威騰電子 (WDC) 2005 Q1 法說會逐字稿

Good day, and welcome to the Komag Inc. first-quarter fiscal 2005 earnings conference call. Today's call is being recorded. I will now turn the call over to the Chief Executive Officer of Komag, Mr. T.H. Tan. Please go ahead, sir.

Thank you, Amy. Good afternoon. I am T.H. Tan, CEO of Komag. With me on the call today, Dr. Mike Russak, our President and CTO, Kathy Bayless, our CFO, and other Company officers.

Today, I'll ask Kathy Bayless to discuss our financial performance for the first quarter of 2005. Then, Mike will discuss customer and market conditions. And I will discuss the first quarter's operations, our outlook for the second quarter of 2005, and later, a few closing comments, then we'll open it up for questions. Kathy?

Thank you, T.H. Before we begin today, I would like to remind the audience that we will be making forward-looking statements during this conference call, such as the statements regarding our outlook for the second quarter of 2005 and our expected capacity and capital spending for 2005. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from our forecast. These forward-looking statements speak as of today and you should not rely on them as representing Komag's views in the future. We undertake no obligation to update forward-looking statements to reflect events or circumstances after the date they are made. In addition to factors that may be discussed on this call, important factors that could cause actual results to differ materially are contained in our press release today announcing our first-quarter results and in our SEC filings, including our annual report on Form 10-K for the year ended January 2nd, 2005. Copies of these documents may be obtained from the SEC's Web site or visiting the Investor Relations portion of our Web site.

The press release describing our first-quarter 2005 results was placed on the news wires today at approximately 4 PM Eastern daylight time. If you do not have a copy of the press release, it is currently posted on our Web site at www.komag.com. Now I will review the financial performance for the first quarter of 2005.

Net sales totaled $140.3 million in the first quarter of 2005 compared to 131.2 million in the fourth quarter of 2004 and 123.6 million in the first quarter of 2004. This is a 7% increase from the prior quarter and a 14% increase from the year-ago quarter. The first quarter of 2004 included 14 weeks compared to 13 weeks in all other quarters of 2004 and 2005.

Finished unit shipments were a record level of 22.2 million in the first quarter compared to 19.8 million in the prior quarter. Unit shipments in the year-ago quarter were 19.2 million. Other disk revenue provided 17.4 million of revenue in the first quarter of 2005 compared to 18.8 million in the prior quarter and 19.6 million in the year-ago quarter.

Net income and earnings per share in the first quarter of 2005 were 18.5 million and $0.59 per share, respectively, compared to 15.8 million and $0.51 per share in the prior quarter. Net income and earnings per share in the year-ago quarter were 18 million and $0.61 per share.

Diluted shares outstanding for the first quarter were 32.3 million. Net interest was positive 0.3 million in the first quarter of 2005. Our income tax provision in the first quarter was 2.7%. Operating and net margin were both approximately 13% in the first quarter. Operating expenses were approximately 11.9% of revenue compared to 11.6% in the prior quarter. The increase included stock compensation expense from the issuance of restricted stock in February and additional R&D spending to support new products.

On our balance sheet and cash flow, we ended the first quarter of 2005 with 116.5 million of cash compared to 104.1 million at the end of the prior quarter. Our ending accounts receivable balance was 85.7 million compared to 79.2 million at the end of the fourth quarter, reflecting the higher sales in the first quarter.

Net inventory was 42 million compared to 35.8 million at the end of the prior quarter. The increase in net inventory was required to support higher production levels to meet continuing strong customer demand.

Depreciation was 10.1 million and amortization of intangible assets was 0.9 million in the first quarter.

Capital expenditures were approximately 16.6 million in the first quarter and cash flow from operations totaled 26.4 million.

Now let me turn it over to Mike.

