  |  | 3.9   | %    |   |   | 18,939  |         |  |  | 4.3   | %   
|                                              
|                                              
|                                              
|                                              
|Gain on disposal of assets                     |              |                 | (1,694  | )               |  |                   | (0.2  | )%   |   |   | (1,028  | )       |  |  | (0.2  | )%   |   |   | (3,021  | )       |  |  | (0.7  | )%  
|                                              
|                                              
|                                              
|                                              
|Interest income                                |              |                 | (5,327  | )               |  |                   | (0.8  | )%   |   |   | (1,371  | )       |  |  | (0.3  | )%   |   |   | (524    | )       |  |  | (0.1  | )%  
|                                              
|                                              
|                                              
|                                              
|Interest expense                               |              |                 | 1,765   |                 |  |                   | 0.3   | %    |   |   | 3,176   |         |  |  | 0.7   | %    |   |   | 13,153  |         |  |  | 3.0   | %   
|                                              
|                                              
|                                              
|                                              
|Other (income) expense, net                    |              |                 | 415     |                 |  |                   | 0.1   | %    |   |   | 151     |         |  |  | 0.0   | %    |   |   | (250    | )       |  |  | (0.1  | )%  
|                                              
|                                              
|                                              
|                                              
|Provision for income taxes                     |              |                 | 5,442   |                 |  |                   | 0.8   | %    |   |   | 1,071   |         |  |  | 0.2   | %    |   |   | 1,000   |         |  |  | 0.2   | %   
|                                               |              |                 |         |                 |  |                   |       |      |   |   |         |         |  |  |       |      |   |   |         |         |  |  |       |     
|                                               | Net income   |                 | $       | 115,637         |  |                   |       | 16.8 | % |   | $       | 51,355  |  |  |       | 11.2 | % |   | $       | 36,040  |  |  |       | 8.2  | %
|                                               |              |                 |         |                 |  |                   |       |      |   |   |         |         |  |  |       |      |   |   |         |         |  |  |       |     



| |                                         
| | ----------------------------------------
| | Fiscal Year 2005 versus Fiscal Year 2004



| |          
| | ---------
| | Net Sales

Consolidated net sales in 2005 were $685.9 million, a 49.6%
increase compared to $458.4 million in 2004. Our finished
unit sales volume increased to 107.0 million units in 2005
from 70.7 million units in 2004. The increase in
consolidated net sales primarily reflected the increase in our
sales volume. Our average selling price in 2005 was slightly
lower compared to 2004.

Other disk sales, which generally include single-sided disks,
aluminum substrate disks, plated disks, textured disks, and
polished disks, were $86.5 million in 2005, compared to
$52.8 million in 2004. The increase reflected higher sales
of textured disks, polished disks, and aluminum substrates. The
increase in other disk sales was related to higher customer
demand. Disk substrate sales vary from period to period based on
customer requirements.

Finished disk shipments for desktop and consumer applications
together represented 93% of our unit shipment volume in 2005
compared to 91% in 2004. The remaining finished disk shipments
(7% in 2005 and 9% in 2004) were disks for enterprise drives.
Sales of 100 GB and greater per platter disks in 2005 increased
to 26.4% of net sales, compared to 8.4% in 2004.

In 2005, sales to Maxtor, Western Digital, HGST, and Seagate
accounted for 32%, 24%, 21%, and 16% respectively, of our
revenue. In 2004, sales to Maxtor, Western Digital , HGST, and
Seagate in 2004 accounted for 47%, 14%, 29%, and 4%
respectively, of our revenue. Our sales are concentrated among a
few customers. We expect to continue to derive a substantial
portion of our sales from Maxtor, Western Digital , HGST and
Seagate, and from a small number of other customers. In December
2005, Seagate and Maxtor announced that they entered into a
definitive agreement under which Seagate will acquire Maxtor.
The transaction is expected to be completed in the second half
of 2006.

Based on the continuing strong market demand, we expect total
revenue for the first quarter of 2006 to be at or slightly above
the $192.9 million total revenue achieved in the fourth
quarter of 2005 and revenue for the second quarter of 2006 to be
above the first quarter. This level of revenue reflects current
continuing strong demand for finished disks, as well as demand
for our substrates.

29



---



##### Table of Contents





| |             
| | ------------
| | Gross Profit

Our gross profit percentage increased 3.0 percentage points
to 27.5% in 2005, compared to 24.5% in 2004. In 2005, a positive
gross profit impact of 4.9 percentage points due to a lower
cost per disk was partially offset by a negative
1.9 percentage point impact from lower finished unit
average selling prices.



| |                                                
| | -----------------------------------------------
| | Research, Development, and Engineering Expenses

Research, development, and engineering (R&D) expenses of
$48.9 million in 2005 were $8.1 million higher than
the $40.8 million in 2004. The increase primarily reflected
higher incentive compensation expense of $5.3 million,
higher payroll costs of $1.8 million associated with an
increase in headcount in 2005, higher equipment related costs of
$1.1 million due to new equipment added to support R&D
activities, and higher deferred stock-based compensation expense
of $0.7 million. The increases were partially offset by
$1.2 million lower materials and operating costs. We expect
2006 R&D spending to be, as a percentage of sales, similar
to 2005 levels.



| |                                              
| | ---------------------------------------------
| | Selling, General, and Administrative Expenses

Selling, general, and administrative (SG&A) expenses of
$23.6 million in 2005 were $5.6 million higher
compared to the $18.0 million incurred in 2004. The
increase primarily reflected higher incentive compensation of
$2.7 million, higher deferred stock-based compensation
expense of $1.2 million and an increase in headcount and
related compensation expense of $1.6 million. We expect
2006 SG&A spending to be, as a percentage of sales, similar
to 2005 levels.



| |                           
| | --------------------------
| | Gain on Disposal of Assets

Gain on disposal of assets in 2005 was $1.7 million, and
primarily reflected the sale of a facility in Eugene, Oregon.
Gain on disposal of assets in 2004 was $1.0 million, and
primarily reflected sales of idle equipment.



| |                 
| | ----------------
| | Interest Expense

Interest expense in 2005 was $1.8 million, and reflected
interest expense on the Convertible Subordinated Notes (see
Note 9 to the consolidated financial statements). Interest
expense in 2004 was $3.2 million, and included
$1.6 million of interest expense on the Convertible
Subordinated Notes, and $1.6 million of interest expense on
the Senior Secured Notes and certain promissory notes. The
Senior Secured Notes and promissory notes were redeemed in full,
including accrued interest, in February 2004. There were no
gains or losses on the redemptions, and there were no
unamortized debt issuance costs.



| |             
| | ------------
| | Income Taxes

Our annual effective income tax rate for 2005 was 4.5% and for
2004 was 2%. The tax provision includes taxes related to our
U.S. and international operations. Our manufacturing facilities,
which are located in Malaysia, have been granted various tax
holidays with varying expiration dates. In July 2005, the
Malaysian government agreed to reset the expiration dates of the
existing tax holidays to December 2006 and approved a new,
10-year tax holiday covering all of our Malaysian operations.
The new tax holiday commences in January 2007 and expires in
December 2016.



| |                                         
| | ----------------------------------------
| | Fiscal Year 2004 versus Fiscal Year 2003



| |          
| | ---------
| | Net Sales

Consolidated net sales for 2004 were $458.4 million, a 4.6%
increase compared to $438.3 million in 2003. Our finished
unit average selling price for 2004 improved slightly compared
to 2003. The higher average selling price reflected a higher mix
of more advanced 80 GB and higher 3 1/2-inch product offerings
in 2004. Our finished unit sales volume increased to
70.7 million units in 2004 from 69.7 million units in
2003.

30



---



##### Table of Contents



Other disk sales, which generally include single-sided disks,
aluminum substrate disks, plated disks, textured disks, and
polished disks, for 2004 were $52.8 million, compared to
$44.6 million in 2003. The increase primarily reflected
higher polished disk and aluminum substrate sales, which were
partially offset by lower textured disk sales. The reduction in
textured disk sales reflected a shift by one customer from
textured disk purchases to finished disk purchases.

Sales of 80 GB and greater per platter disks in 2004 increased
to 87% of net sales, compared to 30% in 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. Sales of
100 GB and greater per platter disks represented 8.4% of
our net sales in 2004 compared to zero in 2003.

Finished disk shipments for desktop and consumer applications
together represented 91% of our unit shipment volume in 2004
compared to 93% in 2003. The remaining finished disk shipments
(9% in 2004 and 7% in 2003) were disks for enterprise drives.

Sales to Maxtor, HGST, and Western Digital in 2004 accounted for
47%, 29%, and 14%, respectively, of our revenue. In 2003, sales
to Maxtor, HGST, and Western Digital accounted for 37%, 17%, and
38%, respectively, of our revenue. Sales to Seagate were less
than 10% of our revenue for both 2004 and 2003.



| |             
| | ------------
| | Gross Profit

For 2004, our gross profit percentage remained flat at 24.5%
compared to 2003. In 2004, the positive gross profit impact of a
higher finished unit average selling price and lower unyielded
variable costs were offset by lower yield and capacity
utilization. The lower yield reflected a significant change in
mix from 40 GB to 80 GB and greater disks in 2004. All current
80 GB and greater disks, as well as enterprise disks, include
new processes and advancements that were not required in 2003.



| |                                                
| | -----------------------------------------------
| | Research, Development, and Engineering Expenses

R&D expenses of $40.8 million in 2004 were
$1.3 million lower than the $42.1 million in 2003. The
decrease primarily reflected lower incentive compensation
expense of $3.7 million and lower deferred stock-based
compensation expense of $0.7 million, partially offset by
higher payroll and related costs of $3.1 million associated
with higher 2004 headcount.



| |                                              
| | ---------------------------------------------
| | Selling, General, and Administrative Expenses

SG&A expenses of $18.0 million in 2004 were
$0.9 million lower compared to the $18.9 million
incurred in 2003. The decrease primarily reflects lower
incentive compensation of $2.0 million and lower deferred
compensation expense of $0.6 million, partially offset by
higher headcount and related compensation expense of
$0.8 million, and higher consulting fees of
$1.2 million. The increase in consulting fees primarily
reflected costs associated with complying with section 404
of the Sarbanes-Oxley Act of 2002.



| |                           
| | --------------------------
| | Gain on Disposal of Assets

Gain on disposal of assets in 2004 was $1.0 million, and
primarily reflected sales of idle equipment. Gain on disposal of
assets in 2003 was $3.0 million, including a
$1.0 million gain on the sale of our Fremont, California
land and buildings, and $2.0 million of gains on various
sales of idle manufacturing equipment.



| |                 
| | ----------------
| | Interest Expense

Interest expense in 2004 was $3.2 million, and included
$1.6 million of interest on the Senior Secured Notes and
certain promissory notes, and $1.6 million of interest
expense on the new Convertible Subordinated Notes (see
Note 9 to the consolidated financial statements). Interest
expense in 2003 was $13.2 million, and primarily
represented interest on the Senior Secured Notes, the Junior
Secured Notes, and certain promissory notes.

31



---



##### Table of Contents



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 annual effective income tax rate for 2004 was 2% and
included taxes on income generated by sales of product no longer
covered under the tax holiday at our first Malaysian plant site
as discussed below ($1.0 million) and other tax expenses
related to our U.S. and international operations (less than
$0.1 million).

In 2004 and 2003, KMS recorded tax expense of $1.0 million
and $1.5 million, respectively, related to the sale of
product no longer covered under the extended tax holiday at our
first plant site. In 2004 and 2003, we utilized
$3.5 million and $5.4 million, respectively, of
Malaysian capital allowances and net operating loss
carryforwards. Upon our reorganization on June 30, 2002, we
provided a full valuation allowance against all tax assets;
therefore, upon utilization of the capital allowances and net
operating loss carryforwards in 2004 and 2003, we reduced
intangible assets by $1.0 million and $1.5 million,
respectively. See Note 5 to the consolidated financial
statements.

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 U.S. We regularly
evaluate our estimates, including those related to our revenues,
allowance for inventories, commitments and contingencies, income
taxes, and asset impairments. We base our estimates on
historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying
values of assets and liabilities. Actual results could differ
significantly from those estimates if our assumptions are
incorrect. We believe that the following discussion addresses
our most critical accounting policies. These policies are most
important to the portrayal of our financial condition and
results and require managements most difficult, subjective
and complex judgments, often as a result of the need to make
estimates about the effect of matters that are inherently
uncertain.



| |                            
| | ---------------------------
| | Allowance for Sales Returns

We estimate our allowance for sales returns based on historical
data as well as current knowledge of product quality. We have
not experienced material differences between our estimated
reserves for sales returns and actual results. It is possible
that the failure rate on products sold could be higher than it
has 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 year
estimates in 2005.



| |                       
| | ----------------------
| | Inventory Obsolescence

Our policy is to provide for inventory obsolescence based upon
an estimated obsolescence percentage applied to the inventory
based on age, historical trends, and requirements to support
forecasted sales. In addition, and as necessary, we may provide
additional charges for future known or anticipated events. There
were no significant changes from prior year estimates in 2005.

Liquidity and Capital Resources

Cash, cash equivalents, and short-term investments of
$205.0 million at the end of 2005 increased by
$100.9 million from the end of 2004. The increase primarily
reflected a $245.5 million increase resulting from

32



---



##### Table of Contents





On July 21, 2005, Malaysia removed its currency peg to the
U.S. dollar in favor of a managed float system. As of
January 1, 2006, we held approximately $34.9 million
(Malaysian ringgit 131.8 million) of cash and cash
equivalents that were denominated in Malaysian ringgit.

Consolidated operating activities generated $245.5 million
in cash in 2005. The primary components of this change include
the following:



| |   |                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | net income of $115.6 million, net of non-cash depreciation
    and amortization of property, plant and equipment of
    $44.5 million and other non-cash charges and gains of
    $10.6 million;           
|
| |  | an accounts receivable increase of $37.0 million, which
    primarily reflected an increase in sales in 2005 compared to
    2004;                                                                         
|
| |  | an inventory increase of $18.2 million, which primarily
    reflected increased inventory to support increased production
    and sales volumes;                                                           
|
| |  | an accounts payable increase of $18.7 million, which
    primarily reflected increased spending for inventory and other
    costs to support our increased level of operations; and                        
|
| |  | a customer advance, accrued expenses, and other liabilities
    increase of $111.3 million, which primarily reflected the
    receipt of customer advances, and higher incentive compensation
    accruals.

Our total capital spending in 2005 was $191.7 million (on
an accrual basis), and included capital expenditures to increase
our substrate and finished disk capacity, to improve our
equipment capability for the manufacture of advanced products,
and for projects designed to improve yield and productivity. We
had approximately $9.2 million of non-cancelable capital
commitments as of January 1, 2006. In 2006, we plan to
spend approximately $250 million to $300 million on
property, plant, and equipment to increase our finished disk and
related substrate capacity and continue to ramp new production
processes. We expect to fund this capital spending with cash
from operations and customer advances.

We have $80.5 million of 2% Convertible Subordinated
Notes (the Notes) outstanding. The Notes mature on
February 1, 2024, bear interest at 2.0%, and require
semiannual interest payments, which began on August 1,
2004. The Notes will be convertible, under certain
circumstances, into shares of our common stock based on an
initial effective conversion price of $26.40. Holders of the
Notes may convert the Notes into shares of our common stock
prior to maturity if: 1) the sale price of our common stock
equals or exceeds $31.68 for at least 20 trading days in any 30
consecutive trading day period within any of our fiscal
quarters; 2) the trading price of the Notes falls
below a specified threshold prior to February 19, 2019;
3) the Notes have been called for redemption; or
4) certain specified corporate transactions (as described
in the offering prospectus for the Notes) occur. The conditions
for conversion have been met, and the debt is currently
convertible. We may redeem the Notes on or after
February 6, 2007, at specified declining redemption
premiums. Holders of the Notes may require us to purchase the
Notes on February 1, 2011, 2014, or 2019, or upon the
occurrence of a fundamental change, at a purchase price equal to
100% of the principal amount of the Notes, plus accrued and
unpaid interest. There are no financial covenants, guarantees,
or collateral associated with the Notes.

We have a Malaysian ringgit 12.5 million (approximately
$3.3 million) bank guarantee. There is no expiration date
on the bank guarantee. No interest will be charged on the bank
guarantee, but there is a commission of 0.05% on the amount of
bank guarantee utilized. As of January 1, 2006, there were
no liabilities outstanding related to this bank guarantee.

As of January 1, 2006, we had a Malaysian ringgit
2.0 million (approximately $0.5 million) stand-by
letter of credit (LOC). This LOC expired in January 2006. The
LOC was secured by fixed deposits of Malaysian ringgit
2.0 million.

33



---



##### Table of Contents



We lease our research and administrative facility in
San Jose, California under an operating lease, which
expires in 2014. Additionally, we lease certain equipment under
operating leases. These leases expire on various dates through
2010. We have no capital leases.

