威騰電子 (WDC) 2005 Q3 法說會逐字稿

Good day, everyone, and welcome to the Komag Incorporated third quarter fiscal 2005 earnings conference call. Today's call is being recorded. And now I’ll turn the call over to the Chief Executive Officer, Mr.T.H. Tan. Sir, please go ahead.

Thank you. Good afternoon. I'm T.H. Tan, CEO of Komag. With me on the call today are Mike Russak, our CTO, Tim Harris, our COO, Kathy Bayless, our CFO, and other company officers. Today, I will ask Kathy Bayless first to discuss our financial performance for the third quarter of 2005. Then, Mike will discuss customer and market conditions. And I will discuss the third quarter's operations, and our outlook for the fourth quarter of 2005. And I'll make a few closing comments, and we will 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 fourth quarter of 2005, and our expected capacity in 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 cannot 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 were 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 third quarter results, and in our recent SEC filings, including our Annual Report on Form 10K for the year ended January 2nd, 2005. Copies of these documents may be obtained from the SEC's website, or by visiting the Investor Relations portion of our website. The press release describing our third quarter 2005 results is currently posted on our website at www.Komag.com.

Now I will review our financial performance for the third quarter of 2005. Net sales totaled 180 million in the third quarter of 2005. This compares to 172.7 million in the second quarter of 2005, and $102.4 million in the third quarter of 2004. This is a 4% increase from the prior quarter and a 76% increase from the year-ago quarter. Finished unit shipments were 27.5 million in the third quarter, compared to 27.6 million in the prior quarter, both quarters at full capacity. Unit shipments in a year-ago quarter were 16.6 million. Other disk revenue provided 24.3 million of revenue in the third quarter of 2005, compared to 20.1 million in the prior quarter, and 11.1 in the year-ago quarter.

Net income and earnings per share in the third quarter of 2005 were 32 million, and $0.97 per share respectively, compared to 29.9 million, and $0.92 per share in the prior quarter. Net income and diluted earnings per share in the year ago quarter were 9.3, and $0.31 per share respectively. Diluted shares outstanding were 33.4 million, 33 million, and 31.3 million in the third quarter of 2005, prior quarter, and the year-ago quarter respectively.

Our income tax provision for the third quarter of 2005 was 1.2 million, compared to 1.5 million in the prior quarter. The tax rate for the first nine months of 2005 was approximately 4%. Net margin was approximately 17.8% in the third quarter of 2005, compared with 17.3 in the prior quarter. Operating expenses were approximately 10.1% of revenue, compared to 10.8 in the prior quarter.

On our balance sheet and cash flow, we ended the third quarter of 2005 with 178.9 million of cash, compared to 104.1 million at the end of the prior quarter. Our ending accounts receivable balance was 116 million, compared to 92 million at the end of the second quarter, reflecting higher sales in the third quarter and timing of customer payments. Net inventory was 49.4 million, compared to 48.3 million at the end of the prior quarter. The majority of the increase was for raw materials inventory, to support production levels to meet continuing strong customer demand. Depreciation was 11.2 million compared to 10.6 million in the prior quarter. Capital expenditures were approximately 55.9 million in the third quarter of 2005.

Now let me turn it over to Mike

Thank you very much, Kathy. Sales mix by major customer was Maxtor at 34%, Western Digital at 25%, HGST at 20%, and Seagate at 16%. Shipments of 100-gigabyte per platter and above advanced disks, increased to 30% of total finished unit shipments. That translates to 8.3 million units, compared to 20% of disks shipped in the prior quarter, which was 5.4 million. These advanced disks are primarily targeted for multi-platter consumer electronic applications, including PVR and DVR applications, as well as near-line storage. Enterprise disk shipments of 70-millimeter and 84-millimeter disks for 15,000 and 10,000 RPM high-end server applications, totaled 2.1 million disks, compared to 1.9 million in the prior quarter.

Our blended average selling price was up somewhat from last quarter, based on the improving mix towards higher capacity disks. We expect this trend to continue in the fourth quarter of '05, and into '06, based on 100-gigabyte and above platter shipments continuing to increase, as a percentage of total shipments. Komag is the world's largest manufacturer of hard disk aluminum substrates, we manufacture substrates primarily for internal use, in the manufacture of our finished disks. In addition, due to the high quality of our substrates, certain strategic arrangements, and the tight market supply of aluminum substrates, we will sell substrates externally. Substrate sales were approximately 13% of total revenue in the third quarter of '05.