Thank you, Kathy. As previously stated, total finished disk shipments were 22.2 million disks in Q1 of '05, a new record level compared to 19.8 million disks in the prior quarter. The increase in units shipped from the prior quarter was due to a higher level of 80 GB per platter 3.5 inch disk shipments. Sales mix by major customer was Maxtor at 35%, HGST at 25%, Western Digital at 19 and Seagate at 16%. Shipments of 100 GB per platter and above advanced disks were 18% of total finished unit shipments, as the number of actual disks shipped was similar to the prior quarter. These advanced disks are primarily targeted for multiplatter consumer electronic applications, including PVR and DVR applications as well as near-line storage.

Enterprise disk shipments included new generation 70 mm and 84 mm disks for 15K and 10K RPM high-end server applications. Enterprise unit shipments totaled 1.2 million disks.

All advanced 100 GB and above disks as well as the new enterprise disks included several new processes to meet the ever more complex specifications required to achieve high performance in today's advanced disk drives. In addition, due to extended product lifecycles and increased focus on product enhancements designed to improve customer drive yields, performance, and DPPM levels, many of these new processes are now included in current generation 80 GB per platter disks.

Our blended average selling prices decreased from the prior quarter due to a higher mix of 80 G per platter products in the first quarter and volume pricing set in prior quarters. We expect stable pricing in the second quarter of 2005 based on a similar product mix.

Over development efforts are focused primarily on qualification and our customers' next generation products and are proceeding on schedule. Additionally, we are shifting more resources to assure our readiness to produce a perpendicular magnetic recording media for future products. We believe PMR media will first be used in ployable (ph) HDD applications, 65 mm and smaller drives that use glass-based media, followed by enterprise applications. The desktop and consumer HDD segment likely will be the last to adopt PMR on AlMg-based media.

Komag is well positioned to support both LMR and PMR media. However, based on our customer requirements, we would not expect to be producing significant volumes of PMR media until the second half of 2006. We will be providing sample quantities of AlMg-based media for portable drives evaluation during Q2 of '05, and we are continuing to assess the market acceptance of this media.

Now, T.H. will provide some further comments on the first quarter and our business outlook.

Thank you, Mike. Needless to say, we are very pleased with our first quarter of 2005 financial performance. First quarter of 2005, finished unit shipments, record number, 232.2 (ph) million. First-quarter 2005 revenues and earnings per share increased 7% and 16% over the prior quarter.

Substrate sales were 12% of total revenue and we expect a similar percent base (ph) in Q2 '05.

In our manufacturing operations, we made improvements in product use as we moved through the first quarter and more fully utilized our existing capacity. It's contributed for an increase in our gross margin to 25%. In addition, we incrementally increased our finished disk capacity from approximately 34 million to 25 million disks per quarter by upgrading all our equipment. Due to the strong market demand, we are working on further equipment efficiency and upgrade projects to increase capacity to approximately 26 million per quarter in 2005. In order to increase finished disks and related substrate capacity and continue to rank new processes, we have increased our capital spending plan to approximately 85 to $90 million for 2005. We are working with all of our customers on ways to satisfy their demand for increasing levels of disks to support the disk drive demand.

Our R&D and manufacturing operations are continuing to work very hard designing, qualifying and shipping new advanced products with ever-tighter product specifications. Bringing up new capacity, (indiscernible) production volumes and controlling costs. I would like to thank all of our employees for their continuing dedication, hard work and excellent performance.

Outlook, looking forward, based on the continuing strong market demand that we are seeing from all four of our major disk drive customers, for the second quarter of 2005, we expect total revenue to be comparable to or up to 10% higher than the first quarter. This level of revenue reflects current continuing strong demand for finished disks as well as demand for our substrates.

With this level of revenue in the second quarter and continuing improvements in product costs and capacity utilization, we believe that the next level (ph) will be in the range of 13% to 15%. In addition, we believe that market demand for the second half of 2005 could continue to be very strong. Industry forecasts indicate that the market for disk drives could grow approximately 20% in 2005, and that the disk per driver ratio may also increase from 2004 levels.