As of January 1, 2006, our long-term debt obligations,
operating lease obligations, and unconditional purchase
obligations were as follows (in thousands):

|                                      |                                    |      |        |        |  |      |       |       |  |      |       |            |  |       |       |       |  |   |       |       |  |   |        |        |  |   |        |         | 
|------------------------------------- | ---------------------------------- | ---- | ------ | ------ |  | ---- | ----- | ----- |  | ---- | ----- | ---------- |  | ----- | ----- | ----- |  | - | ----- | ----- |  | - | ------ | ------ |  | - | ------ | ------- | 
|                                      |                                    | 2006 |        | 2007   |  | 2008 |       | 2009  |  | 2010 |       | Thereafter |  | Total
|                                      |                                    |      |        |        |  |      |       |       |  |      |       |            |  |      
|Long-Term Debt Obligations            |                                    | $    |       |        |  | $    |      |       |  | $    |      |            |  | $     |      |       |  | $ |      |       |  | $ | 80,500 |        |  | $ | 80,500 |        
|                                     
|                                     
|                                     
|                                     
|Operating Lease Obligations           |                                    |      | 2,254  |        |  |      | 2,055 |       |  |      | 2,047 |            |  |       | 3,149 |       |  |   | 3,143 |       |  |   | 13,241 |        |  |   | 25,889 |        
|                                     
|                                     
|                                     
|                                     
|Unconditional Purchase Obligations(1) |                                    |      | 10,647 |        |  |      | 1,203 |       |  |      | 1,162 |            |  |       | 1,162 |       |  |   | 1,162 |       |  |   | 2,017  |        |  |   | 17,353 |        
|                                      |                                    |      |        |        |  |      |       |       |  |      |       |            |  |       |       |       |  |   |       |       |  |   |        |        |  |   |        |        
|                                      | Total Contractual Cash Obligations |      | $      | 12,901 |  |      | $     | 3,258 |  |      | $     | 3,209      |  |       | $     | 4,311 |  |   | $     | 4,305 |  |   | $      | 95,758 |  |   | $      | 123,742 | 
|                                      |                                    |      |        |        |  |      |       |       |  |      |       |            |  |       |       |       |  |   |       |       |  |   |        |        |  |   |        |        



---



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

There was approximately $9.2 million of non-cancelable
capital commitments as of January 1, 2006. This amount is
included in the table above under Unconditional Purchase
Obligations.

Based on current operating forecasts, we estimate that the cash
balance and cash from operations and customer advances will be
adequate to support our continuing operations, capital spending
plan, and interest payments for at least the next twelve months.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements or
transactions.

Other

In December 2004, the FASB issued SFAS No. 123R,
Share-Based Payment(SFAS 123R). SFAS 123R is a
revision of SFAS 123, which addresses financial accounting
and reporting for costs associated with stock-based
compensation. SFAS 123 addresses all forms of share-based
payment (SBP) awards, including shares issued under
employee stock purchase plans, stock options, restricted stock,
and stock appreciation rights. SFAS 123R requires us to
adopt the new accounting provisions beginning in its first
quarter of 2006, and applies to all outstanding and unvested SBP
awards at our adoption date. We are allowed to select one of two
alternative transition methods, each having different reporting
implications. The Company has chosen the modified-prospective
method. On March 29, 2005, the SEC issued Staff Accounting
Bulletin No. 107 (SAB 107) on SFAS 123R to
assist preparers by simplifying some of the implementation
challenges of SFAS 123R. We have not completed our
evaluation or determined the impact of adopting SFAS 123R.
However, we expect the adoption to have a significant impact on
our net income and net income per share.

In December 2004, the FASB issued SFAS No. 151
(SFAS 151), Inventory Costs. SFAS 151 clarifies
the accounting for inventory when there are abnormal amounts of
idle facility expense, freight, handling costs, and wasted
materials. Under existing generally accepted accounting
principles, items such as idle facility expense, excessive
spoilage, double freight, and re-handling costs may be so
abnormal as to require treatment as current period charges
rather than recorded as adjustments to the value of the
inventory. SFAS 151 requires that those items be recognized
as current-period charges regardless of whether they meet the
criterion of so abnormal. In addition, this
Statement requires that allocation of fixed production overheads
to the costs of conversion be based on the normal capacity of
the production facilities. The provisions of this Statement are
effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. Earlier application is
permitted for inventory costs incurred during fiscal years
beginning after

34



---



##### Table of Contents





In March 2005, the FASB issued FIN 47 as an interpretation
of FASB Statement No. 143, Accounting for Asset
Retirement Obligations(SFAS 143). This interpretation
clarifies that the term conditional asset retirement obligation
as used in SFAS 143, refers to a legal obligation to
perform an asset retirement activity in which the timing and/or
method of settlement are conditional on a future event that may
or may not be within the control of the entity. The obligation
to perform the asset retirement activity is unconditional even
though uncertainty exists about the timing and/or method of
settlement. Accordingly, an entity is required to recognize a
liability for the fair value of a conditional asset retirement
obligation if the fair value of the liability can be reasonably
estimated. This interpretation also clarifies when an entity
would have sufficient information to reasonably estimate the
fair value of an asset retirement obligation. The Company
adopted FIN 47 in fiscal 2005. The adoption of this
standard did not have a material impact on the Companys
financial position or results of operations.

In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections(SFAS 154).
SFAS 154 replaces APB No. 20 and FASB Statement
No. 3. SFAS 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections.
It establishes retrospective application as the required method
for reporting a change in accounting principle. SFAS 154
provides guidance for determining whether retrospective
application of a change in accounting principle is impracticable
and for reporting a change when retrospective application is
impracticable. The reporting of a correction of an error by
restating previously issued financial statements is also
addressed by SFAS 154. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. We adopted this
pronouncement as of January 2, 2006.






|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market
    Risk

The primary objective of our investment activities is to
preserve principal while at the same time maximizing yields
without significantly increasing risk. We invest primarily in
high-quality, short-term debt instruments and auction rate
preferred securities (which we roll over every three months or
less), which are accounted for as cash equivalents or short-term
investments, depending on the period of time from the purchase
date to the maturity date. The fair value of these securities
approximated their carrying amounts at January 1, 2006.

We are exposed to foreign currency exchange rate risk. A
majority of our revenue, expense, and capital purchasing
activities is transacted in U.S. dollars. However, a large
portion of our payroll, certain manufacturing and operating
expenses, and inventory and capital purchases is transacted in
the Malaysian ringgit (ringgit). For approximately seven years
prior to July 2005, the exchange rate between the ringgit and
the U.S. dollar has been pegged at 3.8 ringgits to one
U.S. dollar by the Malaysian government. On July 21,
2005, Malaysia removed its currency peg to the U.S. dollar
in favor of a managed float system. Changes in exchange rates
could adversely affect the amount we spend on our payroll,
certain manufacturing and operating expenses, and raw materials
and capital purchases. In 2005, our U.S. dollar-equivalent
spending on payroll, manufacturing and operating expenses, and
raw materials and capital purchases that were denominated in
ringgit was approximately $232.7 million. Additionally, we
paid approximately $78.6 million denominated in Malaysian
ringgit to a Malaysian supplier for raw materials purchases in
2005, based on a cost plus a percentage arrangement. The
Malaysian supplier incurs certain costs denominated in ringgit;
therefore, any change in the valuation of the ringgit could
impact the cost per unit we pay for such raw materials. As of
January 1, 2006, we held approximately $34.5 million
(Malaysian ringgit 131.4 million) of cash and cash
equivalents that were denominated in Malaysian ringgit.

In late September 2005, we began to hedge some of our foreign
currency risk related to anticipated foreign currency
denominated equipment purchases by entering into foreign
exchange forward contracts that generally have maturities of
12 months or less. As of October 3, 2005 these
transactions were designated and qualify as cash flow hedges in
accordance with SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities(SFAS 133). The derivatives associated with our hedging
activities are marked to market

35



---



##### Table of Contents





As of January 1, 2006, we had foreign exchange contracts to
purchase approximately $7.4 million of Japanese Yen. The
fair value of our outstanding forward contracts was recorded as
a $0.4 million other current liability as of
January 1, 2006. The counterparty to these forward
contracts is a creditworthy multinational commercial bank. The
risks of counterparty nonperformance associated with these
contracts are not considered to be material. Notwithstanding our
efforts to mitigate some foreign currency exchange rate risks,
there can be no assurances that our mitigating activities will
adequately protect us against the risks associated with foreign
currency fluctuations.

We have $80.5 million in convertible subordinated notes
outstanding. As of January 1, 2006, these notes were
convertible into approximately 3.0 million shares of common
stock. 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.

36



---



##### Table of Contents








|        |                                                             
|------- | ------------------------------------------------------------
|Item 8. | Consolidated Financial Statements and Supplementary
    Data

KOMAG, INCORPORATED

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                             |  |   
|---------------------------------------------------------------------------- |  | --
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Reports of Independent
    Registered Public Accounting Firm                 |  | 38
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Consolidated Statements of
    Income                                        |  | 40
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Consolidated Balance
    Sheets                                              |  | 41
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Consolidated Statements of
    Cash Flows                                    |  | 42
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Consolidated Statements of
    Stockholders Equity and Comprehensive Income |  | 43
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Notes to Consolidated
    Financial Statements                               |  | 44

37



---



##### Table of Contents






Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders



We have audited the accompanying consolidated balance sheets of
Komag, Incorporated and subsidiaries (the Company) as of
January 1, 2006 and January 2, 2005 and the related
consolidated statements of income, stockholders equity and
comprehensive income, and cash flows for each of the years in
the three-year period ended January 1, 2006. In connection
with our audits of the consolidated financial statements, we
also have audited financial statement Schedule II. These
consolidated financial statements and financial statement
schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Komag, Incorporated and subsidiaries as of
January 1, 2006 and January 2, 2005, and the results
of their operations and their cash flows for each of the years
in the three-year period ended January 1, 2006, in
conformity with U.S. generally accepted accounting
principles. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.

We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
effectiveness of Komag, Incorporateds internal control
over financial reporting as of January 1, 2006, based on
criteria established in Internal Control 
Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), and our report
dated March 6, 2006 expressed an unqualified opinion on
managements assessment of, and the effective operation of,
internal control over financial reporting.



| |         
| | --------
| | KPMG LLP

San Francisco, California



38



---



##### Table of Contents



Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders



We have audited managements assessment, included in the
accompanying Managements Report on Internal Control
over Financial Reportingthat Komag, Incorporated (the
Company) maintained effective internal control over financial
reporting as of January 1, 2006, based on criteria
established in Internal Control  Integrated
Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The
Companys management is responsible for maintaining
effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion
on managements assessment and an opinion on the
effectiveness of the Companys internal control over
financial reporting based on our audit.

We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal
control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating
managements assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinion.

A companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A companys
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
companys assets that could have a material effect on the
financial statements.

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

In our opinion, managements assessment that Komag,
Incorporated maintained effective internal control over
financial reporting as of January 1, 2006, is fairly
stated, in all material respects, based on criteria established
in Internal Control  Integrated Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Also, in our opinion, the Company
maintained, in all material respects, effective internal control
over financial reporting as of January 1, 2006, based on
criteria established in Internal Control 
Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Komag, Incorporated and
subsidiaries as of January 1, 2006 and January 2,
2005, and the related consolidated statements of income,
stockholders equity and comprehensive income, and cash
flows for each of the years in the three-year period ended
January 1, 2006. In connection with our audits of the
consolidated financial statements, we also have audited
financial statement Schedule II. Our report dated
March 6, 2006 expressed an unqualified opinion on those
consolidated financial statements and related financial
statement schedule.



| |         
| | --------
| | KPMG LLP

San Francisco, California



39



---



##### Table of Contents



KOMAG, INCORPORATED




CONSOLIDATED STATEMENTS OF INCOME

|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |         |        | 
|----------------------------------------------------------- | -------------------------------------- | ---------------------------------------- | ------- | --------------- | ------- | ----------------- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                                                            |                                        |                                         
|                                                            |                                        | Year Ended                              
|                                                            |                                        |                                         
|                                                            |                                        | January 1, 2006                          |         | January 2, 2005 |         | December 28, 2003
|                                                            |                                        |                                          |         |                 |         |                  
|                                                            |                                        |                                         
|                                                            |                                        | (In thousands, except per share amounts)
|                                                           
|                                                           
|                                                           
|                                                           
|Net sales                                                   |                                        | $                                        | 685,946 |                 |         | $                 | 458,377 |         |        | $ | 438,292 |        
|                                                           
|                                                           
|                                                           
|                                                           
|Cost of sales                                               |                                        |                                          | 497,213 |                 |         |                   | 346,260 |         |        |   | 330,870 |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                            | Gross profit                           |                                          |         | 188,733         |         |                   |         | 112,117 |        |   |         | 107,422 |       
|                                                           
|                                                           
|                                                           
|                                                           
|Operating expenses:                                         |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Research, development, and engineering |                                          |         | 48,873          |         |                   |         | 40,783  |        |   |         | 42,085  |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Selling, general, and administrative   |                                          |         | 23,622          |         |                   |         | 17,980  |        |   |         | 18,939  |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Gain on disposal of assets             |                                          |         | (1,694          | )       |                   |         | (1,028  | )      |   |         | (3,021  | )     
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                            |                                        |                                          | 70,801  |                 |         |                   | 57,735  |         |        |   | 58,003  |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                            |                                        | Operating income                         |         |                 | 117,932 |                   |         |         | 54,382 |   |         |         | 49,419 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Other income (expense):                                     |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Interest income                        |                                          |         | 5,327           |         |                   |         | 1,371   |        |   |         | 524     |       
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Interest expense                       |                                          |         | (1,765          | )       |                   |         | (3,176  | )      |   |         | (13,153 | )     
|                                                           
|                                                           
|                                                           
|                                                           
|                                                            | Other income (expense), net            |                                          |         | (415            | )       |                   |         | (151    | )      |   |         | 250     |       
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                            |                                        |                                          | 3,147   |                 |         |                   | (1,956  | )       |        |   | (12,379 | )      
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|Income before income taxes                                  |                                        |                                          | 121,079 |                 |         |                   | 52,426  |         |        |   | 37,040  |        
|                                                           
|                                                           
|                                                           
|                                                           
|Provision for income taxes                                  |                                        |                                          | 5,442   |                 |         |                   | 1,071   |         |        |   | 1,000   |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|                                                            |                                        | Net income                               |         | $               | 115,637 |                   |         | $       | 51,355 |   |         | $       | 36,040 | 
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|Basic net income per share                                  |                                        | $                                        | 3.99    |                 |         | $                 | 1.88    |         |        | $ | 1.53    |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|Diluted net income per share                                |                                        | $                                        | 3.55    |                 |         | $                 | 1.71    |         |        | $ | 1.47    |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|Number of shares used in basic per share
    computations   |                                        |                                          | 29,003  |                 |         |                   | 27,384  |         |        |   | 23,504  |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        
|Number of shares used in diluted per share
    computations |                                        |                                          | 33,042  |                 |         |                   | 31,017  |         |        |   | 24,518  |        
|                                                            |                                        |                                          |         |                 |         |                   |         |         |        |   |         |        

See accompanying notes to consolidated financial statements.