Our development efforts continue to focus primarily on qualification in our customers' next-generation longitudinal magnetic recording, and perpendicular magnetic recording products. And the qualifications are proceeding on schedule. Komag continues to be well-positioned to support both LMR and PMR media for next-generation hard disk drive products.

We are very excited about opportunities for AlMg based media in mobile applications. We are in the late stages of qualification of a 65-millimeter AlMg-based longitudinal recording product for mobile drive applications. We expect to provide significant quantities of this product in early 2006. This will be a breakthrough event, as it will be the first time an AlMg substrate-based disk will be used in an application, where glass substrate-based media has been used exclusively. In addition, we expect to begin shipments of significant quantities of 160-gigabyte per platter 95-millimeter disks in the first quarter of 2006. Further, we are establishing mass production capability for AlMg-based PMR disks for enterprise applications in early 2006, for volume shipments later in 2006.

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

Thank you, Mike. We are extremely pleased and proud with another consecutive quarter of outstanding performance in 2005. Third quarter 2005 revenue was an all-time high for Komag. Third quarter 2005 revenue increased 4% over prior quarter, and 76% over the third quarter of 2004.

Our net income increased 7% over the prior quarter, and a whopping 245% over the third quarter of 2004. In our manufacturing operations, we continued our strong execution with excellent yield and productivity, leading to an improvement in gross margin. Gross margin was 28.3% in the third quarter of 2005, compared to 27.8% in the second quarter.

We continue to run at full capacity, and the demands for our products exceeds what we can produce. Our capacity expansion plans remain on-track. The facility is mostly completed. And equipment has been delivered and installed on-schedule for the first new capacity expansion. We expect that the first disk from the new capacity, will be delivered to our customers by the latter part of quarter 4 '05.

We expect to have 31 million a quarter in finished [meter] capacity, variable by the time we exit the first quarter of '06. In addition, we continue to proceed with our plan for capacity of 14 million disks per quarter by the time we exit 2006. This additional capacity will be added in a modular fashion, and is geared towards the second half of 2006.

It's important to remember that our capacity expansion plans, are a part of strategic supply agreements we signed with several customers. In these agreements, Komag has made commitments to deliver several levels of media, and our customers have made commitments to purchase third levels of media. In addition, our customers are making certain prepayments for media, to help mitigate the cash cost of the capacity expansion.

Now, we believe that these agreements with our customers are true win/win situations. It allows us to meet their increasing needs for disks, by increasing capacity in a very prudent and responsible way. We believe this reflects true strategic relationships with our customers. And we appreciate their support.

I would like to thank all of our employees for their continuing extraordinary effort, which makes these outstanding results possible, quarter after quarter, year after year.

Outlook. Looking forward, overall market demand remains very strong, entering the normally seasonally strong fourth quarter. As we are currently running at full manufacturing capacity, we expect our total revenue to increase 2 to 4% for the third quarter of 2005, assuming some contribution of new capacity, and continuing improvement in product mix to higher-capacity disks. With this level of revenue in the fourth quarter, and continuing excellent factory productivity, we believe that net margin will be similar to third quarter of '05, approximately 17 to 18%.

We are very optimistic 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 recording devices such as PVR, DVR, HDTV, external storage, and other home entertainment devices. We believe that we continue to be well-positioned to benefit from this growing demand for disk drives, in multiple markets and applications.

In summary, we believe we have the right financial model. We are committed to maintaining low-cost manufacturing, technology leadership and we continue to strengthen our strategic customer relationships, grow our business, and provide positive financial performance.

Now, I turn the call over to Ashley to conduct Q&A. Ashley?

Thank you, Mr. Tan. Ladies and gentlemen, [OPERATOR INSTRUCTIONS]

We'll take our first question from Rich Kugele, Needham & Co.

First I wanted to start with one point of clarification. I wanted to make sure I heard Mike right. You've benefited to date from the continued mix shift, but you do expect ASPs to increase again in the fourth quarter, and perhaps also into the first half of '06?