We are excited about the outlook for growing demand for disk drives and disks in both traditional computer-related markets as well as the expanding market for consumer electronic devices. We believe that we are well positioned in the high-growth consumer application markets for PVR, DVR, HDTV, external storage, and other home entertainment devices.

In summary, we believe we have the right financial model. We are committed to maintaining our low-cost manufacturing structure, advancing technology, and strengthening our customer relationships to grow our business and provide positive financial performance. Now, I'll turn the call to Amy, please, for Q&A.

Thank you. (OPERATOR INSTRUCTIONS). Shebly Seyrafi.

Yes, nice quarter. So as you think about your second quarter, do you expect broad-based customer strength to continue? Do you expect four 10% customers, for example? And I have a few more.

Yes, I think it's clear from other customers and also so far for a lot of components manufacturers of our business, I think (indiscernible) is that the second quarter, all four of our major customers, which made up 80 something percent of the total available market will be strong.

Okay. And as I look at my model, you'll be bumping up against your capacity target toward the end of the year. I'm wondering how much you think about your capacity in 2006 or exiting 2006?

Okay. As you heard me saying, we are improving our efficiency and we add a little bit of capital to increase the balancing of the kumens (ph) and improve utilization. (indiscernible) million, okay, going forward. And we will hit it this quarter if the demand continues to be strong. We will not (indiscernible) unless the market is telling us that you have the business and we have to see (indiscernible) before we do it the next extension. This is our policy for the last few years, as you can tell.

Last one for me, your gross margin, could it hit 27% do you think sometime this year?

I don't want to go into that, Shelby, and you should know that this is the one area, the customers would not want to have our controlled (indiscernible) gross (ph). On the other hand, we manage our net very carefully. We (indiscernible) the growth is. We constantly reduce our operating costs. So we manage our net. You can see when gross goes down in the prior quarters, when during the seasonally is the weak quarters, we do not allow our net to go down, okay, correspondingly, we control it. And when the gross goes up, we also continue to grow the net. So this is how we operate. Again, the gross is an issue that we have to be very careful; we don't want our customers to be competing with us.

Thank you. I guess just, first, congratulations on a great quarter. Just a few questions. Should we assume from your CapEx commentary that maybe if you have capacity up to 26 million per quarter that you shouldn't have to expedite at the same level? And then I guess should we also assume that that CapEx level does not actually include any equipment purchases, that these are just upgrades and tweaks to the system to make them more efficient?

The answer is yes.

Okay. And so you'll have to expedite less in the quarter with that type of level?

Yes.

Okay. And then I guess, in terms of the average platter count, can you give us a sense on where you think it may be settled out in the quarter and your expectations for the balance? You said you thought it was -- the industry people think it's going to be up for the year. Do you agree with that assessment?

Yes, we saw our numbers going up and we see our customers announced plans for drives and what they want for disks, we do our own math and say yes, it goes up. And Hutchison and everyone else who sells other components say the same thing. So we're not alone.

And I guess just lastly, in terms of the increasing volume of 80 G, you expected that to be fairly comparable here in this quarter, but should we expect any sequential improvement in the 100 G and higher for the June quarter?

I think you've got it right. Okay? The June quarter is the same as the March quarter; you already see the plan. We already know what we're making. But the second half of the year, the 100 G and above making a rank (ph). The (indiscernible) happen to be an indicate (ph) for the PC5 (ph). But if you note that PVR, the DVRs and other stuff favors the 100 G and up and those are coming in the second quarter.

Mark Miller.

Congratulations for another strong quarter. I'd just like to talk about margins year-over-year. There are down around 500 basis points. Pricing got tough in that time. You indicated also that 80 G per platter, you have a mixed shift more towards that. Were they the primary factors? Or were there things such as having to expedite more media or yields on higher intensity programs that were contributing to the decrease in the margins year-over-year?

