威騰電子 (WDC) 2006 Q2 法說會逐字稿

Good day and welcome to the Komag Incorporated Second Quarter Fiscal 2006 Earnings Conference Call.

As a reminder today's call is being recorded.

I would now like to turn the conference over to the Chief Executive Officer of Komag, Mr. TH Tan.

Sir, please go ahead.

Thank you.

Good afternoon.

I am TH Tan, CEO of Komag.

With me on the call today are Mike Russak, our CTO, Kathy Bayless, our CFO, Tim Harris, our COO and other company officers.

Today, I will ask Kathy to discuss our financial performance for the second quarter of 2006.

Then Mike will discuss customer and market conditions.

And I will discuss operations, our outlook for the third quarter and the balance of 2006 and make a few closing remarks.

Then we will open it up for Q&A.

Kathy?

Thank you TH.

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 third quarter of 2006 and our expected capacity for 2006.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from our forecasts.

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 were made.

In addition to factors that may be discussed in this call, important factors that could cause actual results to differ materially are contained in our press release today announcing our second quarter results and in our recent SEC filings including our annual report on form 10-K for the 2005 fiscal year and the Form 10-Q for the first quarter 2006.

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 today describing our second quarter 2006 financial results is currently posted on our website at www.komag.com.

Now I will review the financial performance for the second quarter of 2006.

Net sales totaled 233.6 million in the second quarter of 2006, compared to 2008.5 million in the fourth quarter of 2006 and 172.7 million in the second quarter of 2005.

This is a 12% increase from the prior quarter and a 35% increase from the year ago quarter.

Finished disc shipments were 36.6 million in the second quarter compared to 31.9 million in the prior quarter.

Full capacity for both quarters.

Unit shipments in the year ago quarter were 27.6 million.

Other disk revenue provided 23.6 million of revenue in the second quarter of 2006, compared to 25.8 million in the prior quarter and 20.1 million in the year ago quarter.

Net income and diluted earnings per share in the second quarter of 2006 were 40.3 million and $1.21 per share respectively, an 11% increase over the prior quarter.

First quarter net income and diluted earnings per share were 36.2 million and $1.09 per share respectively.

Net income and diluted earnings per share in the year ago quarter were 29.9 million and $0.92 per share respectively.

Our income tax provision for the second quarter of 2006 was approximately $1 million as in the prior quarter.

We currently expect the 2006 tax rate to approximate 3%.

The tax provision is primarily non-cash due to tax holidays in Malaysia through 2016.

Net margin was approximately 17.2% in the second quarter of 2006 compared with 17.4% in the prior quarter.

Operating expenses in the second quarter were approximately 11% of revenue as in the prior quarter.

R&D spending included continued accelerated development activities for new advanced products.

In addition, SG&A spending in the second quarter included 3.1 million of FAS 123R non-cash stock comp expense, including 2.1 million of stock compensation related to accelerated vesting of options and restricted stock as discussed in the Form 8-K filed in February 2006.

We expect this level of non-cash stock compensation expense to be similar in our third quarter.

And this expense is included in our third quarter guidance.

Non-cash stock compensation for these items was 1.8 million in the prior quarter, the first quarter of 2006.

Depreciation for the second quarter was 18.3 million compared with 14.5 in the prior quarter.

Depreciation a year ago quarter was 10.6 million.

On our balance sheet and cash flow, we ended the second quarter with 190.2 million of cash compared to 191 million at the end of the prior quarter and 145.9 million at the end of the second quarter of 2005.

Our ending accounts receivable balance was 128 million compared to 119 million at the end of the first quarter, reflecting higher sales in the second quarter and the timing of customer payments.

DSO was 50 days at the end of the second quarter, compared to 52 days for the prior quarter.

Net inventory was 75.4 million compared to 72.5 million at the end of the prior quarter.

Finished goods inventory at the end of the quarter was $7.1 million.

This includes inventory in house and in all customer hub locations.

This represents about one week of inventory based on the rate of total shipments for the quarter.

The balance of inventory was raw materials and work in process.