Yes, we do, Richard.

Okay. And then just regarding the substrate capacity, how does industry supply demand look to you for the fourth quarter, and what are your expectations for that segment just in general next year?

Okay. Let me answer that, Rich. You know that [inaudible]. You know that the substrate capacity [achievement] is even tighter in our situation than media. When you do all the math, you add all the math. The industry has been underinvesting in aluminum-based substrates. This has been going on for more than five years. The only company that has invested in the aluminum-based substrates, and we are proud to say that is Komag, and we have enough to fill our own prudent and judicious expansion, but no one else has that.

And as you know, we don't substrate economic media and we don't make economic drives, so the tight situation is very tight now, and will only get tighter as time goes on, as more programs are converting from glass to aluminum. You never see programs converting from aluminum to glass. But you can see more and more aluminum converting to glass -- glass to aluminum, sorry.

And, just to refresh me, the lead times on the equipment to add substrate capacity even if you wanted to do it today, are they still 6 to 12 months?

You are being optimistic is you say 6 months, nobody is talking about 6 months now [inaudible], due to the starvation of the supply chain upstream, everyone has been booked and those that have got originally 6 months, now have stretched to more than 12 months.

Okay. And then I guess just lastly, your operating expenses have not been increasing as much as revenue. Do you expect you can continue to leverage your operating expenses, as we go out into '06?

This is Kathy, Rich. Yes, on the operating expenses, we do expect that as we go into '06, as we continue to grow unit volumes. I think for '05 the expectation is, we continue to be somewhere around the year-to-date percentage of 10.7%.

Great. Great quarter. Thank you.

We'll take our next question from Les Santiago with Piper Jaffray.

Great quarter. Could you give us more color on this AlMg disk being used in mobile applications? Are these mainstream mobile applications? What kind of mobile applications would these be?

And then secondly, the 160 gigabyte per platter that you talked about in the first quarter of '06, would that be the last iteration of GMR-based areal density expansion, or do you see more to come?

Okay. Take them in order. The aluminum-based, AlMg-based disk products you're talking about are mainstream mobile applications. Because the product has not been announced by our customer, I would not want to say any more than that at this point.

As far as the 160 goes, we've long projected, we've projected that between 160 and 240, would probably be the transition from LMR to PMR in the desktop space. And I think that it's still accurate. I think the 160s will continue on, and we could possibly get up to 200 gigabytes a platter using longitudinal, but I think we're about ready to make the transition on the desktop products.

Thank you.

You're welcome.

And we'll take our next question from Mark Miller with Hoefer & Arnett.

I'd like to add my congratulations, a great quarter. Also very good news about the ASPs. I'm just wondering in terms of cash, what are you going to do with all this cash? Go to Hawaii for a couple of years, or something?

[Laughter] Actually --

Basically, I mean, we do generate strong EBITDA from the business, we are also at this point investing in a lot of capital because of our CapEx. So as T.H. mentioned, our plan for this year, 2005, is $200 million, we'll continue to have significant CapEx as we continue our expansion.

What about longer term if you continue to generate cash at this level?

Mark, you can never have too much cash. Just like you cannot be too thin.

I was wondering, T.H., you or Mike follow-up on the good news also on this mobile -- aluminum magnesium on the mobile application. What innovations led you to that? Was it innovations in shock resistance on the PC itself, or slider, or a combination of things? And also, could you maybe just refresh our memory, what would be the advantages? I know price is one advantage of using aluminum for mobile over glass.

Okay. I'll try to cover all those things. Generally improvements have been made. Remember, the decision to go to glass-based media was something that the IBM Corporation did, like, 12 years ago, and it was based on a very, very different slider and suspension and spacing, and latching, and all sorts of other technologies, that has continued to develop. So it's a combination of advances, in terms of the drive mechanics that have really enables the use of AlMg.

As far as the advantages, the products we're talking about will continue to be longitudinal recording. There is a 1 to 2-gb advantage in longitudinal media of doing it on AlMg, because you can get a better texture process.

So what we'll see is enhanced performance from a magnetic point of view, which will help the customers' yields, as well as a cost savings using the AlMg. So it's both performance and cost.