I think you got all the answers in Kathy's commentary, which is the mixed style on the (indiscernible). As you know, as I indicated, they are off of two years and the pricing has been negotiated many quarters in advance. And that's the reason when the number goes up, those are our increases this quarter compared to last one came from 80. You can get corresponding job (ph) in the (indiscernible). But it is not bad news. It just means that we did the first (indiscernible) specification at 80 G and kept the space down by 100 and above. (indiscernible) future is very bright.

Second question, your largest customer has announced plans to relocate over somewhere in Asia. I'm expecting that within the next year. Have they given you any leading indicators that there might be additional slack from this transfer that you might have to pick up the slack and then actually receive more orders from them as they are in the process of relocating their whole manufacturing operation overseas?

I will say I'd rather not go into that because it's a confidential discussion going on within our biggest customer and ourselves. (indiscernible) we are qualified in other programs in this customer, so we are in the best position to ensure a seamless transition.

Thank you very much.

Kevin Hunt.

Yes, thank you. I wanted to follow up on some of the earlier questions about the capacity. It looks to me like you're going to be out of capacity again by at least by the September quarter, so what are you guys going to do I guess in December when you can't grow and obviously demand will probably be going up at that point?

And then, also just on Seagate, they were a 16% customer this quarter. What should we think about them going forward? Are they just typically I think an overflow type of customer? Would they be falling off as the year progresses?

Let me (indiscernible) we are (indiscernible) an overflow customer. We are actually a strategy customer supplier to them. And they need this relationship of (indiscernible) standpoint, want (ph) sharing and getting better. So we see our application of our way (indiscernible) very appropriate from our (indiscernible) and (indiscernible) as appropriate for them. They have announced a (indiscernible) that they will buy (indiscernible) 10% of what they consume from an outside source. And we are an American company; have 22 years of history; have been delivering (indiscernible); our design (indiscernible) are just next to (indiscernible) 2, 3 miles apart. So we are in a very strategic position. So we are not just overflow. If we are overflow, we'd rather not be. So we are now overflow capacity for Seagate. So it is a strategy for both companies (indiscernible) too.

About our future, the next (indiscernible) quarters, we have not only announced our growth plan beyond 26 million. So I'd rather not talk about it here. I just want you to know that how we got here is by judiciously spending our money and we will not spend money unless we see returns. And we must (indiscernible) the customer buys, customers (indiscernible) with us together and we will not do anything unilaterally, is all I want to say. So we'll fall a few more months and then we will be making some other plans and when the time is right, we'll tell the whole world.

Okay, can I make one follow-up on a gross margin question also? Can you maybe help us understand with all this capacity coming online kind of how that flows through the gross margin line and when we might expect to get back towards like a 30% gross margin like you had historically at these kind of volumes?

I don't want to discuss gross margin. I tell you my customers are listening right now; no, I cannot do that. We have managed our net. You get our kind of growth, (indiscernible) spend the money, and we are launching that, it's no good. So as we fall into the channels (ph), it's getting better and better EPS. And we are working on that all the time and you can see our results. Okay?

If Seagate is a customer, should we assume that that is 100% at the 80 G capacity that you're manufacturing for them?

I cannot tell you this, but I can tell you, but you would be breaking a rule. I can tell you on every customers what they buy without breaking down by density and that may be a different business (ph), some customers compared to others. So it's not that big of a deal (indiscernible), I just cannot say.

I can tell you one thing. All our increases this quarter compared to last quarter in volume, 180 (ph) gig, okay?

Great. Regarding your volume purchase agreement with Western Digital in your quality issues that you had in 2004, is Western Digital purchasing at their obligated percentage requirement currently? Or is there still room for improvement there?

I cannot comment on that because as you may already know, in this business, if your product networks (ph) and you are competitive, that will guarantee your business. And we never go by anything like obligation or committee numbers on paper and we live and die by our product in the hands. Okay? If we don't, then we don't sell. If we do, we sell a lot.