40



---



##### Table of Contents



KOMAG, INCORPORATED




CONSOLIDATED BALANCE SHEETS

|                                         |                                                                              |                                                                     |                            |                 |     |         |         |         |     |         | 
|---------------------------------------- | ---------------------------------------------------------------------------- | ------------------------------------------------------------------- | -------------------------- | --------------- | --- | ------- | ------- | ------- | --- | ------- | 
|                                         |                                                                              | January 1, 2006                                                     |                            | January 2, 2005
|                                         |                                                                              |                                                                     |                            |                
|                                         |                                                                              |                                                                    
|                                         |                                                                              | (In thousands)                                                     
|                                        
|                                        
|                                        
|                                        
|ASSETS                                  
|Current assets                           |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                        
|                                        
|                                        
|                                        
|                                         | Cash and cash equivalents                                                    |                                                                     | $                          | 99,984          |     |         | $       | 26,410  |    
|                                        
|                                        
|                                        
|                                        
|                                         | Short-term investments                                                       |                                                                     |                            | 105,050         |     |         |         | 77,700  |    
|                                        
|                                        
|                                        
|                                        
|                                         | Accounts receivable (less allowances of $2,866
    and $1,075, respectively) |                                                                     |                            | 116,217         |     |         |         | 79,213  |    
|                                        
|                                        
|                                        
|                                        
|                                         | Inventories                                                                  |                                                                     |                            | 54,000          |     |         |         | 35,815  |    
|                                        
|                                        
|                                        
|                                        
|                                         | Prepaid expenses and deposits                                                |                                                                     |                            | 1,846           |     |         |         | 1,815   |    
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                         |                                                                              |                                                                     | Total current assets       |                 |     | 377,097 |         |         |     | 220,953 | 
|                                        
|                                        
|                                        
|                                        
|Property, plant, and equipment, net      |                                                                              |                                                                     | 351,046                    |                 |     |         | 205,642 |        
|                                        
|                                        
|                                        
|                                        
|Other assets                             |                                                                              |                                                                     | 3,308                      |                 |     |         | 4,500   |        
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                         |                                                                              | $                                                                   | 731,451                    |                 |     | $       | 431,095 |        
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                        
|                                        
|                                        
|                                        
|                                        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities                      |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                        
|                                        
|                                        
|                                        
|                                         | Trade accounts payable                                                       |                                                                     | $                          | 97,901          |     |         | $       | 43,082  |    
|                                        
|                                        
|                                        
|                                        
|                                         | Customer advances                                                            |                                                                     |                            | 102,898         |     |         |         |        |    
|                                        
|                                        
|                                        
|                                        
|                                         | Accrued expenses and other liabilities                                       |                                                                     |                            | 28,585          |     |         |         | 19,887  |    
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                         |                                                                              |                                                                     | Total current liabilities  |                 |     | 229,384 |         |         |     | 62,969  | 
|                                        
|                                        
|                                        
|                                        
|Long-term debt                           |                                                                              |                                                                     | 80,500                     |                 |     |         | 80,500  |        
|                                        
|                                        
|                                        
|                                        
|Deferred rent                            |                                                                              |                                                                     | 2,562                      |                 |     |         |        |        
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                         |                                                                              |                                                                     | Total liabilities          |                 |     | 312,446 |         |         |     | 143,469 | 
|Stockholders equity                     |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                        
|                                        
|                                        
|                                        
|                                         | Common stock, $0.01 par value per share:                                     |                                                                     |                            |                 |     |         |         |         |    
|                                         |                                                                              | Authorized  50,000 shares                                          |                            |                 |     |         |         |         |     |        
|                                        
|                                        
|                                        
|                                        
|                                         |                                                                              | Issued and outstanding  30,092 and
    28,065 shares, respectively |                            |                 | 301 |         |         |         | 281 |        
|                                        
|                                        
|                                        
|                                        
|                                         | Additional paid-in capital                                                   |                                                                     |                            | 267,920         |     |         |         | 241,960 |    
|                                        
|                                        
|                                        
|                                        
|                                         | Deferred stock-based compensation                                            |                                                                     |                            | (9,695          | )   |         |         | (91     | )  
|                                        
|                                        
|                                        
|                                        
|                                         | Accumulated other comprehensive loss                                         |                                                                     |                            | (634            | )   |         |         |        |    
|                                        
|                                        
|                                        
|                                        
|                                         | Retained earnings                                                            |                                                                     |                            | 161,113         |     |         |         | 45,476  |    
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                         |                                                                              |                                                                     | Total stockholders equity |                 |     | 419,005 |         |         |     | 287,626 | 
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        
|                                         |                                                                              | $                                                                   | 731,451                    |                 |     | $       | 431,095 |        
|                                         |                                                                              |                                                                     |                            |                 |     |         |         |        

See accompanying notes to consolidated financial statements.

41



---



##### Table of Contents



KOMAG, INCORPORATED




CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |         |         |  
|------------------------------------------------------------------------------------- | ------------------------------------------------------------------- | ------------------------------------------------------- | -------- | --------------- | -------- | ----------------- | -------- | ------- | ------- | - | ------- | ------- | ------- | -
|                                                                                      |                                                                     |                                                        
|                                                                                      |                                                                     | Year Ended                                             
|                                                                                      |                                                                     |                                                        
|                                                                                      |                                                                     | January 1, 2006                                         |          | January 2, 2005 |          | December 28, 2003
|                                                                                      |                                                                     |                                                         |          |                 |          |                  
|                                                                                      |                                                                     |                                                        
|                                                                                      |                                                                     | (In thousands)                                         
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Operating Activities                                                                  |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Net income                                                                            |                                                                     | $                                                       | 115,637  |                 |          | $                 | 51,355   |         |         | $ | 36,040  |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Adjustments to reconcile net income to net cash
    provided by operating activities: |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Depreciation and amortization of property, plant,
    and equipment |                                                         |          | 44,519          |          |                   |          | 37,086  |         |   |         | 38,625  |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Tax adjustments to additional paid-in capital                       |                                                         |          | 5,194           |          |                   |          |        |         |   |         |        |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Amortization and adjustments of intangible assets                   |                                                         |          | 1,072           |          |                   |          | 3,023   |         |   |         | 5,256   |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Stock-based compensation                                            |                                                         |          | 3,308           |          |                   |          | 555     |         |   |         | 1,980   |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Deferred rent                                                       |                                                         |          | 2,562           |          |                   |          |        |         |   |         |        |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Non-cash interest charges                                           |                                                         |          | 154             |          |                   |          | 436     |         |   |         | 6,657   |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Gain on disposal of assets                                          |                                                         |          | (1,694          | )        |                   |          | (1,028  | )       |   |         | (3,021  | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Changes in operating assets and liabilities:                                          |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Accounts receivable, net                                            |                                                         |          | (37,004         | )        |                   |          | (18,585 | )       |   |         | (14,387 | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Inventories                                                         |                                                         |          | (18,185         | )        |                   |          | (10,314 | )       |   |         | (10,576 | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Prepaid expenses and deposits                                       |                                                         |          | (31             | )        |                   |          | 221     |         |   |         | (468    | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Trade accounts payable                                              |                                                         |          | 18,741          |          |                   |          | 3,338   |         |   |         | 4,746   |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Customer advances                                                   |                                                         |          | 102,898         |          |                   |          |        |         |   |         |        |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      | Accrued expenses and other liabilities                              |                                                         |          | 8,353           |          |                   |          | (4,820  | )       |   |         | 11,337  |        
|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                      |                                                                     | Net cash provided by operating activities               |          |                 | 245,524  |                   |          |         | 61,267  |   |         |         | 76,189  |  
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Investing Activities                                                                  |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Acquisition of property, plant, and equipment                                         |                                                                     |                                                         | (155,613 | )               |          |                   | (59,202  | )       |         |   | (25,892 | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Purchases of short-term investments                                                   |                                                                     |                                                         | (282,450 | )               |          |                   | (157,000 | )       |         |   | (72,150 | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from short-term investments                                                  |                                                                     |                                                         | 255,100  |                 |          |                   | 122,150  |         |         |   | 32,300  |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from disposal of property, plant, and
    equipment                          |                                                                     |                                                         | 3,173    |                 |          |                   | 2,038    |         |         |   | 26,766  |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Other                                                                                 |                                                                     |                                                         | (34      | )               |          |                   | (257     | )       |         |   | (372    | )      
|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                      |                                                                     | Net cash used in investing activities                   |          |                 | (179,824 | )                 |          |         | (92,271 | ) |         |         | (39,348 | )
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Financing Activities                                                                  |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Payment of debt                                                                       |                                                                     |                                                         |         |                 |          |                   | (116,341 | )       |         |   | (30,761 | )      
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from the issuance of long-term debt                                          |                                                                     |                                                         |         |                 |          |                   | 77,419   |         |         |   |        |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Proceeds from sale of common stock, net of
    issuance costs                         |                                                                     |                                                         | 7,874    |                 |          |                   | 69,128   |         |         |   | 608     |        
|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                      |                                                                     | Net cash provided by (used in) financing
    activities |          |                 | 7,874    |                   |          |         | 30,206  |   |         |         | (30,153 | )
|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|Increase (decrease) in cash and cash equivalents                                      |                                                                     |                                                         | 73,574   |                 |          |                   | (798     | )       |         |   | 6,688   |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|Cash and cash equivalents at beginning of year                                        |                                                                     |                                                         | 26,410   |                 |          |                   | 27,208   |         |         |   | 20,520  |        
|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                      |                                                                     | Cash and cash equivalents at end of year                |          | $               | 99,984   |                   |          | $       | 26,410  |   |         | $       | 27,208  |  
|                                                                                      |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|Supplemental disclosure of cash flow
    information                                  |                                                                     |                                                         |          |                 |          |                   |          |         |         |   |         |        
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                                     | Cash paid for interest                                  |          | $               | 1,611    |                   |          | $       | 2,739   |   |         | $       | 6,549   |  
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                     
|                                                                                      |                                                                     | Cash paid for income taxes                              |          | $               | 541      |                   |          | $       | 331     |   |         | $       | 25      |  

See accompanying notes to consolidated financial statements.

42



---



##### Table of Contents





KOMAG, INCORPORATED




CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND

COMPREHENSIVE INCOME


|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |       |         |   |  |   |         |   |  |   |      |   |  |   |         |         | 
|------------------------------------------------- | -------------------- | -------------- | ------ | ---------- |  | ----------- | --- | ------------ |  | ------------- | ------- | ---- |  | ----- | ------- | - |  | - | ------- | - |  | - | ---- | - |  | - | ------- | ------- | 
|                                                  |                      |                |        |            |  |             |     | Retained     |  | Accumulated   |         |     
|                                                  |                      | Common Stock   |        | Additional |  | Deferred    |     | Earnings     |  | Other         |         |     
|                                                  |                      |                |        | Paid-in    |  | Stock-Based |     | (Accumulated |  | Comprehensive |         |     
|                                                  |                      | Shares         |        | Amount     |  | Capital     |     | Compensation |  | Deficit)      |         | Loss |  | Total
|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |      
|                                                  |                      |               
|                                                  |                      | (In thousands)
|                                                 
|                                                 
|                                                 
|                                                 
|Balance at December 29, 2002                      |                      |                | 23,172 |            |  | $           | 232 |              |  | $             | 171,876 |      |  | $     | (2,229  | ) |  | $ | (41,919 | ) |  | $ |     |   |  | $ | 127,960 |        
|                                                 
|                                                 
|                                                 
|                                                 
|Net income                                        |                      |                |       |            |  |             |    |              |  |               |        |      |  |       |        |   |  |   | 36,040  |   |  |   |     |   |  |   | 36,040  |        
|                                                 
|                                                 
|                                                 
|                                                 
|Deferred stock-based compensation                 |                      |                |       |            |  |             |    |              |  |               | (21     | )    |  |       | 21      |   |  |   |        |   |  |   |     |   |  |   |        |        
|                                                 
|                                                 
|                                                 
|                                                 
|Stock-based compensation                          |                      |                |       |            |  |             |    |              |  |               |        |      |  |       | 1,980   |   |  |   |        |   |  |   |     |   |  |   | 1,980   |        
|                                                 
|                                                 
|                                                 
|                                                 
|Common stock issued under stock plans             |                      |                | 581    |            |  |             | 6   |              |  |               | 602     |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 608     |        
|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |       |         |   |  |   |         |   |  |   |      |   |  |   |         |        
|Balance at December 28, 2003                      |                      |                | 23,753 |            |  |             | 238 |              |  |               | 172,457 |      |  |       | (228    | ) |  |   | (5,879  | ) |  |   |     |   |  |   | 166,588 |        
|                                                 
|                                                 
|                                                 
|                                                 
|Net income                                        |                      |                |       |            |  |             |    |              |  |               |        |      |  |       |        |   |  |   | 51,355  |   |  |   |     |   |  |   | 51,355  |        
|                                                 
|                                                 
|                                                 
|                                                 
|Issuance of common stock, net of issuance costs   |                      |                | 3,525  |            |  |             | 35  |              |  |               | 66,356  |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 66,391  |        
|                                                 
|                                                 
|                                                 
|                                                 
|Deferred stock-based compensation                 |                      |                |       |            |  |             |    |              |  |               | 252     |      |  |       | (252    | ) |  |   |        |   |  |   |     |   |  |   |        |        
|                                                 
|                                                 
|                                                 
|                                                 
|Stock-based compensation                          |                      |                |       |            |  |             |    |              |  |               | 166     |      |  |       | 389     |   |  |   |        |   |  |   |     |   |  |   | 555     |        
|                                                 
|                                                 
|                                                 
|                                                 
|Exercise of warrants                              |                      |                | 90     |            |  |             | 1   |              |  |               | 1       |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 2       |        
|                                                 
|                                                 
|                                                 
|                                                 
|Common stock issued under stock plans             |                      |                | 697    |            |  |             | 7   |              |  |               | 2,728   |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 2,735   |        
|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |       |         |   |  |   |         |   |  |   |      |   |  |   |         |        
|Balance at January 2, 2005                        |                      |                | 28,065 |            |  |             | 281 |              |  |               | 241,960 |      |  |       | (91     | ) |  |   | 45,476  |   |  |   |     |   |  |   | 287,626 |        
|                                                 
|                                                 
|                                                 
|                                                 
|Net income                                        |                      |                |       |            |  |             |    |              |  |               |        |      |  |       |        |   |  |   | 115,637 |   |  |   |     |   |  |   | 115,637 |        
|                                                 
|                                                 
|                                                 
|                                                 
|Unrealized loss on cash flow hedging arrangements |                      |                |       |            |  |             |    |              |  |               |        |      |  |       |        |   |  |   |        |   |  |   | (634 | ) |  |   | (634    | )      
|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |       |         |   |  |   |         |   |  |   |      |   |  |   |         |        
|                                                  | Comprehensive income |                |        |           |  |             |     |             |  |               |         |     |  |       |         |  |  |   |         |  |  |   |      |  |  |   |         | 115,003 | 
|                                                 
|                                                 
|                                                 
|                                                 
|Deferred stock-based compensation                 |                      |                |       |            |  |             |    |              |  |               | 12,769  |      |  |       | (12,769 | ) |  |   |        |   |  |   |     |   |  |   |        |        
|                                                 
|                                                 
|                                                 
|                                                 
|Stock-based compensation                          |                      |                |       |            |  |             |    |              |  |               | 143     |      |  |       | 3,165   |   |  |   |        |   |  |   |     |   |  |   | 3,308   |        
|                                                 
|                                                 
|                                                 
|                                                 
|Income tax adjustments                            |                      |                |       |            |  |             |    |              |  |               | 5,194   |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 5,194   |        
|                                                 
|                                                 
|                                                 
|                                                 
|Exercise of warrants                              |                      |                | 604    |            |  |             | 6   |              |  |               | 2,103   |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 2,109   |        
|                                                 
|                                                 
|                                                 
|                                                 
|Common stock issued under stock plans             |                      |                | 1,423  |            |  |             | 14  |              |  |               | 5,751   |      |  |       |        |   |  |   |        |   |  |   |     |   |  |   | 5,765   |        
|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |       |         |   |  |   |         |   |  |   |      |   |  |   |         |        
|Balance at January 1, 2006                        |                      |                | 30,092 |            |  | $           | 301 |              |  | $             | 267,920 |      |  | $     | (9,695  | ) |  | $ | 161,113 |   |  | $ | (634 | ) |  | $ | 419,005 |        
|                                                  |                      |                |        |            |  |             |     |              |  |               |         |      |  |       |         |   |  |   |         |   |  |   |      |   |  |   |         |        

See accompanying notes to consolidated financial statements.

43



---



##### Table of Contents






KOMAG, INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



|        |                                                          
|------- | ---------------------------------------------------------
|Note 1. | Basis of Presentation and Significant Accounting Policies

Company Business: The Company is a leading independent
supplier of thin-film disks, the primary high-capacity storage
medium for digital data in computers and consumer electronic
appliances. Since it was founded in 1983, the Company has been
an industry leader in production volume and technology for
thin-film disks.

Consolidation: The consolidated financial statements
include the accounts of the Company and its majority-owned
subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.

Fiscal Year: The Company uses a 52-53 week fiscal
year ending on the Sunday closest to December 31. The
Companys 2003 and 2005 fiscal years were 52-week years.
The Companys 2004 fiscal year was a 53-week year;
accordingly, the additional week in 2004 was included in the
Companys first quarter of 2004.

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

Reclassification: Certain amounts in fiscal 2004 as
reported on the Consolidated Balance Sheet and Consolidated
Statements of Cash Flows have been reclassified to conform to
the current year presentation. The Company reclassified
$77.7 million in auction rate securities from cash and cash
equivalents to short-term investments on the Consolidated
Balance Sheet as of January 2, 2005. The Company also
reclassified $42.9 million and $3.0 million in auction
rate securities from cash and cash equivalents to short-term
investments as of December 28, 2003 and December 29,
2002, respectively. These reclassifications decreased cash flows
from investing activities by $34.9 million and
$39.9 million in the Consolidated Statements of Cash Flows
for the years ended January 2, 2005 and December 28,
2003, respectively. The reclassification to short-term
investments is based on the latest interpretation of cash
equivalents pursuant to Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standards
(SFAS) No. 95, Statement of Cash Flows.

Foreign Currency Translation: The Companys
functional currency for its Malaysian operations is the
U.S. dollar. Remeasurement gains and losses resulting from
the process of remeasuring these foreign currency financial
statements into U.S. dollars are included in operations.