Final question. You continue to do well getting into the high-end programs. Do you fear your main competitor is as successful as you are, or are you getting more than your share of these high-end programs?

Well, I wouldn't say anything from the locker room. I won't say anything about our competitor. But I can tell you that we have a few factors that we have, that our competitors don't have. We have the lowest costs, in terms of our locations, and the way we run our Company.

We have our own aluminum substrates in tight supply, and other people have to pay more for aluminum substrates. And in order to gain back in shares in aluminum, they have to start investing in aluminum substrate capacity, and the equivalent to make aluminum substrate capacities having a long lead time. So we are in great position to continue at this level.

And any available additional new capacity that anyone will bring to this world, will be more costly than our incumbent capacity, because the incumbent capacity mostly has been written off, and there's a strong gain. [inaudible].

Any new capacity would be very expensive. Only a few companies in this world with enough critical mass, can afford to take on incremental new capacity, and the higher cost of the new capacity, which is higher economic cost, will be offset by savings in SG&A and R&D. Only a few companies I can tell you, have that. So not everybody has that conditions.

Now, of course you know, we are proud to say that through our efforts with our customers all these years, we have earned their respect to enter into strategic agreements. They pay money up-front for our installed improvements. That means they would like to get the product coming from this machine. There is a guarantee that the product that we make has a home, when people are pre-paying for the equipment.

None of this conditions I just listed can be found in totality in any other competitor. [inaudible]. We feel very good about our chances. We like our chances. We like our performance. And we would rather let our actions do the talking.

I'm sure it is. Thank you very much.

Thank you.

And we'll take our next question Christian Schwab of Craig-Hallum Capital.

It's Christian. The aluminum, just to follow up on the enabler, besides the huge cost initiative, is the enabling technology truly the suspension, or is it just the fact that aluminum cost is good enough?

Oh, no. Clearly there's a combination of improvement in the -- what's happening on the slider, the size of the head. Remember, you're talking about a head-slap phenomenon. If the head is smaller and the suspension is stiffer, then the head will not be able to come as far off the disk, as it could with the older technology.

So the enablement is primarily for the mechanics of the drive. As far as the disk itself, what we're doing is we're providing a better magnetic performance, which will help the customer in yield, and maybe relaxation if glide (ph) height.

Great. And then, can you, the idea of 31 million in capacity, can you give us roughly, you know, how much capacity, you know, in Q1 or Q2 you'll have, for the mobile?

At this point, we're not really at liberty to divulge the forecast from the customers.

Right, right.

All the equipment is capable of making 65-millimeter, if that's the question.

Right, okay. That is my question.

Oh, okay.

That gets to my point. And then, on the 160-gigabyte, you know, can you give us any idea of how long you've been R&D dollars kind of the same for each platter technology? Is this something that just happened rather quickly, or have we been working on this behind-the-scenes for a while?

Well, I think the technology transitions in general, if you look at the areal density growth rate, it slowed down to about 40%. So compared to what was happening a couple of years ago, you will in a sense spend more on each transition, because you're doing it for a longer period of time, because the technology is more difficult. We've been working on the 160 for probably months and months, as we have with other transitions.

Sure, that makes sense. And then, finished goods inventory? Do we have that number, Kathy?

Finished goods inventory, as I said on the call, the primary increase for inventory was in raw materials.

So it's not in finished goods?

Finished goods was flat, maybe slightly down.

Great. And then my last question, kind of centers around the mix of business in the September quarter. Is there anything that we should be reading into the falloff in business, you know, at Hitachi and Seagate, or is that just customer mix demand?

You cannot do that. First of all, we have four biggest customers. They are all more or less, serving the same customer base. And you are going to see, there will be ebbs and flows. Okay. Some [inaudible] will be more this quarter, next quarter, and the difference will be made up, offset by some other customers. [inaudible] this way looking at the ups and downs by one quarter, and if do something, you come to the wrong conclusion.

All right. Excellent. Thank you, sir. That's it.

You're welcome.

And we'll take our next question from Robert Stottman with Bentley Capital.

Hi. I've got a few questions. Number one, could you better describe if possible the arrangements with customers who have put capital up, in terms of their obligation to take your capacity?