Fantastic. Can you give us an update? You mentioned it briefly earlier, on the viability of using aluminum based disks in small form factor drives versus glass? I think you previously stated that you're working with several drive companies on that. Can you give us an update there?

Sure. Dr. Russak will talk about this.

Yes, thanks, T.H. What we're doing, I think we said last time that during the first quarter of this year, we were going to set up our pilot production capabilities here in San Jose. We've done that. We are beginning to produce 65 mm and smaller form factor aluminum disks and we are beginning to sample across the customer base and some potential customers that are not in the customer base right now. So we would expect over the next several months to really determine the viability of this approach and in what applications.

So, from that comment, should we assume that 2.5 in. drives would adopt prior -- before 45 mm, 27 mm customers?

I think it's difficult at this point to say that. We are looking at -- when we talk about the portable drive applications, we talk about 65 mm and below, slower speed; I mean 65 mm high-speed drives are of course enterprise products.

Yes, I think the only differentiator (indiscernible). I will say this, at the 65 mm level, aluminum based substrate media, it's not a tentacle issue but a customer acceptance issue, marketing issue. And it takes a big customer of our customers to come in and the rest will be history. We are waiting for that magical moment.

For smaller than 65, due to the sales plus (ph), these are the design points like the sales plus, and this is the nice mature, that will be a different dynamic working at that level. But there is something in favor of that form factor of one inch of the 80 mm to the 70 (ph) mm. And there is quantification (ph) for -- that's our drive (ph). It's not the same -- it's the same intensity as (indiscernible) level compared to the traditional IT products. So there are pros and cons. We'll adjust with our customers (indiscernible) end customers (indiscernible).

Could I ask more question? Kathy, what percentage -- what was your finished goods number?

Total inventory -- I gave the total inventory number. And that was 40 -- I believe that was what, 40 million? 42 million.

Percentage of that that was in finished goods?

I haven't broken that out.

No?

Basically, there is -- it's comprised of raw materials within finished goods. And the increase in the inventory was in raw materials as well as some finished goods. It was all just to support current ongoing operations at higher levels.

You don't have a finished goods at your fingertips? (indiscernible) in the Q in a few days?

Yes, it will be in the Q.

(OPERATOR INSTRUCTIONS). Naveen Bobba.

Thank you. Nice results. (indiscernible) customers (indiscernible) talk about potential constraints, volume and the media in the second half. What are your thoughts on that? And based on what you see with your customers and your competition, when do you think those constraints could ease if at all in the second half?

First of all, it's (indiscernible) these days when supply and demand are in balance. We all go for these days in many, many news outlines, we are now in a situation where the balance, and we have now looked at rational costing versus our pricing, and also expansion. We have to look at share and (indiscernible) going forward. And one thing we all know is that people who are in this business, which includes our customers and our captive competition -- captive suppliers to our customers, and our (indiscernible) competitors, we have all been through this wall and we would not be crazy in expanding capacity. Okay? So all I can tell you is I've seen optimism. I've seen rationality right now.

Okay. Fair enough. And I guess Kathy, two questions for you, one on the gross margin side air freight are a lower yield on new products material impact on gross margins this quarter? In the market?

No, not really. I mean air freight was probably a little bit less than last quarter, but not material. There was improvement basically in production costs and yields.

Throughout the quarter.

Right, throughout the quarter.

Okay. And on OpEx, Kathy, what's a good estimate for OpEx for second quarter and beyond?

OpEx, as I said, we were at about 11.9% of revenue this quarter; we expect it to be similar.

Okay. And Mike, finally, too for you, one on the enterprise side, any realistic chances of getting another customer on the enterprise side?

We always live in hope. We continue to engage other customers in the customer base that have enterprise products, but we're not announcing anything at this point.

Okay. And on PMR, I think you said that you expect volume shipments for you in the second half of '06. When do you think you'll actually have to find equipment and (indiscernible) for that?