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

44



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Short-Term Investments: The Company invests its excess
cash in high-quality, short-term debt instruments and auction
rate preferred securities (which the Company rolls over every
three months or less). At January 1, 2006, all short-term
investments are designated as available for sale. Interest and
dividends on the investments are included in interest income.
The cost of the Companys investments approximates fair
value. The information in the following table (in thousands)
reflects a summary of the Companys investments by major
security type at amortized cost, which approximates fair value:

|                                              |  |                   |         |      |  |   |        | 
|--------------------------------------------- |  | ----------------- | ------- | ---- |  | - | ------ | 
|                                              |  |                  
|                                              |  | Fiscal Year Ended
|                                              |  |                  
|                                              |  | 2005              |         | 2004
|                                              |  |                   |         |     
|Municipal auction rate preferred securities   |  | $                 | 105,050 |      |  | $ | 77,700 | 
|                                             
|                                             
|                                             
|                                             
|Corporate debt securities                     |  |                   | 73,168  |      |  | $ | 4,053  | 
|                                             
|                                             
|                                             
|                                             
|Mortgage-backed securities                    |  |                   | 13,527  |      |  |   | 15,962 | 
|                                              |  |                   |         |      |  |   |        | 
|                                              |  | $                 | 191,745 |      |  | $ | 97,715 | 
|                                              |  |                   |         |      |  |   |        | 
|Amounts included in cash and cash equivalents |  | $                 | 86,695  |      |  | $ | 20,015 | 
|                                             
|                                             
|                                             
|                                             
|Amounts included in short-term investments    |  |                   | 105,050 |      |  |   | 77,700 | 
|                                              |  |                   |         |      |  |   |        | 
|                                              |  | $                 | 191,745 |      |  | $ | 97,715 | 
|                                              |  |                   |         |      |  |   |        | 

The Companys investments are considered
available-for-sale under SFAS No. 115,
Accounting for Certain Investments in Debt and Equity
Securities(SFAS 115). The costs of the Companys
investments approximate fair value; accordingly, there were no
realized gains or losses.

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

|                |  |                 |        |                 |  |   |        | 
|--------------- |  | --------------- | ------ | --------------- |  | - | ------ | 
|                |  | January 1, 2006 |        | January 2, 2005
|                |  |                 |        |                
|Raw materials   |  | $               | 39,230 |                 |  | $ | 20,647 | 
|               
|               
|               
|               
|Work in process |  |                 | 6,489  |                 |  |   | 7,785  | 
|               
|               
|               
|               
|Finished goods  |  |                 | 8,281  |                 |  |   | 7,383  | 
|                |  |                 |        |                 |  |   |        | 
|                |  | $               | 54,000 |                 |  | $ | 35,815 | 
|                |  |                 |        |                 |  |   |        | 

Property, Plant, and Equipment: Property, plant, and
equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is recognized using the straight-line
method over the estimated useful lives of the assets. The
estimated useful lives of the Companys buildings in Penang
and Sarawak, Malaysia is 30 years, and 20 to 22 years
for the Companys buildings in Johor, Malaysia. Furniture
and equipment are generally depreciated over five years, and
leasehold improvements are amortized over the shorter of the
lease term or their estimated useful life.

On September 30, 2003, the Company completed the sale of
its idle Fremont, California land and buildings. The land and
buildings were acquired through the merger with HMT Technology
Corporation (HMT) in October 2000 and had been idle and
held for sale since 2001. The net proceeds from the sale of the
land and buildings were approximately $24.0 million,
resulting in a gain of approximately $1.0 million. The sale
was recorded in the fourth quarter of 2003.

45



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Property, plant, and equipment consists of the following (in
thousands):

|                                               |  |                 |          |                 |  |   |         |  
|---------------------------------------------- |  | --------------- | -------- | --------------- |  | - | ------- | -
|                                               |  | January 1, 2006 |          | January 2, 2005
|                                               |  |                 |          |                
|Land                                           |  | $               | 8,206    |                 |  | $ | 8,206   |  
|                                              
|                                              
|                                              
|                                              
|Buildings                                      |  |                 | 153,433  |                 |  |   | 127,348 |  
|                                              
|                                              
|                                              
|                                              
|Leasehold improvements                         |  |                 | 3,974    |                 |  |   | 2,987   |  
|                                              
|                                              
|                                              
|                                              
|Furniture                                      |  |                 | 1,968    |                 |  |   | 1,580   |  
|                                              
|                                              
|                                              
|                                              
|Equipment                                      |  |                 | 324,123  |                 |  |   | 164,586 |  
|                                               |  |                 |          |                 |  |   |         |  
|                                               |  |                 | 491,704  |                 |  |   | 304,707 |  
|                                              
|                                              
|                                              
|                                              
|Less accumulated depreciation and amortization |  |                 | (140,658 | )               |  |   | (99,065 | )
|                                               |  |                 |          |                 |  |   |         |  
|                                               |  | $               | 351,046  |                 |  | $ | 205,642 |  
|                                               |  |                 |          |                 |  |   |         |  

Impairment of Long-lived Assets: Long-lived assets are
evaluated for impairment whenever events or changes in
circumstances indicate that such assets may be impaired or the
estimated useful lives are no longer appropriate. The Company
reviews its long-lived assets for impairment based on estimated
future undiscounted cash flows attributable to the assets. In
the event that such 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.

Revenue Recognition: In recognizing revenue, the Company
applies the provisions of the Securities and Exchange Commission
(SEC) Staff Accounting Bulletin 104, Revenue
Recognition. The Company recognizes revenue from the sale of
its products when persuasive evidence of an arrangement exists,
the product has been delivered, the price is fixed or
determinable, and collection of the resulting receivable is
reasonably assured. Amounts billed to customers for shipping and
handling costs associated with products sold are classified as
revenue.

The Company generally uses a purchase order as evidence of an
arrangement. In certain cases its products are sold with terms
signifying that delivery occurs at the destination point. The
Company defers revenue associated with these transactions until
the delivery has occurred to the customers premises and it
has evidence of such delivery.

The Company provides an allowance for estimated returns of
defective products based on historical data, as well as current
knowledge of product quality.

Cost of Sales: Cost of sales includes direct and indirect
manufacturing costs, inbound, outbound, and internal freight
costs, purchasing and receiving costs, quality inspection costs,
and warehousing costs.

Research and Development: Research and development costs
are expensed as incurred.

Leases: The Company leases one facility in the U.S.. The
Company accounts for this lease under the provisions of
SFAS No. 13, Accounting for Leases(SFAS 13), and subsequent amendments. SFAS 13
requires leases to be evaluated and classified as operating or
capitalized leases for financial reporting purposes. In
addition, the Company records the total rent payable during the
operating lease term on a straight-line basis over the term of
the lease, and records the difference between the rent paid and
the straight-line rent as a deferred rent liability.

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

46



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS 123), and
SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure 
an Amendment of SFAS 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 123,
been used.

The following table reflects the effect on the Companys
net income and income per share had the fair value method been
applied to all outstanding and unvested awards. The table is in
thousands, except per share amounts.

|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |      |        | 
|------------------------------------------------------------------------------------------------- | --------------------- | -------------------- | ------- | --------------- | ------- | ----------------- | ------ | ---- | ------ | - | ------ | ---- | ------ | 
|                                                                                                  |                       |                     
|                                                                                                  |                       | Year Ended          
|                                                                                                  |                       |                     
|                                                                                                  |                       | January 1, 2006      |         | January 2, 2005 |         | December 28, 2003
|                                                                                                  |                       |                      |         |                 |         |                  
|Net income, as reported                                                                           |                       | $                    | 115,637 |                 |         | $                 | 51,355 |      |        | $ | 36,040 |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Add stock-based employee compensation expense
    included in reported net income                 |                       |                      | 3,308   |                 |         |                   | 555    |      |        |   | 1,980  |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Deduct stock-based compensation expense
    determined under the fair value method for all awards |                       |                      | (5,973  | )               |         |                   | (3,571 | )    |        |   | (4,265 | )   
|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |     
|                                                                                                  |                       | Pro forma net income |         | $               | 112,972 |                   |        | $    | 48,339 |   |        | $    | 33,755 | 
|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |     
|Net income per share:                                                                             |                       |                      |         |                 |         |                   |        |      |        |   |        |     
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                  | Basic  as reported   |                      | $       | 3.99            |         |                   | $      | 1.88 |        |   | $      | 1.53 |       
|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |     
|                                                                                                  | Diluted  as reported |                      | $       | 3.55            |         |                   | $      | 1.71 |        |   | $      | 1.47 |       
|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |     
|                                                                                                  | Basic  pro forma     |                      | $       | 3.90            |         |                   | $      | 1.77 |        |   | $      | 1.44 |       
|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |     
|                                                                                                  | Diluted  pro forma   |                      | $       | 3.47            |         |                   | $      | 1.61 |        |   | $      | 1.38 |       
|                                                                                                  |                       |                      |         |                 |         |                   |        |      |        |   |        |     

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 fiscal 2005, 2004, and 2003:

|                                                                                 |  |      |       |      |  |      |      |   |  |   |      |  
|-------------------------------------------------------------------------------- |  | ---- | ----- | ---- |  | ---- | ---- | - |  | - | ---- | -
|                                                                                 |  | 2005 |       | 2004 |  | 2003
|                                                                                 |  |      |       |      |  |     
|Risk-free interest rate                                                          |  |      | 4.0   | %    |  |      | 2.7  | % |  |   | 2.6  | %
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Volatility factor of the expected market price of
    the Companys common stock |  |      | 71.8  | %    |  |      | 81.8 | % |  |   | 86.7 | %
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Weighted-average expected option life (in years)                                 |  |      | 4.0   |      |  |      | 4.0  |   |  |   | 4.0  |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Weighted-average fair value of options granted                                   |  | $    | 11.57 |      |  | $    | 7.02 |   |  | $ | 5.77 |  

47



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following assumptions were used to estimate the fair value
of employee purchase rights under the Amended and Restated 2002
Employee Stock Purchase Plan in 2005, 2004, and 2003:

|                                                                                 |  |      |      |      |  |      |      |   |  |   |      |  
|-------------------------------------------------------------------------------- |  | ---- | ---- | ---- |  | ---- | ---- | - |  | - | ---- | -
|                                                                                 |  | 2005 |      | 2004 |  | 2003
|                                                                                 |  |      |      |      |  |     
|Risk-free interest rate                                                          |  |      | 1.7  | %    |  |      | 1.6  | % |  |   | 1.1  | %
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Volatility factor of the expected market price of
    the Companys common stock |  |      | 50.8 | %    |  |      | 61.2 | % |  |   | 60.8 | %
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Weighted-average expected purchase rights life
    (in years)                    |  |      | 0.5  |      |  |      | 0.5  |   |  |   | 0.5  |  
|                                                                                
|                                                                                
|                                                                                
|                                                                                
|Weighted-average fair value of purchase rights
    granted                       |  | $    | 3.12 |      |  | $    | 3.43 |   |  | $ | 7.84 |  

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

In December 2004, the FASB issued SFAS No. 123R,
Share-Based Payment(SFAS 123R). SFAS 123R is a
revision of SFAS 123, which addresses financial accounting
and reporting for costs associated with stock-based
compensation. SFAS 123 addresses all forms of share-based
payment (SBP) awards, including shares issued under
employee stock purchase plans, stock options, restricted stock,
and stock appreciation rights. SFAS 123R requires the
Company to adopt the new accounting provisions beginning in its
first quarter of 2006, and applies to all outstanding and
unvested SBP awards at the Companys adoption date. The
Company is allowed to select one of two alternative transition
methods, each having different reporting implications. The
Company has chosen the modified-prospective method. On
March 29, 2005, the SEC issued Staff Accounting
Bulletin No. 107 (SAB 107) on SFAS 123R to
assist preparers by simplifying some of the implementation
challenges of SFAS 123R. The Company has not completed its
evaluation or determined the impact of adopting SFAS 123R.
However, we expect the adoption to have a significant impact on
our net income and net income per share.

Income Taxes: The Company accounts for income taxes using
the asset and liability method. Under this method, deferred tax
assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities
and their respective tax bases and for operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are
measured using the enacted tax laws expected to apply to taxable
income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax laws is recognized in
the results of operations in the period that includes the
enactment date. A valuation allowance is recorded to reduce the
carrying amounts of deferred tax assets if it is likely that
such assets will not be realized.

Comprehensive Income: Comprehensive income is defined as
the change in equity during a period for non-owner transactions,
and is composed of net income and other comprehensive income
(loss). Other comprehensive income (loss) includes revenues,
expenses, gains, and losses that are excluded from earnings
under current accounting standards. The Companys other
comprehensive loss included the unrealized losses, net of income
taxes, related to the Companys foreign currency forward
contracts that are designated as cash flow hedges.

Computation of 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 dilutive effect of
outstanding contingently convertible debt is

48



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

reflected in diluted net income per share by application of the
if-converted method. Interest expense related to the
contingently convertible debt is an adjustment to net income for
the diluted net income per share calculations.

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

|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |        |     | 
|------------------------------------------- | --------------------------------------------------------------- | ---------------------------------------------------------- | ------- | --------------- | ----- | ----------------- | ------ | ------ | ----- | - | ------ | ------ | --- | 
|                                            |                                                                 |                                                           
|                                            |                                                                 | Year Ended                                                
|                                            |                                                                 |                                                           
|                                            |                                                                 | January 1, 2006                                            |         | January 2, 2005 |       | December 28, 2003
|                                            |                                                                 |                                                            |         |                 |       |                  
|Numerator for basic net income per share:   |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|                                           
|                                           
|                                           
|                                           
|                                            | Net income as reported                                          |                                                            | $       | 115,637         |       |                   | $      | 51,355 |       |   | $      | 36,040 |    
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|Numerator for diluted net income per share: |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|                                           
|                                           
|                                           
|                                           
|                                            | Net income as reported                                          |                                                            | $       | 115,637         |       |                   | $      | 51,355 |       |   | $      | 36,040 |    
|                                           
|                                           
|                                           
|                                           
|                                            | Interest adjustment related to contigently
    convertible debt |                                                            |         | 1,765           |       |                   |        | 1,642  |       |   |        |       |    
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|                                            |                                                                 | $                                                          | 117,402 |                 |       | $                 | 52,997 |        |       | $ | 36,040 |       
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|Denominator for basic income per share:     |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|                                           
|                                           
|                                           
|                                           
|                                            | Weighted average shares                                         |                                                            |         | 29,003          |       |                   |        | 27,384 |       |   |        | 23,504 |    
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|Denominator for diluted income per share:   |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|                                           
|                                           
|                                           
|                                           
|                                            | Weighted average shares                                         |                                                            |         | 29,003          |       |                   |        | 27,384 |       |   |        | 23,504 |    
|                                           
|                                           
|                                           
|                                           
|                                            | Effect of dilutive securities:                                  |                                                            |         |                 |       |                   |        |        |       |   |        |        |    
|                                           
|                                           
|                                           
|                                           
|                                            |                                                                 | Contingently convertible shares under convertible
    debt |         |                 | 3,049 |                   |        |        | 2,803 |   |        |        |    | 
|                                           
|                                           
|                                           
|                                           
|                                            |                                                                 | Stock options                                              |         |                 | 572   |                   |        |        | 468   |   |        |        | 337 | 
|                                           
|                                           
|                                           
|                                           
|                                            |                                                                 | Warrants                                                   |         |                 | 220   |                   |        |        | 362   |   |        |        | 221 | 
|                                           
|                                           
|                                           
|                                           
|                                            |                                                                 | Stock purchase rights                                      |         |                 | 198   |                   |        |        |      |   |        |        | 456 | 
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|                                            |                                                                 |                                                            | 33,042  |                 |       |                   | 31,017 |        |       |   | 24,518 |       
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|Basic net income per share                  |                                                                 | $                                                          | 3.99    |                 |       | $                 | 1.88   |        |       | $ | 1.53   |       
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       
|Diluted net income per share                |                                                                 | $                                                          | 3.55    |                 |       | $                 | 1.71   |        |       | $ | 1.47   |       
|                                            |                                                                 |                                                            |         |                 |       |                   |        |        |       |   |        |       

Incremental common shares attributable to outstanding common
stock options (assuming proceeds would be used to purchase
treasury stock) that were not included in the diluted net income
per share computation because the effect would have been
antidilutive were zero in 2005, and approximately 264,000 and
192,000 in 2004 and 2003, respectively.

In January 2004, the Company issued $80.5 million of
2.0% Convertible Subordinated Notes (the Notes). The Notes
are convertible, under certain circumstances, into shares of the
Companys common stock at an initial conversion price of
$26.40, or approximately 3,049,000 shares. 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 became
effective in the fourth quarter of 2004, requires the Company to
include these additional shares in its calculation of diluted
earnings per share as of the date of issuance of the Notes (the
first quarter of 2004). Accordingly, these shares have been
included in the Companys diluted earnings per share
calculations for fiscal 2005 and 2004.

49



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Recent Accounting Pronouncements: In December 2003, the
FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities(FIN 46R), which addresses how a business enterprise
should evaluate whether it has a controlling financial interest
in an entity through means other than voting rights and
accordingly should consolidate the entity. FIN 46R replaces
FASB Interpretation No. 46, Consolidation of Variable
Interest Entities(VIE), which was issued in January 2003.
The Company is required to apply FIN 46R to variable
interests in VIEs created after December 31, 2003. For
variable interests in VIEs created before January 1, 2004,
the Interpretation has been applied beginning on January 1,
2005. For any VIEs that must be consolidated under FIN 46R
that were created before January 1, 2004, the assets,
liabilities and non-controlling interests of the VIE initially
would be measured at their carrying amounts with any difference
between the net amount added to the balance sheet and any
previously recognized interest being recognized as the
cumulative effect of an accounting change. If determining the
carrying amounts is not practicable, fair value at the date
FIN 46R first applies may be used to measure the assets,
liabilities and non-controlling interest of the VIE. The
Companys adoption of FIN 46R had no impact on its
consolidated financial statements.