Okay. First of all, if you say there is a lot of capacity coming onstream, these are the same person, why are they putting up money to buy capacity for next year? There's an easier rebuttal, not anyone wants to gap our losses, the same person who has raw capacity, why would they put money up front.

So first, [inaudible] we only put capacity onstream after our customers have twisted our arms, and I use that word in a mild way. They are just (ph) when they are doing this. They say we are limiting their growth, they want more growth, and we are only giving them maybe half of what they wanted, in terms of our capacity plan. And they put money up front, and they do.

After saying all this, and after I give them half of what they wanted, okay, you can expect if they cut time to take the product, they have a chance, they will try, they can take the profit loss and they can get some of their money back, the capital money that they put on file for a year, they can not take their money back, or they can get it from somewhere else, what you will do, an IQ test for you guys. So I don't go into guarantee, or any other strong words, but do the mathematics, people covet money, millions and millions of dollars for a year in advance.

First of all, they put that money up. Tells you something already. They couldn't find this capacity somewhere else. If they have, if they can get it for free, they will not put money with us. That is the best answer to a lot of rumors that are flying around, and after I say that, I will follow up by saying this. That if you have a choice, when it comes time to have product from us, additional capacity from us, and get it from somewhere else, you get part of the money back, [inaudible] and you get it from somewhere else, you don't get that. What will you do? Okay?

All right.

I answer your question with that question.

Well, just reading analysts' reports, aside from Komag, five or four other manufacturers are increasing media capacity including Seagate, [inaudible], MMC, which is Maxtor, Hitachi. With the returns, the disk business is basically a very low-margin business for your customers, and yet you're making 17 to 18% after tax. Why would they not shift their focus to producing media, when it's so inordinately profitable, relative to their business, rather than buying it on the outside?

I would like you to direct your questions to these people, you know? But I can only tell you that we have listed a few favorable conditions that we are sitting on, including our lowest cost facilities, and high-margins come from not high price. We have the same price as everybody else. But it come from good execution, comes from good yield, good productivity. It comes with a lot of blood, sweat and tears. So it is well earned, number one. Okay?

And then the other thing is, we are [vivid] technology, and it works and we have got the very important stuff, called aluminum-based substrate, aluminum substrate, that people are under-investing all over the world for more than five years, actually. Since IBM decided to change their desktop to aluminum, things they're very big, when the switchover from glass to aluminum, there's a shortage of aluminum substrate in the world because nobody is adding any aluminum before that.

So, I'll give you this few conditions to tell you that we are sitting on several situations here, several conditions here that is unrivaled. Why do they want to do it with us, and not with themselves, or other people, ask them.

Okay. Thank you very much.

And we'll take our next question from Vince [Shrock] with L&S Investment.

An excellent quarter, gentlemen. I had a question on this excess cash that is generated. Would any of it be used for stock repurchase programs, or anything like that?

Hi, this is Kathy. As far as again, as far as cash balance goes, I mean, we do look at that all the time. Basically, we have those conversations with our Board. At this point in time, we don't have an approved program to do that, but we do discuss that with our Board.

Again, I mean, as far as our cash balance goes, the main thing is we are adding capacity in this industry. The capital required to do that is substantial, because it's a fixed-cost business. So that's the primary activity at this point.

But down the line, have, will you all be considering any?

As I said, we discuss it with the Board, and we consider that regularly.

Okay. Great. Excellent. Thank you.

[OPERATOR INSTRUCTIONS] We'll take our next question from Andrew Neff with Bear, Stearns.

Thanks, it's Bill Hand for Andy. Can you clarify exactly, I know you commented on accounts receivable, but it was up 26% sequentially versus only 4% sales growth. Just give more clarity around that? Thanks.

Yes. As I say, I mean, it was sales growth, and also just basic timing. So there were some, there was a payment basically that ended up coming in after the end of the quarter, instead of before the end.

Okay. Thanks.

[OPERATOR INSTRUCTIONS] And we're standing by with no further questions at this time. I'd like to turn the conference back over to the Chief Executive Officer, Mr.T.H. Tan for any additional or closing remarks.

Thank you very much. Thank you all for joining with us on this call today. Looking forward to speak to you next quarter.

That does conclude today's conference. We thank you for your participation, and you may disconnect at this time.