Well, we're not talking about expansion. I think part of our -- I mentioned we're directing more resources within the organization to get ready for PMR media, so we are spending some money on upgrading current tools where necessary to produce product going forward. However, we're ready to do -- we're doing LMR and PMR and within our customer base, we think we're in the right time to meet their requirements going forward on perpendicular.

Okay, thank you. And again, nice results.

Les Santiago.

Yes, could you talk about your enterprise shipments? They were at about -- was it 1.2 million this quarter, with Maxtor and Hitachi starting to ramp their enterprise businesses after a couple of quarters of slowdown because of transitions and product issues. Should we expect that number to increase throughout the year?

The answer is yes. Because as our customers ramp then we (indiscernible) supply media and of course --

So in terms of an '06 percent, contribution to units this quarter, (indiscernible) in terms of how high that can get?

We cannot (indiscernible) whether the customer is programmed to launch and if you just say very accurately (indiscernible) product transition, some issues and not (indiscernible) on their feet and they're going to do (indiscernible) big things. It's a matter of them as the one guy (indiscernible) an amount. We will be there to support.

Okay. And then the Q2 '05, you talked about some outback (ph) portable media. Was that sold (ph) at a constant level? You said that sold in your (ph) little (ph) samples, right?

Yes, that's correct. We're not announcing participation in a program at this point. But we are sampling the customer base.

Is that just LMR or is that PMR also?

Yes and yes.

Okay. All right. Thank you.

Kevin Hunt.

Thanks. I just had one follow-up question. You guys talked about expanding your substrate capacity end of last quarter. Where does that stand today and it's kind of interesting because your other revenue looked like it kind of went down a little bit. And should we be expecting that to kind of ramp up with that additional capacity? Or is that more targeted at your own internal usage?

Kevin, (indiscernible) we are a substrate company. We are a media company. We want to sell (indiscernible) media. We would do -- we (indiscernible) sell substrate; sell substrate in second class. And our customers trying to (indiscernible). Altogether, (indiscernible) some substrates. So last quarter, we got a huge influx of media business. (indiscernible) as substrate goes down not because of anything else. Invariably our way, that's 100% of media. But right now, we think this number is about right because a couple of (indiscernible) want more. They really want more. They've been knocking on our door every day. Okay, Kevin?

Okay, thanks.

Frank Bift (ph).

Hi, nice quarter. Could you break out for me if you could in terms of either or revenue in units, sales for consumer products?

No, we cannot do that.

Or just could you even give me guidance? Is it 10%, 20%?

(indiscernible). Okay? We say that approximately 25% (indiscernible) this year is in consumer electronics. And you can look at Seagate (indiscernible) order numbers. Seagate has allowed one inch. And you can look at that plus (indiscernible) 25 (indiscernible) consumers.

Okay. But what you're saying is 25% of our orders shipped are in consumer electronics, about?

No, I'm not saying what we are shipping. I'm just saying at least when they are published numbers by our customers, you can see the media is 20%. (indiscernible) you have to go and do your own estimate, but all the 1-inch or consumer, you can take that to the bank. And then the next storage is the first company that goes through this consumer driving a multi-platter drive, (indiscernible) group. And we can sell it a lot with that. I suggest you look at the published numbers and you get an answer.

Okay. Thank you. And then I didn't hear, did you say what the average ASP was this quarter?

No, we didn't say what the average ASP was. We said it decreased on an average -- overall average ASP decrease because we sold more 80 G this quarter than last quarter.

Okay thank you.

Christian Schwab.

Actually, my follow-up question has been answered. Thank you.

Thank you. (OPERATOR INSTRUCTIONS). Ladies and gentlemen, there are no further questions. I'll turn it back over to you for any closing comments.

Thank you very much. Thank you, all of you, for joining with us today. We look forward to speaking with you again next quarter. Thank you.

That does conclude today's conference. We thank you for your participation.