In December 2004, the FASB issued SFAS No. 151,
Inventory Costs(SFAS 151). SFAS 151 clarifies
the accounting for inventory when there are abnormal amounts of
idle facility expense, freight, handling costs, and wasted
materials. Under existing generally accepted accounting
principles, items such as idle facility expense, excessive
spoilage, double freight, and re-handling costs may be so
abnormal as to require treatment as current period charges
rather than recorded as adjustments to the value of the
inventory. SFAS 151 requires that those items be recognized
as current-period charges regardless of whether they meet the
criterion of so abnormal. In addition, this
Statement requires that allocation of fixed production overheads
to the costs of conversion be based on the normal capacity of
the production facilities. The provisions of this Statement are
effective for inventory costs incurred during fiscal years
beginning after June 15, 2005. Earlier application is
permitted for inventory costs incurred during fiscal years
beginning after the date this Statement is issued. The Company
will adopt this pronouncement beginning in fiscal year 2006. The
adoption of SFAS 151 is not expected to have a material
effect on the Companys financial position or results of
operations.

In March 2005, the FASB issued FIN 47 as an interpretation
of FASB Statement No. 143, Accounting for Asset
Retirement Obligations(SFAS 143). This interpretation
clarifies that the term conditional asset retirement obligation
as used in SFAS 143, refers to a legal obligation to
perform an asset retirement activity in which the timing and/or
method of settlement are conditional on a future event that may
or may not be within the control of the entity. The obligation
to perform the asset retirement activity is unconditional even
though uncertainty exists about the timing and/or method of
settlement. Accordingly, an entity is required to recognize a
liability for the fair value of a conditional asset retirement
obligation if the fair value of the liability can be reasonably
estimated. This interpretation also clarifies when an entity
would have sufficient information to reasonably estimate the
fair value of an asset retirement obligation. The Company
adopted FIN 47 in fiscal 2005. The adoption of this
standard did not have a material impact on the Companys
financial position or results of operations.

In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections(SFAS 154).
SFAS 154 replaces APB No. 20 and FASB Statement
No. 3. SFAS 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections.
It establishes retrospective application as the required method
for reporting a change in accounting principle. SFAS 154
provides guidance for determining whether retrospective
application of a change in accounting principle is impracticable
and for reporting a change when retrospective application is
impracticable. The reporting of a correction of an error by
restating previously issued financial statements is also
addressed by SFAS 154. SFAS 154 is effective for
accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005. The Company will
adopt this pronouncement beginning in fiscal year 2006.

50



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|        |                                   
|------- | ----------------------------------
|Note 2. | Segment and Geographic Information

The Company operates in one business segment, which is the
development, production, and marketing of high-performance
thin-film media (disks) for use in hard disk drives. The
Company primarily sells to original equipment manufacturers in
the rigid disk drive market. The Companys operations are
treated as one operating segment, as the Company reports profit
and loss information on an aggregate basis to the chief
operating decision-maker of the Company.

Summary information for the Companys operations by
geographic location is as follows (in thousands):

|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |         |         | 
|------------------------ | -------------------------------------- | ----------------------- | ------- | --------------- | ------- | ----------------- | ------- | ------- | ------- |  | ------- | ------- | ------- | 
|                         |                                        |                        
|                         |                                        | Year Ended             
|                         |                                        |                        
|                         |                                        | January 1, 2006         |         | January 2, 2005 |         | December 28, 2003
|                         |                                        |                         |         |                 |         |                  
|Net sales:               |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                        
|                        
|                        
|                        
|                         | To customers from U.S. parent          |                         | $       | 37,021          |         |                   | $       | 21,520  |         |  | $       | 1,141   |        
|                        
|                        
|                        
|                        
|                         | To customers from Malaysian subsidiary |                         |         | 648,925         |         |                   |         | 436,857 |         |  |         | 437,151 |        
|                        
|                        
|                        
|                        
|                         | Intercompany from Malaysian subsidiary |                         |         | 24,284          |         |                   |         | 20,868  |         |  |         | 1,495   |        
|                        
|                        
|                        
|                        
|                         | Intercompany from U.S. parent          |                         |         | 808             |         |                   |         | 170     |         |  |         | 369     |        
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                         |                                        |                         | 711,038 |                 |         |                   | 479,415 |         |         |  | 440,156 |        
|                        
|                        
|                        
|                        
|                         | Intercompany eliminations              |                         |         | (25,092         | )       |                   |         | (21,038 | )       |  |         | (1,864  | )      
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                         |                                        | Total net sales         |         | $               | 685,946 |                   |         | $       | 458,377 |  |         | $       | 438,292 | 
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|Operating income (loss): |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                        
|                        
|                        
|                        
|                         | U.S. parent                            |                         | $       | 1,604           |         |                   | $       | (5,823  | )       |  | $       | (2,679  | )      
|                        
|                        
|                        
|                        
|                         | Malaysian subsidiary                   |                         |         | 116,328         |         |                   |         | 60,205  |         |  |         | 52,098  |        
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                         |                                        | Total operating income  |         | $               | 117,932 |                   |         | $       | 54,382  |  |         | $       | 49,419  | 
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|Long-lived assets:       |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                        
|                        
|                        
|                        
|                         | U.S. parent                            |                         | $       | 34,709          |         |                   | $       | 20,094  |         |  |         |         |        
|                        
|                        
|                        
|                        
|                         | Malaysian subsidiary                   |                         |         | 319,645         |         |                   |         | 190,048 |         |  |         |         |        
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        
|                         |                                        | Total long-lived assets |         | $               | 354,354 |                   |         | $       | 210,142 |  |         |         |         | 
|                         |                                        |                         |         |                 |         |                   |         |         |         |  |         |        

External sales by geographic location, which is determined by
the customers sold-to address, are as follows (in
thousands):

|              |                 |                 |         |                 |  |                   |         |         |  |   |         |         | 
|------------- | --------------- | --------------- | ------- | --------------- |  | ----------------- | ------- | ------- |  | - | ------- | ------- | 
|              |                 |                
|              |                 | Year Ended     
|              |                 |                
|              |                 | January 1, 2006 |         | January 2, 2005 |  | December 28, 2003
|              |                 |                 |         |                 |  |                  
|Thailand      |                 | $               | 272,392 |                 |  | $                 | 111,904 |         |  | $ | 68,855  |        
|             
|             
|             
|             
|Singapore     |                 |                 | 201,007 |                 |  |                   | 201,686 |         |  |   | 138,584 |        
|             
|             
|             
|             
|Malaysia      |                 |                 | 78,047  |                 |  |                   | 42,704  |         |  |   | 137,977 |        
|             
|             
|             
|             
|China         |                 |                 | 65,341  |                 |  |                   | 1,792   |         |  |   | 737     |        
|             
|             
|             
|             
|United States |                 |                 | 33,735  |                 |  |                   | 53,535  |         |  |   | 36,347  |        
|             
|             
|             
|             
|Taiwan        |                 |                 | 32,855  |                 |  |                   | 25,940  |         |  |   | 8,719   |        
|             
|             
|             
|             
|Europe        |                 |                 | 1,574   |                 |  |                   | 37      |         |  |   | 20,966  |        
|             
|             
|             
|             
|Japan         |                 |                 | 995     |                 |  |                   | 20,779  |         |  |   | 26,107  |        
|              |                 |                 |         |                 |  |                   |         |         |  |   |         |        
|              | Total net sales |                 | $       | 685,946         |  |                   | $       | 458,377 |  |   | $       | 438,292 | 
|              |                 |                 |         |                 |  |                   |         |         |  |   |         |        

51



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|        |                                            
|------- | -------------------------------------------
|Note 3. | Concentration of Customer and Supplier Risk

Most of the Companys sales are derived from a relatively
small number of customers, which results in a concentration of
credit risk regarding trade receivables. The Company performs
ongoing credit evaluations of its customers, and generally
requires no collateral for sales to these customers. Based on
managements evaluation of potential credit losses and the
relative strength of the disk drive industry, the Company
believes that an allowance for doubtful accounts as of
January 1, 2006 is not required.

In December 2005, two of our major customers, Seagate Technology
(Seagate) and Maxtor Corporation (Maxtor), announced that they
entered into a definitive agreement under which Seagate will
acquire Maxtor. The transaction is expected to be completed in
the second half of calendar 2006, subject to obtaining
shareholder approvals and customary regulatory approvals. Until
the closing, Seagate and Maxtor will continue to operate as
separate businesses.

Maxtor accounted for $34.1 million of the Companys
accounts receivable at January 1, 2006, and 32% of its net
sales for 2005. HGST accounted for $23.0 million of the
Companys accounts receivable at January 1, 2006, and
21% of its net sales for 2005. Western Digital accounted for
$35.6 million of the Companys accounts receivable at
January 1, 2006, and 24% of its net sales for 2005. Seagate
accounted for $15.6 million of the Companys accounts
receivable at January 1, 2006, and 16% of its net sales for
2005.

The Companys customers are concentrated in the disk drive
industry. Accordingly, the Companys future success depends
on the buying patterns of these customers and the continued
demand by these customers for the Companys products.
Additionally, the disk drive market is characterized by rapidly
changing technology, evolving industry standards, changes in end
user requirements, and frequent new product introductions and
enhancements. The Companys continued success will depend
upon its ability to enhance existing products and to develop and
introduce, on a timely basis, new products and features that
keep pace with technological developments and emerging industry
standards. Furthermore, as a result of its international sales,
the Companys operations are subject to risks of doing
business abroad, including but not limited to, fluctuations in
the value of currency, longer payment cycles, and greater
difficulty in collecting accounts receivable.

Because of the Companys small customer base, the loss of
any one significant customer would have a material impact on the
Companys business operations.

Significant customers accounted for the following percentages of
net sales in 2005, 2004, and 2003:

|                                       |  |                 |    |                 |  |                   |    |   |  |  |    |  
|-------------------------------------- |  | --------------- | -- | --------------- |  | ----------------- | -- | - |  |  | -- | -
|                                       |  |                
|                                       |  | Year Ended     
|                                       |  |                
|                                       |  | January 1, 2006 |    | January 2, 2005 |  | December 28, 2003
|                                       |  |                 |    |                 |  |                  
|Maxtor Corporation                     |  |                 | 32 | %               |  |                   | 47 | % |  |  | 37 | %
|                                      
|                                      
|                                      
|                                      
|Western Digital Corporation            |  |                 | 24 | %               |  |                   | 14 | % |  |  | 38 | %
|                                      
|                                      
|                                      
|                                      
|Hitachi Global Storage Technologies(1) |  |                 | 21 | %               |  |                   | 29 | % |  |  | 17 | %
|                                      
|                                      
|                                      
|                                      
|Seagate Technology                     |  |                 | 16 | %               |  |                   | 4  | % |  |  | 1  | %



---



|    |                                                                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Hitachi Global Storage Technologies (HGST) was founded in
    2003, and was formed as a result of the combination of
    Hitachis and IBMs storage technology business. Sales
    to HGST include sales made to its contract manufacturer.

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

52



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|        |                                                  
|------- | -------------------------------------------------
|Note 4. | Employee Savings and Deferred Profit Sharing Plan

The Company maintains a savings and deferred profit sharing
plan. Employees who meet certain criteria are eligible to
participate. In addition to voluntary employee contributions to
the plan, the Company matches a portion of each employees
contributions to the plan, up to a maximum amount. The Company
contributed a total of $2.2 million to the plan in 2005,
$0.8 million in 2004, and $0.7 million in 2003. Plan
expenses are included in selling, general, and administrative
expenses.

Note 5.                      Income
Taxes

The Companys income (loss) before provision for income
taxes consisted of the following (in thousands):

|         |  |                 |         |                 |  |                   |        |   |  |   |         |  
|-------- |  | --------------- | ------- | --------------- |  | ----------------- | ------ | - |  | - | ------- | -
|         |  |                
|         |  | Year Ended     
|         |  |                
|         |  | January 1, 2006 |         | January 2, 2005 |  | December 28, 2003
|         |  |                 |         |                 |  |                  
|Domestic |  | $               | 9,311   |                 |  | $                 | (3,977 | ) |  | $ | (10,914 | )
|        
|        
|        
|        
|Foreign  |  |                 | 111,768 |                 |  |                   | 56,403 |   |  |   | 47,954  |  
|         |  |                 |         |                 |  |                   |        |   |  |   |         |  
|         |  | $               | 121,079 |                 |  | $                 | 52,426 |   |  | $ | 37,040  |  
|         |  |                 |         |                 |  |                   |        |   |  |   |         |  

The Companys provision for income taxes consisted of the
following (in thousands):

|         |          |                 |       |                 |  |                   |       |       |  |   |       |     | 
|-------- | -------- | --------------- | ----- | --------------- |  | ----------------- | ----- | ----- |  | - | ----- | --- | 
|         |          |                
|         |          | Year Ended     
|         |          |                
|         |          | January 1, 2006 |       | January 2, 2005 |  | December 28, 2003
|         |          |                 |       |                 |  |                  
|Current: |          |                 |       |                 |  |                   |       |       |  |   |       |    
|        
|        
|        
|        
|         | Domestic |                 | $     | 5,272           |  |                   | $     | 1     |  |   | $     | 2   | 
|        
|        
|        
|        
|         | Foreign  |                 |       | 170             |  |                   |       | 1,070 |  |   |       | 998 | 
|         |          |                 |       |                 |  |                   |       |       |  |   |       |    
|         |          | $               | 5,442 |                 |  | $                 | 1,071 |       |  | $ | 1,000 |    
|         |          |                 |       |                 |  |                   |       |       |  |   |       |    

The Companys Malaysian manufacturing facilities operate
under various tax holidays. The net impact of these tax holidays
increased the Companys net income by $41.1 million
($1.42 per basic share and $1.24 per diluted share) in
2005, $25.1 million ($0.92 per basic share and
$0.81 per diluted share) in 2004, and $21.2 million
($0.90 per basic share and $0.86 per diluted share) in
2003. In July 2005, the Malaysian government agreed to reset the
expiration dates of the existing tax holidays to December 2006
and approved a new, 10-year tax holiday covering all of the
Companys Malaysian operations. The new tax holiday
commences in January 2007 and expires in December 2016.

A substantial majority of the Companys income is generated
by its Malaysian subsidiary covered by tax holidays. No federal
and state income taxes have been provided on net undistributed
earnings from foreign subsidiaries, which, as of January 1,
2006, amounted to $136.5 million. The net undistributed
earnings are intended to finance local operating requirements
and to satisfy the intercompany payables to the parent company.
Accordingly, additional federal and state income tax provisions
have not been made on these earnings.

53



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A reconciliation of the actual income tax provision to the
expected income tax provision (as measured by the
U.S. statutory corporate income tax rate of 35% to pretax
earnings) is as follows (in thousands):

|                                                                |  |                 |         |                 |  |                   |         |   |  |   |         |  
|--------------------------------------------------------------- |  | --------------- | ------- | --------------- |  | ----------------- | ------- | - |  | - | ------- | -
|                                                                |  |                
|                                                                |  | Year Ended     
|                                                                |  |                
|                                                                |  | January 1, 2006 |         | January 2, 2005 |  | December 28, 2003
|                                                                |  |                 |         |                 |  |                  
|Income tax expense at federal statutory rate                    |  | $               | 42,378  |                 |  | $                 | 18,349  |   |  | $ | 12,964  |  
|                                                               
|                                                               
|                                                               
|                                                               
|State income taxes, net of federal benefit                      |  |                 | 525     |                 |  |                   | 1       |   |  |   | 1       |  
|                                                               
|                                                               
|                                                               
|                                                               
|Foreign withholding refund                                      |  |                 |        |                 |  |                   | (182    | ) |  |   | (834    | )
|                                                               
|                                                               
|                                                               
|                                                               
|Foreign rate differential                                       |  |                 | (38,431 | )               |  |                   | (18,489 | ) |  |   | (14,948 | )
|                                                               
|                                                               
|                                                               
|                                                               
|Losses and/or temporary differences not currently
    benefited |  |                 | 1,176   |                 |  |                   | 1,392   |   |  |   | 3,820   |  
|                                                               
|                                                               
|                                                               
|                                                               
|Other                                                           |  |                 | (206    | )               |  |                   |        |   |  |   | (3      | )
|                                                                |  |                 |         |                 |  |                   |         |   |  |   |         |  
|                                                                |  | $               | 5,442   |                 |  | $                 | 1,071   |   |  | $ | 1,000   |  
|                                                                |  |                 |         |                 |  |                   |         |   |  |   |         |  

Deferred income taxes reflect the tax effect of temporary
differences between the carrying amount of assets and
liabilities for financial reporting purposes and the amounts
used for income tax purpose. The significant components of the
Companys deferred tax assets and liabilities are as
follows (in thousands):

|                         |                                                 |                           |                               |                 |         |                   |   |          |         |   |      |          |         |   | 
|------------------------ | ----------------------------------------------- | ------------------------- | ----------------------------- | --------------- | ------- | ----------------- | - | -------- | ------- | - | ---- | -------- | ------- | - | 
|                         |                                                 |                          
|                         |                                                 | Year Ended               
|                         |                                                 |                          
|                         |                                                 | January 1, 2006           |                               | January 2, 2005 |         | December 28, 2003
|                         |                                                 |                           |                               |                 |         |                  
|Deferred tax assets      |                                                 |                           |                               |                 |         |                   |   |          |         |   |      |         
|                        
|                        
|                        
|                        
|                         | Depreciation and amortization                   |                           | $                             | 16,469          |         |                   | $ | 22,037   |         |   | $    | 23,739   |        
|                        
|                        
|                        
|                        
|                         | Accrued compensation and benefits               |                           |                               | 2,547           |         |                   |   | 1,456    |         |   |      | 1,262    |        
|                        
|                        
|                        
|                        
|                         | Other                                           |                           |                               | 3,772           |         |                   |   | 2,207    |         |   |      | 5,344    |        
|                        
|                        
|                        
|                        
|                         | Tax benefit of net operating loss carryforwards |                           |                               | 75,340          |         |                   |   | 68,480   |         |   |      | 62,729   |        
|                        
|                        
|                        
|                        
|                         | Tax benefit of credit carryforwards             |                           |                               | 33,810          |         |                   |   | 32,887   |         |   |      | 31,409   |        
|                         |                                                 |                           |                               |                 |         |                   |   |          |         |   |      |         
|                         |                                                 | Gross deferred tax assets |                               |                 | 131,938 |                   |   |          | 127,067 |   |      |          | 124,483 |  
|                        
|                        
|                        
|                        
|Deferred tax liabilities |                                                 |                           |                              |                 |         |                   |  |          |         |   | (800 | )       
|                         |                                                 |                           |                               |                 |         |                   |   |          |         |   |      |         
|                         |                                                 | Net deferred tax assets   |                               |                 | 131,938 |                   |   |          | 127,067 |   |      |          | 123,683 |  
|                        
|                        
|                        
|                        
|                         | Valuation allowance                             |                           |                               | (131,938        | )       |                   |   | (127,067 | )       |   |      | (123,683 | )      
|                         |                                                 |                           |                               |                 |         |                   |   |          |         |   |      |         
|                         |                                                 |                           | Total net deferred tax assets |                 | $       |                  |   |          | $       |  |      |          | $       |  | 
|                         |                                                 |                           |                               |                 |         |                   |   |          |         |   |      |         

The recorded valuation allowance against deferred tax assets
increased by $4.9 million in 2005, $3.4 million in
2004, and $9.5 million in 2003. The Company provides a full
valuation allowance against its net deferred tax assets due to
the uncertainty of the timing and amount of future taxable
income in the U.S. Approximately $7.7 million of the
valuation allowance as of January 1, 2006 was attributable
to the federal and state income tax benefits of stock
compensation deductions, the benefit of which will be credited
to additional paid in capital when, and if, realized.

The Company has deferred tax assets with full valuation
allowance generated prior to the Companys reorganization
in 2002. Upon utilization of those deferred tax assets, the
Company first reduced intangible assets to zero and then
credited additional paid-in capital. In 2005, the Company
utilized $4.9 million pre-emergence deferred tax assets. In
2004 and 2003, the Company utilized $1 million and
$1.5 million pre-emergence deferred tax assets, resulting
in reductions to intangible assets of $1 million and
$1.5 million, respectively.

54



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

At January 1, 2006, the Company had federal and state net
operating loss carryforwards of approximately
$202.4 million and $58.6 million, which are available
to offset future federal and state taxable income through 2025
and 2015, respectively. In addition, the Company had various
federal and state tax credit carryforwards of approximately
$43.2 million,of which $14 million are
available to offset future taxable income through 2025, and the
remaining $29.2 million are available indefinitely.

Prior to the Companys reorganization, $163.6 million
of the total federal net operating loss carryforwards,
$7.7 million of federal credits, and $18.3 million of
state credit carryforwards were generated. In addition, the
Company has pre-reorganization Malaysian unabsorbed losses and
reinvestment allowance carryforwards of $4 million.

The utilization of the Companys net operating loss and tax
credit carryforwards are subject to certain annual limitation
due to the ownership change, as defined by the Internal Revenue
Code of 1986. The annual limitation on these net operating
losses and credits are $8.4 million and $2.9 million
for losses and credits generated before June 30, 2002.



|        |                                    
|------- | -----------------------------------
|Note 6. | Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, short-term
investments, accounts receivable, and accounts payable
approximate their fair values as of January 1, 2006 and
January 2, 2005, due to the relatively short period to
maturity of these instruments.

As of January 1, 2006 and January 2, 2005, the fair
value of the Companys Convertible Subordinated Notes was
$109.9 million and $80.1 million, respectively. These
values were based on the quoted price of the Notes (which are
traded in the open market) as of the last business day of the
Companys 2005 and 2004 fiscal years.



|        |                                       
|------- | --------------------------------------
|Note 7. | Accrued Expenses and Other Liabilities

The following table (in thousands) summarizes accrued expenses
and other liabilities for fiscal 2005 and fiscal 2004:

|                                  |  |                 |        |                 |  |   |        | 
|--------------------------------- |  | --------------- | ------ | --------------- |  | - | ------ | 
|                                  |  | January 1, 2006 |        | January 2, 2005
|                                  |  |                 |        |                
|Accrued compensation and benefits |  | $               | 24,986 |                 |  | $ | 15,777 | 
|                                 
|                                 
|                                 
|                                 
|Other liabilities                 |  |                 | 3,599  |                 |  |   | 4,110  | 
|                                  |  |                 |        |                 |  |   |        | 
|                                  |  | $               | 28,585 |                 |  | $ | 19,887 | 
|                                  |  |                 |        |                 |  |   |        | 



|        |                  
|------- | -----------------
|Note 8. | Customer Advances

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



|        |                        
|------- | -----------------------
|Note 9. | Debt and Bank Guarantee

The Companys Senior Secured Notes and Junior Secured Notes
were fully repaid and terminated in 2003 and 2004, and the
promissory notes were fully repaid and terminated in 2004.

55



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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. The conditions for conversion have been met, and
the debt is currently 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
January 1, 2006, unamortized loan fees were
$2.8 million.

The Company has a Malaysian ringgit 12,500,000 (approximately
$3.3 million) bank guarantee. There is no expiration date
on the bank guarantee. No interest will be charged on the bank
guarantee, but there is a commission of 0.05% on the amount of
bank guarantee utilized. As of January 1, 2006, there were
no liabilities outstanding related to this bank guarantee.

As of January 1, 2006, The Company had a Malaysian ringgit
2.0 million (approximately $0.5 million) stand-by
letter of credit (LOC). This LOC expired in January 2006. The
LOC was secured by fixed deposits of Malaysian ringgit
2.0 million.



|         |                                 
|-------- | --------------------------------
|Note 10. | Derivative Financial Instruments

The Company accounts for its derivative and hedging activities
under SFAS 133. The assets or liabilities associated with
its derivative instruments and hedging activities are recorded
at fair value in prepaid expenses and other current assets or
other current liabilities, respectively, in the consolidated
balance sheets. As discussed below, the accounting for gains and
losses resulting from changes in fair value depends on the use
of the derivative and whether it is designated and qualifies for
hedge accounting.

As of January 1, 2006, the Company had foreign exchange
forward contracts to purchase approximately $7.4 million of
Japanese Yen for cash flow payments denominated in Japanese Yen
for future equipment purchases. These contracts have been
designated as a cash flow hedge in accordance with
SFAS 133. The fair value of the Companys forward
contracts was recorded as a $0.4 million other current
liability as of January 1, 2006. Fair value is determined
by the counterparty to the foreign exchange forward contracts.
The effectiveness of the contracts that qualify as cash flow
hedges is assessed quarterly through an evaluation of critical
terms and other criteria required by SFAS 133. The
effective portion of gains or losses resulting from changes in
fair value is initially reported as a component of accumulated
other comprehensive income or (loss), net of any tax effects, in
stockholders equity and subsequently reclassified into
depreciation expense over the useful life of the purchased
equipment. The ineffective portion of gains or losses resulting
from changes in fair value, if any, is reported in other income
(expense) in the consolidated statements of income.

The Companys foreign exchange forward contracts have
maturities of less than 12 months. The Company does not use
foreign exchange forward contracts for speculative or trading
purposes.

56



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|         |                     
|-------- | --------------------
|Note 11. | Stockholders Equity



| |             
| | ------------
| | Common Stock

As of January 1, 2006, the Company is authorized to issue
50.0 million shares of common stock. The following shares
of common stock are reserved for future issuance (in thousands):

|                               |  |  |       | 
|------------------------------ |  |  | ----- | 
|                              
|                              
|                              
|                              
|Convertible Subordinated Notes |  |  | 3,049 | 
|                              
|                              
|                              
|                              
|2002 Qualified Stock Plan      |  |  | 1,476 | 
|                               |  |  |       | 
|                               |  |  | 4,525 | 
|                               |  |  |       | 



| |                                               
| | ----------------------------------------------
| | Amended and Restated 2002 Qualified Stock Plan

The 2002 Qualified Stock Plan (the 2002 Stock Plan) provides for
the grant of incentive stock options to the Companys
employees, and for the grant of non-statutory stock options,
stock purchase rights, stock appreciation rights, performance
shares and performance units to the Companys employees,
directors, and consultants. The term for stock options granted
may not exceed 10 years. In May 2004, the Companys
stockholders approved an increase to the number of shares
reserved for future issuance by 650,000 shares. In May
2005, shareholders voted to terminate the Employee Stock
Purchase Plan (ESPP) and transfer the remaining 317,054
unissued shares that were previously reserved under the ESPP to
the 2002 Stock Plan.

As of January 1, 2006, the Company had authorized a total
of 4,242,054 shares of its common stock for issuance under
the 2002 Stock Plan. As of January 1, 2006, the Company had
a net balance of 1,476,262 shares of the Companys
common stock reserved for issuance under the 2002 Stock Plan. Of
the 1,476,262 shares reserved for future issuance under the
2002 Stock Plan, 29,833 are for stock purchase rights deferred
under the Deferred Compensation Plan, 868,853 are for the
exercise of outstanding stock options, and 577,576 are for
future grants of stock options and stock purchase rights.

Under the 2002 Stock Plan, as of January 1, 2006, 1,743,020
stock purchase rights were offered and accepted. Of this total,
1,670,489 were issued and outstanding (573,201 were unvested),
42,698 were cancelled, and 29,833 were deferred under the
Deferred Compensation Plan (which is discussed below).

A summary of stock option transactions is as follows:

|                                 |           |                |           |                  |   |   |       |       | 
|-------------------------------- | --------- | -------------- | --------- | ---------------- | - | - | ----- | ----- | 
|                                 |           |                |           | Weighted-Average
|                                 |           | Shares         |           | Exercise Price  
|                                 |           |                |           |                 
|                                 |           | (In thousands) |           | (Per share)     
|                                
|                                
|                                
|                                
|Outstanding at December 29, 2002 |           |                | 403,491   |                  |   | $ |      |      
|                                
|                                
|                                
|                                
|                                 | Granted   |                |           | 1,205,672        |   |   |       | 9.09  | 
|                                
|                                
|                                
|                                
|                                 | Exercised |                |           | (367,675         | ) |   |       | 0.67  | 
|                                
|                                
|                                
|                                
|                                 | Cancelled |                |           | (21,403          | ) |   |       | 5.87  | 
|                                 |           |                |           |                  |   |   |       |      
|Outstanding at December 28, 2003 |           |                | 1,220,085 |                  |   |   | 8.68  |      
|                                
|                                
|                                
|                                
|                                 | Granted   |                |           | 422,880          |   |   |       | 17.19 | 
|                                
|                                
|                                
|                                
|                                 | Exercised |                |           | (237,912         | ) |   |       | 5.78  | 
|                                
|                                
|                                
|                                
|                                 | Cancelled |                |           | (37,669          | ) |   |       | 12.50 | 
|                                 |           |                |           |                  |   |   |       |      
|Outstanding at January 2, 2005   |           |                | 1,367,384 |                  |   |   | 11.72 |      
|                                
|                                
|                                
|                                
|                                 | Granted   |                |           | 53,436           |   |   |       | 20.34 | 
|                                
|                                
|                                
|                                
|                                 | Exercised |                |           | (489,716         | ) |   |       | 10.13 | 
|                                
|                                
|                                
|                                
|                                 | Cancelled |                |           | (62,251          | ) |   |       | 13.80 | 
|                                 |           |                |           |                  |   |   |       |      
|Outstanding at January 1, 2006   |           |                | 868,853   |                  |   | $ | 12.99 |      
|                                 |           |                |           |                  |   |   |       |      

57



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes information concerning
outstanding and exercisable options as of January 1, 2006
(option shares in thousands):

|                         |  |                     |         |                     |  |          |      |             |  |          |       |  |  |  |         |  |  |   |       | 
|------------------------ |  | ------------------- | ------- | ------------------- |  | -------- | ---- | ----------- |  | -------- | ----- |  |  |  | ------- |  |  | - | ----- | 
|                         |  |                     |         |                     |  |         
|                         |  | Options Outstanding |         |                    
|                         |  |                     |         | Options Exercisable
|                         |  |                     |         | Remaining           |  |          |      |            
|                         |  | Number              |         | Contractual         |  | Exercise |      | Number      |  | Exercise
|Range of Exercise Prices |  | Outstanding         |         | Life (yrs)*         |  | Price*   |      | Exercisable |  | Price*  
|                         |  |                     |         |                     |  |          |      |             |  |         
|$ 6.48 - $ 6.48          |  |                     | 270,060 |                     |  |          | 7.05 |             |  | $        | 6.45  |  |  |  | 139,845 |  |  | $ | 6.48  | 
|                        
|                        
|                        
|                        
|10.30 -  13.16           |  |                     | 280,533 |                     |  |          | 7.66 |             |  |          | 12.80 |  |  |  | 152,876 |  |  |   | 13.05 | 
|                        
|                        
|                        
|                        
|13.97 -  18.85           |  |                     | 265,078 |                     |  |          | 8.17 |             |  |          | 18.35 |  |  |  | 89,541  |  |  |   | 18.34 | 
|                        
|                        
|                        
|                        
|18.86 -  23.52           |  |                     | 53,182  |                     |  |          | 8.98 |             |  |          | 20.53 |  |  |  | 1,903   |  |  |   | 19.96 | 
|                         |  |                     |         |                     |  |          |      |             |  |          |       |  |  |  |         |  |  |   |       | 
|                         |  |                     | 868,853 |                     |  |          |      |             |  |          |       |  |  |  | 384,165 |  |  |   |       | 
|                         |  |                     |         |                     |  |          |      |             |  |          |       |  |  |  |         |  |  |   |       | 



---



|  |                 
|- | ----------------
|* | Weighted-average



| |                           
| | --------------------------
| | Deferred Compensation Plan

Employees at or above the director level are eligible to
participate in the Companys Deferred Compensation Plan,
which provides for the deferral of stock purchase rights.
Eligible employees may elect to defer any stock purchase rights
they are eligible to receive during any calendar year the plan
remains in effect. All deferrals must equal 100% of the shares
to be awarded at the fair market value, calculated on the date
of grant, of the stock purchase rights that would have otherwise
been received. Distributions shall be paid in the form of shares
of the Companys common stock at such time as may be
elected by each participant.

As of January 1, 2006, 29,833 shares were not issued
in accordance with The Deferred Compensation Plan. See the
Deferred Stock-Based Compensation section below.



| |                                  
| | ---------------------------------
| | 2002 Employee Stock Purchase Plan

In October 2002, the Companys stockholders approved the
2002 Employee Stock Purchase Plan (ESPP). The Company has
reserved a total of 600,000 shares of its common stock for
issuance under the ESPP. Shares of common stock issued under the
ESPP in 2005, 2004, and 2003 were 82,825, 128,337, and 71,784,
respectively.

In May 2005, shareholders voted to terminate the ESPP and
transfer the remaining 317,054 unissued shares that were
previously reserved under the ESPP to the 2002 Qualified Stock
Plan.



| |         
| | --------
| | Warrants

In June 2002, the Company issued warrants to
purchase 1,000,000 shares of the Companys common
stock. The warrants were exercisable until June 30, 2005
and had an exercise price of $9.00. In 2003 through 2005,
approximately 992,000 warrants were exercised, and approximately
300,000 were surrendered in lieu of paying cash upon the
exercise of certain warrants. The remaining approximate 8,000
warrants which expired as of June 30, 2005 were cancelled.



| |                                  
| | ---------------------------------
| | Deferred Stock-Based Compensation

During the second six months of fiscal 2002, the Company
recorded deferred stock-based compensation of $4.6 million,
which represented the difference between the exercise price of
stock options granted (which was zero) or the purchase price of
a share of common stock (which was zero), and the fair value of
the Companys stock (which ranged from $3.00 to $3.70) as
of the date of grant. The amount was amortized ratably over the
vesting periods of the individual stocks, and was fully
amortized as of January 2, 2005.

58



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In 2004 and 2005, the Company recorded an additional
$0.3 million and $12.8 million, respectively, of
deferred stock-based compensation, which is being amortized over
the vesting period of 36 months. The weighted average value
of the stock purchase rights granted in 2004 and 2005 was $10.85
and $22.45, respectively.

The Company recorded $3.2 million for amortization of
deferred stock-based compensation expense for 2005,
$0.4 million for 2004, and $2.0 million for 2003.



|         |                       
|-------- | ----------------------
|Note 12. | Leases and Commitments

The Company leases a research and administrative facility under
an operating lease that expires in 2014. The lease includes two
renewal options for five years.

As of January 1, 2006, the future minimum commitments for
the non-cancelable operating facility lease, and non-cancelable
equipment leases, are as follows (in thousands):

|           |  |          |        | 
|---------- |  | -------- | ------ | 
|           |  | Minimum 
|           |  | Lease   
|           |  | Payments
|           |  |         
|2006       |  | $        | 2,253  | 
|          
|          
|          
|          
|2007       |  |          | 2,055  | 
|          
|          
|          
|          
|2008       |  |          | 2,047  | 
|          
|          
|          
|          
|2009       |  |          | 3,149  | 
|          
|          
|          
|          
|2010       |  |          | 3,143  | 
|          
|          
|          
|          
|Thereafter |  |          | 13,242 | 
|           |  |          |        | 
|           |  | $        | 25,889 | 
|           |  |          |        | 

Rental expense for all operating leases was $3.5 million in
2005, $3.9 million in 2004, and $3.4 million in 2003.

During 2005, the Company recorded $2.6 million of deferred
rent related to the Companys renewal of its leased
headquarters facility in San Jose, California. As of
January 1, 2006, the deferred rent balance was
$2.6 million.



|         |                                     
|-------- | ------------------------------------
|Note 13. | Quarterly Financial Data (Unaudited)

|                                                            |  |             |         |             |  |             |         |             |  |   |         |  |  |   |         | 
|----------------------------------------------------------- |  | ----------- | ------- | ----------- |  | ----------- | ------- | ----------- |  | - | ------- |  |  | - | ------- | 
|                                                            |  |            
|                                                            |  | 2005       
|                                                            |  |            
|                                                            |  | 1st Quarter |         | 2nd Quarter |  | 3rd Quarter |         | 4th Quarter
|                                                            |  |             |         |             |  |             |         |            
|Net sales                                                   |  | $           | 140,275 |             |  | $           | 172,740 |             |  | $ | 180,011 |  |  | $ | 192,920 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Gross profit                                                |  |             | 35,063  |             |  |             | 48,080  |             |  |   | 50,887  |  |  |   | 54,703  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Operating income                                            |  |             | 18,762  |             |  |             | 30,819  |             |  |   | 32,343  |  |  |   | 36,008  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Net income                                                  |  | $           | 18,527  |             |  | $           | 29,893  |             |  | $ | 31,982  |  |  | $ | 35,235  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Basic net income per share                                  |  | $           | 0.66    |             |  | $           | 1.04    |             |  | $ | 1.09    |  |  | $ | 1.20    | 
|                                                           
|                                                           
|                                                           
|                                                           
|Diluted net income per share                                |  | $           | 0.59    |             |  | $           | 0.92    |             |  | $ | 0.97    |  |  | $ | 1.07    | 
|                                                           
|                                                           
|                                                           
|                                                           
|Number of shares used in basic per share
    computations   |  |             | 28,261  |             |  |             | 28,834  |             |  |   | 29,396  |  |  |   | 29,476  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Number of shares used in diluted per share
    computations |  |             | 32,313  |             |  |             | 32,971  |             |  |   | 33,381  |  |  |   | 33,329  | 

59



---



##### Table of Contents



KOMAG, INCORPORATED


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                                            |  |             |         |             |  |             |         |             |  |   |         |  |  |   |         | 
|----------------------------------------------------------- |  | ----------- | ------- | ----------- |  | ----------- | ------- | ----------- |  | - | ------- |  |  | - | ------- | 
|                                                            |  |            
|                                                            |  | 2004       
|                                                            |  |            
|                                                            |  | 1st Quarter |         | 2nd Quarter |  | 3rd Quarter |         | 4th Quarter
|                                                            |  |             |         |             |  |             |         |            
|Net sales                                                   |  | $           | 123,585 |             |  | $           | 101,139 |             |  | $ | 102,424 |  |  | $ | 131,229 | 
|                                                           
|                                                           
|                                                           
|                                                           
|Gross profit                                                |  |             | 36,929  |             |  |             | 21,629  |             |  |   | 23,168  |  |  |   | 30,391  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Operating income                                            |  |             | 20,143  |             |  |             | 8,888   |             |  |   | 9,755   |  |  |   | 15,596  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Net income                                                  |  | $           | 17,973  |             |  | $           | 8,368   |             |  | $ | 9,264   |  |  | $ | 15,750  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Basic net income per share                                  |  | $           | 0.68    |             |  | $           | 0.30    |             |  | $ | 0.33    |  |  | $ | 0.56    | 
|                                                           
|                                                           
|                                                           
|                                                           
|Diluted net income per share                                |  | $           | 0.61    |             |  | $           | 0.28    |             |  | $ | 0.31    |  |  | $ | 0.51    | 
|                                                           
|                                                           
|                                                           
|                                                           
|Number of shares used in basic per share
    computations   |  |             | 26,307  |             |  |             | 27,526  |             |  |   | 27,792  |  |  |   | 27,975  | 
|                                                           
|                                                           
|                                                           
|                                                           
|Number of shares used in diluted per share
    computations |  |             | 29,778  |             |  |             | 31,553  |             |  |   | 31,334  |  |  |   | 31,875  | 



|         |                  
|-------- | -----------------
|Note 14. | Subsequent Events



| |                       
| | ----------------------
| | Stock Purchase Rights:

On February 15, 2006, the Companys Compensation
Committee of its Board of Directors approved the grant of a
total of 458,116 stock purchase rights with an exercise price of
$0.01 to employees. The vesting for the stock purchase rights
grants is one-third at the end of each of the first three
anniversaries of the date of grant, subject to the employee
continuing to be a service provider of the Registrant.



| |                  
| | -----------------
| | Supply Agreement:

On January 31, 2006, the Company signed Amendment
No. 3 to the Volume Purchase Agreement with Western Digital
Technologies, Inc. (WDC). The amendment increases the level of
prepayments to be made by WDC, increases the volume
requirements, and makes certain other modifications to terms of
the Agreement.



| |                      
| | ---------------------
| | Executive Retirement:

On February 15, 2006, the Company entered into certain
agreements in connection with the planned retirement of
Mr. T.H. Tan, its Chief Executive Officer (CEO). The CEO
plans to retire late in 2006. Under the Stock Options and
Restricted Stock Awards agreements, upon the first business date
which a successor CEO commences employment with the Company,
each stock option held by Mr. Tan as of February 15,
2006 will immediately vest as to 100% of the then unvested
shares subject to such options, and each restricted stock award
held by Mr. Tan as of February 15, 2006 will
immediately vest as to 40% of the then unvested shares subject
to such awards, and thereafter the remaining unvested shares
subject to the awards will vest in full on the later of three
(3) months or January 2, 2007, subject to Mr. Tan
continuing to provide services to the Company through such date.
As of February 15, 2006, Mr. Tan held stock options
with an aggregate of 44,531 unvested shares, and restricted
stock awards with an aggregate of 59,999 unvested shares. In
addition, on February 15, 2006, the Company granted
Mr. Tan a new restricted stock award under the Plan for
35,000 shares of Common Stock. This restricted stock award
will be subject to the same three-year vesting period and
accelerated vesting terms as Mr. Tans outstanding
amended restricted stock awards, as described above. The Company
also agreed to engage Mr. Tan to provide the Company with
consulting and advisory services effective on the first day
after a successor CEO commences employment with the Company and
continuing through that later of (i) three (3) months
after commencement of the consulting term, or
(ii) January  2, 2007. Under the Consulting
Services Agreement, Mr. Tan will be paid a monthly retainer
of $10,000 per month for four days per month, with any
additional days of service provided by Mr. Tan to the
Company at a rate of $2,500 per day. Mr. Tan will be
paid a bonus for the 2006 fiscal year under our Target Incentive
Plan subject to the terms of the Consulting Services Agreement.
Copies of the agreements that we entered into with Mr. Tan
are attached as Exhibit 10.13 to this Report.

60



---



##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of January 1, 2006, our management, including our Chief
Executive Officer (CEO) and Chief Financial Officer (CFO),
has conducted an evaluation of the effectiveness of our
disclosure controls and procedures pursuant to
Rule 13a-15(b) of the Exchange Act. Based on that
evaluation, the CEO and CFO concluded that our disclosure
controls and procedures are effective in ensuring that all
material information required to be filed in this annual report
has been made known to them in a timely manner.

Internal Control over Financial Reporting

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



| |   |                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | pertain to the maintenance of records that, in reasonable
    detail, accurately and fairly reflect the transactions and
    dispositions of the assets of the company;                                                                                                                                                                                        
|
| |  | provide reasonable assurance that transactions are recorded as
    necessary to permit preparation of financial statements in
    accordance with generally accepted accounting principles, and
    that receipts and expenditures of the company are being made
    only in accordance with authorizations of management and
    directors of the company; and
|
| |  | provide reasonable assurance regarding prevention or timely
    detection of unauthorized acquisition, use or disposition of the
    companys assets that could have a material effect on the
    financial statements.                                                                                                                                       

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

Managements Report on Internal Control Over Financial
Reporting

Our management is responsible for establishing and maintaining
adequate internal control over financial reporting as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our
independent auditors, KPMG LLP, have issued an auditors
report on managements assessment of Komags internal
report over financial reporting. This report is on page 39.

Our management assessed the effectiveness of Komags
internal control over financial reporting as of January 1,
2006. In making this assessment, management used the criteria
set forth in Internal Control  Integrated
Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Based on its
assessment and those criteria, management concluded that Komag
maintained effective internal control over financial reporting
as of January 1, 2006.

Changes in Internal Control Over Financial Reporting

There has been no change in Komags internal control over
financial reporting during its fourth fiscal quarter ended
January 1, 2006 that has materially affected, or is
reasonably likely to materially affect, Komags internal
control over financial reporting.

61



---



##### Table of Contents








|         |                  
|-------- | -----------------
|Item 9B. | Other Information

None.

PART III




Item(s) 10, 11, 12, 13, and 14.

Items 10 through 14 of Part III will be contained in
our Proxy Statement for the Annual Meeting of Stockholders to be
held on May 24, 2006 (the 2006 Proxy Statement), which will
be filed with the SEC no later than May 1, 2006. The
cross-reference table below sets forth the captions under which
the responses to these items are found:

|          |    |             |  |                                                                                                    |  |                                                                                              
|--------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------
|10-K Item |    | Description |  | Caption in 2006 Proxy Statement                                                                   
|          |    |             |  |                                                                                                   
|          | 10 |             |  | Directors and Executive Officers                                                                   |  | Election of Directors and
    Section 16(a) Beneficial Ownership Reporting
    Compliance
|          | 11 |             |  | Executive Compensation                                                                             |  | Executive Compensation and Related
    Information                                         
|          | 12 |             |  | Security Ownership of Certain Beneficial Owners
    and Management and Related Stockholder Matters |  | Stock Ownership by Directors, Nominees and
    Executive Officers                          
|          | 13 |             |  | Certain Relationships and Related Transactions                                                     |  | Certain Relationships and Related
    Transactions                                         
|          | 14 |             |  | Principal Accountant Fees and Services                                                             |  | Principal Accountant Fees and Services                                                     

The information set forth under the captions listed above, which
is to be contained in our 2006 Proxy Statement, are hereby
incorporated herein by reference in response to Items 10
through 14 of this Report on Form 10-K.

Most of our executive officers have entered into individual
Rule 10b5-1 trading plans pursuant to which stock of the
Company will be sold for their account from time to time in
accordance with the provisions of the plans without any further
action or involvement by the officers.

PART IV






|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules

(a) List of Items filed as part of this Report

1. Financial Statements.

The following consolidated financial statements of Komag,
Incorporated are filed in Part II, Item 8 of this
Report on Form 10-K:



| |                                                                                        
| | ---------------------------------------------------------------------------------------
| | Consolidated Statements of Operations  Fiscal Years
    2005, 2004, and 2003          
|
| | Consolidated Balance Sheets  January 1, 2006 and
    January 2, 2005                  
|
| | Consolidated Statements of Cash Flows  Fiscal Years
    2005, 2004, and 2003          
|
| | Consolidated Statements of Stockholders Equity 
    Fiscal Years 2005, 2004, and 2003
|
| | Notes to Consolidated Financial Statements                                             

2. Financial Statement Schedules.

62



---



##### Table of Contents



The following financial statement schedule of Komag,
Incorporated is filed in Part IV, Item 15(c) of this
report on Form 10-K:



| |                                                
| | -----------------------------------------------
| | Schedule II  Valuation and Qualifying Accounts

All other schedules for which provision is made in the
applicable accounting regulation of the SEC are not required
under the related instructions or are inapplicable and therefore
have been omitted.

3. Exhibits.

The list of exhibits to this Report set forth under
Part IV, Item 15(b) below, is incorporated herein by
reference.

(b) Exhibits

|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                                          
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1          |  | Komag Incorporateds Further Modified First
    Amended Plan of Reorganization, dated May 7, 2002
    (incorporated by reference from Exhibit 2.1 filed with the
    Companys Form 8-K filed on July 11, 2002).                                                                                                                                                         
|        | 2  | .2          |  | Findings of Fact, Conclusions of Law and Order,
    dated May 9, 2002, Confirming Further Modified First
    Amended Plan of Reorganization of Komag, Incorporated, dated
    May 7, 2002 (incorporated by reference from
    Exhibit 2.2 filed with the Companys Form 8-K
    filed on July 11, 2002).                                                                 
|       
|        | 3  | .1          |  | Amended and Restated Certificate of Incorporation
    of Komag, Incorporated (incorporated by reference from
    Exhibit 3.1 filed with the Companys Form 10-Q
    filed on August 13, 2002).                                                                                                                                                                           
|       
|        | 3  | .2          |  | Bylaws of Komag, Incorporated (incorporated by
    reference from Exhibit 3.2 filed with the Companys
    Form 10-Q filed on August 13, 2002).                                                                                                                                                                                                                          
|       
|        | 4  | .1          |  | Form of Stock Certificate for Common Stock
    (incorporated by reference from Exhibit 4.1 filed with the
    Companys Form 10-Q filed on August 13, 2002).                                                                                                                                                                                                             
|       
|        | 4  | .2          |  | Registration Rights Agreement between Komag,
    Incorporated and certain holders of common stock and Senior
    Secured Notes due 2007, (incorporated by reference from
    Exhibit 4.2 filed with the Companys Form 10-Q
    filed on August 13, 2002), as amended by Amendment
    No. 1 thereto dated October 1, 2002.                                              
|       
|        | 4  | .3          |  | Form of Indenture by and between Komag,
    Incorporated and U.S. Bank National Association
    (incorporated by reference from Exhibit 4.8 filed with the
    Companys Form S-3/ A filed on January 15, 2004).                                                                                                                                                         
|       
|        | 10 | .1          |  | Lease Agreement (B10) dated May 24, 1996
    between Sobrato Development Companies #871 and Komag,
    Incorporated (incorporated by reference from
    Exhibit 10.1.1.1 filed with the Companys report on
    Form 10-K for the year ended January 2, 2005).                                                                                                           
|       
|        | 10 | .1.1        |  | Second Amendment to Lease (B10) dated
    December 17, 2004, between DIVCO West Properties and Komag,
    Incorporated (incorporated by reference from
    Exhibit 10.1.1.1 filed with the companys report on
    form 10-K for the year ended January  2, 2005).                                                                                                       
|       
|        | 10 | .2          |  | Form of Indemnification Agreement (incorporated
    by reference from Exhibit 10.2 filed with the
    Companys report on Form S-1 on August 27, 2002).                                                                                                                                                                                                                  
|       
|        | 10 | .3          |  | Amended and Restated 2002 Qualified Stock Option
    Plan (incorporated by reference from Exhibit 10.1 filed
    with the Companys report on Form 10-Q for the quarter
    ended April 3, 2005).                                                                                                                                                                        
|       
|        | 10 | .3.1        |  | Komag, Incorporated 2002 Deferred Compensation
    Plan (incorporated by reference from Exhibit 10.4.2 filed
    with the Companys report on Form S-1 on
    August 27, 2002).                                                                                                                                                                                          
|       
|        | 10 | .4          |  | Letter dated August 6, 2003 from the
    Malaysian Industrial Development Authority addressed to Komag
    USA (Malaysia) Sdn. extending the Pioneer Status of
    the Companys thin-film media venture in Malaysia
    (incorporated by reference from Exhibit 10.5.2 filed with
    the Companys report on Form 10-Q for the quarter
    ended September 28, 2003).
|       
|        | 10 | .4.1        |  | Letter dated July 21, 2005 from the
    Malaysian Industrial Development authority addressed to Komag
    USA (Malaysia) Sdn. extending the Pioneer Status of
    the Companys thin-film media venture in Malaysia.                                                                                                                                                   

63



---



##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                  
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|       
|        | 10 | .5          |  | Business Agreement by and between the Company and
    Maxtor Corporation dated October  6, 2003
    (incorporated by reference from Exhibit 10.7 filed with the
    Companys Form S-3/ A filed on December 9, 2003).                                                                                                                            
|       
|        | 10 | .5.1        |  | Addendum to Business Agreement between Maxtor,
    Inc. and Komag, Incorporated dated October 6, 2003, as
    amended on July 8, 2005 * (incorporated by reference from
    Exhibit 10.2 filed with the Companys report on
    Form 10-Q for the quarter ended October 2, 2005).                                                                
|       
|        | 10 | .6          |  | Discretionary Bonus Plan (incorporated by
    reference from Exhibit 10.7 filed with the Companys
    Form 10-K for the year ended January 2, 2005).                                                                                                                                                                                            
|       
|        | 10 | .7          |  | Bonus Plan.                                                                                                                                                                                                                                                                                                                                      
|       
|        | 10 | .7.1        |  | Target Incentive Plan.                                                                                                                                                                                                                                                                                                                           
|       
|        | 10 | .8          |  | Form of Notice of Grant of Stock Purchase
    Right  Employees (incorporated by reference from
    Exhibit 10.9 filed with the Companys Form 10-K
    for the year ended January 2, 2005).                                                                                                                                                     
|       
|        | 10 | .8.1        |  | Form of Notice of Grant of Stock Purchase
    Right  Officers and Directors (incorporated by
    reference from Exhibit 10.9.1 filed with the Companys
    Form 10-K for the year ended January 2, 2005).                                                                                                                                      
|       
|        | 10 | .9          |  | Form of Stock Option Agreement (incorporated by
    reference from Exhibit 10.10 filed with the Companys
    Form 10-K for the year ended January 2, 2005).                                                                                                                                                                                     
|       
|        | 10 | .10         |  | Volume Purchase Agreement dated June 6, 2005
    between the Company, Komag USA (Malaysia) Sdn, and Western
    Digital Technologies, Inc. as amended by Amendment No. 1 thereto
    dated July 22, 2005 * (incorporated by reference from
    Exhibit 10.1 filed with the Companys report on
    Form 10-Q for the quarter ended July 3, 2005).
|       
|        | 10 | .10.1       |  | Amendment No. 2 to Volume Purchase
    Agreement, dated November 29, 2005, and Amendment
    No. 3 to Volume Purchase Agreement, dated January 31,
    2006, between the Company, Komag USA (Malaysia) Sdn., and
    Western Digital Technologies, Incorporated. *                                                                               
|       
|        | 10 | .11         |  | Media Supply Agreement dated July 4, 2005
    between the Company, Komag USA (Malaysia) Sdn, and Seagate
    Technology International. * (incorporated by reference from
    Exhibit 10.1 filed with the Companys report on
    Form 10-Q for the quarter ended October 2, 2005).                                                               
|       
|        | 10 | .12         |  | Form of Officer Employment Agreements
    (incorporated by reference from Exhibit 10.3 filed with the
    Companys report on Form 10-Q for the quarter ended
    October 2, 2005).                                                                                                                                                              
|       
|        | 10 | .13         |  | Amendment to Stock Option Agreements, Amendment
    to Stock Purchase Agreements, Amended and Restated Notice of
    Grant of Stock Purchase Right, and Consulting Services
    Agreement, each dated February 15, 2006, between the
    company and Thian H. Tan.                                                                               
|       
|        | 21 |             |  | Subsidiaries of Komag, Incorporated.                                                                                                                                                                                                                                                                                                             
|       
|        | 23 | .1          |  | Consent of KPMG LLP, Independent Registered
    Public Accounting Firm.                                                                                                                                                                                                                                                                          
|       
|        | 24 |             |  | Power of Attorney. Reference is hereby made to
    the signature pages of this report.                                                                                                                                                                                                                                                           
|       
|        | 31 | .1          |  | Rule 13a-14(a) Certification of Chief
    Executive Officer.                                                                                                                                                                                                                                                                                     
|       
|        | 31 | .2          |  | Rule 13a-14(a) Certification of Chief
    Financial Officer.                                                                                                                                                                                                                                                                                     
|        | 32 |             |  | Section 1350 Certifications of Chief
    Executive Officer and Chief Financial Officer.                                                                                                                                                                                                                                                          



---



|  |                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | Confidential treatment has been requested with respect to
    certain portions of this exhibit. Omitted portions have been
    filed separately with the SEC.

The Company agrees to furnish to the Commission upon request a
copy of any instrument with respect to long-term debt where the
total amount of securities authorized thereunder does not exceed
10% of the total assets of the Company.



|           |                             
|---------- | ----------------------------
|Item 15(c) | Financial Statement Schedule

See attached Schedule II.

64



---



##### Table of Contents



SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto
duly authorized, in San Jose, California on this
7th day of March, 2006.



| |                    
| | -------------------
| | KOMAG, INCORPORATED



| |     |                  
| | --- | -----------------
| | By: | /s/ THIAN HOO TAN

| |                        
| | -----------------------
| |                        
| | Thian Hoo Tan          
| | Chief Executive Officer

65



---



##### Table of Contents



POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears herein constitutes and appoints Thian Hoo Tan
and Kathleen A. Bayless, and each of them, as his true and
lawful attorneys-in-fact and agents, with full power of
substitution and re-substitution, for him and in his name, place
and stead, in any and all capacities, to sign any and all
amendments to this Report on Form 10-K, and to file the
same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and
each of them, full power and authority to do and perform each
and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or any of them, or their
or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons in
the capacities and on the dates indicated:

|                                             |  |                                                                                                           |  |               |  | 
|-------------------------------------------- |  | --------------------------------------------------------------------------------------------------------- |  | ------------- |  | 
|                                             |  |                                                                                                           |  |              
|Signature                                    |  | Title                                                                                                     |  | Date         
|                                             |  |                                                                                                           |  |              
|                                            
|/s/ THIAN HOO TAN(Thian Hoo Tan)             |  | Chief Executive Officer and Director (Principal
    Executive Officer)                                    |  | March 7, 2006
|                                            
|/s/ KATHLEEN A. BAYLESS(Kathleen A. Bayless) |  | Senior Vice President, Chief Financial Officer,
    and Secretary
    (Principal Financial Officer)       |  | March 7, 2006
|                                            
|/s/ PAUL G. JUDY(Paul G. Judy)               |  | Vice President, Corporate Controller, and Chief
    Accounting Officer
    (Principal Accounting Officer) |  | March 7, 2006
|                                            
|/s/ PAUL A. BRAHE(Paul A. Brahe)             |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ CHRIS A. EYRE(Chris A. Eyre)             |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ RICHARD A. KASHNOW(Richard A. Kashnow)   |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ KENNETH R. SWIMM(Kenneth R. Swimm)       |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ DAVID G. TAKATA(David G. Takata)         |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ HARRY G. VAN WICKLE(Harry G. Van Wickle) |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ DENNIS P. WOLF(Dennis P. Wolf)           |  | Director                                                                                                  |  | March 7, 2006
|                                            
|/s/ MICHAEL LEE WORKMAN(Michael Lee Workman) |  | Director                                                                                                  |  | March 7, 2006

66



---



##### Table of Contents



KOMAG, INCORPORATED

Schedule II  VALUATION AND QUALIFYING
ACCOUNTS

|                             |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |     | 
|---------------------------- | ------------------------------- | -------------- | - | ---------- |  | ---------- | - | --------- | - |  | - | - |  |  | - | --- | 
|Column A                     |                                 | Column B       |   | Column C   |  | Column D   |   | Column E 
|                             |                                 |                |   |            |  |            |   |          
|                             |                                 |                |   | Additions  |  |            |   |          
|                             |                                 | Balance at     |   | Charged to |  |            |   | Balance  
|                             |                                 | Beginning      |   | Costs and  |  |            |   | at End of
|Description                  |                                 | of Year        |   | Expenses   |  | Deductions |   | Year     
|                             |                                 |                |   |            |  |            |   |          
|                             |                                 |               
|                             |                                 | (In thousands)
|Year ended December 28, 2003 |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |    
|                            
|                            
|                            
|                            
|                             | Allowance for doubtful accounts |                | $ | 401        |  |            | $ | (3        | ) |  | $ |  |  |  | $ | 398 | 
|                             |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |    
|Year ended January 2, 2005   |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |    
|                            
|                            
|                            
|                            
|                             | Allowance for doubtful accounts |                | $ | 398        |  |            | $ | (398      | ) |  | $ |  |  |  | $ |    | 
|                             |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |    
|Year ended January 1, 2006   |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |    
|                            
|                            
|                            
|                            
|                             | Allowance for doubtful accounts |                | $ |           |  |            | $ |          |   |  | $ |  |  |  | $ |    | 
|                             |                                 |                |   |            |  |            |   |           |   |  |   |   |  |  |   |    

67



---



##### Table of Contents



EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                                          
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1          |  | Komag Incorporateds Further Modified First
    Amended Plan of Reorganization, dated May 7, 2002
    (incorporated by reference from Exhibit 2.1 filed with the
    Companys Form 8-K filed on July 11, 2002).                                                                                                                                                         
|        | 2  | .2          |  | Findings of Fact, Conclusions of Law and Order,
    dated May 9, 2002, Confirming Further Modified First
    Amended Plan of Reorganization of Komag, Incorporated, dated
    May 7, 2002 (incorporated by reference from
    Exhibit 2.2 filed with the Companys Form 8-K
    filed on July 11, 2002).                                                                 
|       
|        | 3  | .1          |  | Amended and Restated Certificate of Incorporation
    of Komag, Incorporated (incorporated by reference from
    Exhibit 3.1 filed with the Companys Form 10-Q
    filed on August 13, 2002).                                                                                                                                                                           
|       
|        | 3  | .2          |  | Bylaws of Komag, Incorporated (incorporated by
    reference from Exhibit 3.2 filed with the Companys
    Form 10-Q filed on August 13, 2002).                                                                                                                                                                                                                          
|       
|        | 4  | .1          |  | Form of Stock Certificate for Common Stock
    (incorporated by reference from Exhibit 4.1 filed with the
    Companys Form 10-Q filed on August 13, 2002).                                                                                                                                                                                                             
|       
|        | 4  | .2          |  | Registration Rights Agreement between Komag,
    Incorporated and certain holders of common stock and Senior
    Secured Notes due 2007, (incorporated by reference from
    Exhibit 4.2 filed with the Companys Form 10-Q
    filed on August 13, 2002), as amended by Amendment
    No. 1 thereto dated October 1, 2002.                                              
|       
|        | 4  | .3          |  | Form of Indenture by and between Komag,
    Incorporated and U.S. Bank National Association
    (incorporated by reference from Exhibit 4.8 filed with the
    Companys Form S-3/ A filed on January 15, 2004).                                                                                                                                                         
|       
|        | 10 | .1          |  | Lease Agreement (B10) dated May 24, 1996
    between Sobrato Development Companies #871 and Komag,
    Incorporated (incorporated by reference from
    Exhibit 10.1.1.1 filed with the Companys report on
    Form 10-K for the year ended January 2, 2005).                                                                                                           
|       
|        | 10 | .1.1        |  | Second Amendment to Lease (B10) dated
    December 17, 2004, between DIVCO West Properties and Komag,
    Incorporated (incorporated by reference from
    Exhibit 10.1.1.1 filed with the companys report on
    form 10-K for the year ended January  2, 2005).                                                                                                       
|       
|        | 10 | .2          |  | Form of Indemnification Agreement (incorporated
    by reference from Exhibit 10.2 filed with the
    Companys report on Form S-1 on August 27, 2002).                                                                                                                                                                                                                  
|       
|        | 10 | .3          |  | Amended and Restated 2002 Qualified Stock Option
    Plan (incorporated by reference from Exhibit 10.1 filed
    with the Companys report on Form 10-Q for the quarter
    ended April 3, 2005).                                                                                                                                                                        
|       
|        | 10 | .3.1        |  | Komag, Incorporated 2002 Deferred Compensation
    Plan (incorporated by reference from Exhibit 10.4.2 filed
    with the Companys report on Form S-1 on
    August 27, 2002).                                                                                                                                                                                          
|       
|        | 10 | .4          |  | Letter dated August 6, 2003 from the
    Malaysian Industrial Development Authority addressed to Komag
    USA (Malaysia) Sdn. extending the Pioneer Status of
    the Companys thin-film media venture in Malaysia
    (incorporated by reference from Exhibit 10.5.2 filed with
    the Companys report on Form 10-Q for the quarter
    ended September 28, 2003).
|       
|        | 10 | .4.1        |  | Letter dated July 21, 2005 from the
    Malaysian Industrial Development authority addressed to Komag
    USA (Malaysia) Sdn. extending the Pioneer Status of
    the Companys thin-film media venture in Malaysia.                                                                                                                                                   
|       
|        | 10 | .5          |  | Business Agreement by and between the Company and
    Maxtor Corporation dated October  6, 2003
    (incorporated by reference from Exhibit 10.7 filed with the
    Companys Form S-3/ A filed on December 9, 2003).                                                                                                                                                    
|       
|        | 10 | .5.1        |  | Addendum to Business Agreement between Maxtor,
    Inc. and Komag, Incorporated dated October 6, 2003, as
    amended on July 8, 2005 * (incorporated by reference from
    Exhibit 10.2 filed with the Companys report on
    Form 10-Q for the quarter ended October 2, 2005).                                                                                        
|       
|        | 10 | .6          |  | Discretionary Bonus Plan (incorporated by
    reference from Exhibit 10.7 filed with the Companys
    Form 10-K for the year ended January 2, 2005).                                                                                                                                                                                                                    
|       
|        | 10 | .7          |  | Bonus Plan.                                                                                                                                                                                                                                                                                                                                                              
|       
|        | 10 | .7.1        |  | Target Incentive Plan.                                                                                                                                                                                                                                                                                                                                                   
|       
|        | 10 | .8          |  | Form of Notice of Grant of Stock Purchase
    Right  Employees (incorporated by reference from
    Exhibit 10.9 filed with the Companys Form 10-K
    for the year ended January 2, 2005).                                                                                                                                                                             



---



##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                                                                                                                                                  
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|       
|        | 10 | .8.1        |  | Form of Notice of Grant of Stock Purchase
    Right  Officers and Directors (incorporated by
    reference from Exhibit 10.9.1 filed with the Companys
    Form 10-K for the year ended January 2, 2005).                                                                                                                                      
|       
|        | 10 | .9          |  | Form of Stock Option Agreement (incorporated by
    reference from Exhibit 10.10 filed with the Companys
    Form 10-K for the year ended January 2, 2005).                                                                                                                                                                                     
|       
|        | 10 | .10         |  | Volume Purchase Agreement dated June 6, 2005
    between the Company, Komag USA (Malaysia) Sdn, and Western
    Digital Technologies, Inc. as amended by Amendment No. 1 thereto
    dated July 22, 2005 * (incorporated by reference from
    Exhibit 10.1 filed with the Companys report on
    Form 10-Q for the quarter ended July 3, 2005).
|       
|        | 10 | .10.1       |  | Amendment No. 2 to Volume Purchase
    Agreement, dated November 29, 2005, and Amendment
    No. 3 to Volume Purchase Agreement, dated January 31,
    2006, between the Company, Komag USA (Malaysia) Sdn., and
    Western Digital Technologies, Incorporated. *                                                                               
|       
|        | 10 | .11         |  | Media Supply Agreement dated July 4, 2005
    between the Company, Komag USA (Malaysia) Sdn, and Seagate
    Technology International. * (incorporated by reference from
    Exhibit 10.1 filed with the Companys report on
    Form 10-Q for the quarter ended October 2, 2005).                                                               
|       
|        | 10 | .12         |  | Form of Officer Employment Agreements
    (incorporated by reference from Exhibit 10.3 filed with the
    Companys report on Form 10-Q for the quarter ended
    October 2, 2005).                                                                                                                                                              
|       
|        | 10 | .13         |  | Amendment to Stock Option Agreements, Amendment
    to Stock Purchase Agreements, Amended and Restated Notice of
    Grant of Stock Purchase Right, and Consulting Services
    Agreement, each dated February 15, 2006, between the
    company and Thian H. Tan.                                                                               
|       
|        | 21 |             |  | Subsidiaries of Komag, Incorporated.                                                                                                                                                                                                                                                                                                             
|       
|        | 23 | .1          |  | Consent of KPMG LLP, Independent Registered
    Public Accounting Firm.                                                                                                                                                                                                                                                                          
|       
|        | 24 |             |  | Power of Attorney. Reference is hereby made to
    the signature pages of this report.                                                                                                                                                                                                                                                           
|       
|        | 31 | .1          |  | Rule 13a-14(a) Certification of Chief
    Executive Officer.                                                                                                                                                                                                                                                                                     
|       
|        | 31 | .2          |  | Rule 13a-14(a) Certification of Chief
    Financial Officer.                                                                                                                                                                                                                                                                                     
|        | 32 |             |  | Section 1350 Certifications of Chief
    Executive Officer and Chief Financial Officer.                                                                                                                                                                                                                                                          



---



|  |                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | Confidential treatment has been requested with respect to
    certain portions of this exhibit. Omitted portions have been
    filed separately with the SEC.