We continue to maintain high levels or raw materials to be able to support our rapid capacity expansion and longer lead times for some key materials.

Capital expenditures were 96.7 million in the second quarter of 2006 and 199.4 million for the first half of 2006.

Operating cash flows in the second quarter was 100.6 million and 169.3 million for the first half of 2006.

Now let me turn it over to Mike.

Thank you, Kathy.

We shipped a total of 36.6 million disks in the second quarter.

This represents a 15% increase over the 31.9 million disks shipped in the prior quarter.

Sales mix by major customer was Western Digital at 38%, Seagate Maxtor at 32% and Hitachi Global Storage Technologies at 26%.

Shipments of 120 gigabyte per platter and above disks were 44% of total finished unit shipments, about 16 million units.

This compares to 24% of 120 gigabyte per platter and above disks shipped in the prior quarter, which was 7.5 million units.

We expect the migration of our products toward the higher capacity 120 to 160 gigabyte disks to continue for the rest of this year.

Enterprise disk shipments declined to 5%, about 1.74 million units of total disks shipped, compared with 7% or 2.24 million units of shipments in the prior quarter.

We expect the enterprise shipments to continue to decline over the balance of this year due to the recently completed acquisition of Maxtor by Seagate.

As we have noted previously, our customer’s product shipment plans determine our product mix.

We ship the products that each of our customer needs.

Some customers are requiring increasing numbers of 80 gigabyte per platter disks because that is what their product shipment plan requires.

While others are moving quickly to the 160 gigabyte per platter products.

We will continue to work to have the flexibility in our manufacturing operations to support all of our customers and maintain a broad product portfolio to accommodate their requirements.

Our blended average selling price was similar to the prior quarter.

The reduction in enterprise disk shipments which have a little higher ASP than desktop type products was offset by the move towards higher capacity products.

About 10% of our second quarter revenue was derived from sales of NPP substrates and related products.

On the technology and product development fronts, Komag continues to be well positioned to support both Longitudinal Magnetic Recording and Perpendicular Magnetic Recording media for next generation HDD products.

We continue to develop and transfer to volume manufacturing several new products, including LMR 160 gigabyte disks designs and LMR 65 millimeter [Almag] based disk products.

We are also beginning qualification activities on 95 millimeter diameter desktop PMR programs with several customers.

Our PMR qualifications are going well and we expect first volume shipments to start later this year.

We continue to have a higher than normal R&D spending as we continue to qualify and ramp a higher than normal amount of new programs, including 160 gigabyte programs, PMR, and 65 millimeter programs to multiple customers.

We expect to return to more historical spending levels as a percentage of sales by the end of the year.

As we have said previously, our core customers command about 90% share of the 95 millimeter form factor HDD market space.

We are working to expand our customer base to cover 100% of the total available 95 millimeter disk market.

We continue to believe that the transition of 95 millimeter based HDDs from LMR to PMR will occur over an extended period of time.

Each customer will transition their products from LMR to PMR on different schedules.

As a result we expect that 160 gigabyte per platter LMR disks will peacefully co-exist with 200+ gigabyte per platter PMR disks beyond calendar year 2007.

Finally on the 65 millimeter Almag product front, we shipped a meaningful number of disks to our first customer during the second quarter and expect this ramp to continue over the balance of this year.

We are pleased to have entered this market space that had previously been the exclusive domain of glass based recording media.

Additionally we are in the final phases of qualification with a second customer for the 65 millimeter aluminum products and expect to start shipping volumes to them by the end of Q3.

We also continue to work with other companies interested in Almag based products for 2.5 inch drive applications.

Now TH will provide further comments on the second quarter, as well as our business outlook.

TH?

Thank you, Mike.

Let me start by saying we are extremely proud of the Q2 results.

Our second quarter revenues was another all-time high for Komag.

In fact, it was the fifth consecutive quarter of sequential increase in both revenue and net income.

Second quarter 2006 revenue and net income increased 12% and 11% respectively over the prior quarter and 35% over the prior year same quarter.

We continue to run at full capacity in the second quarter and continue to bring out new production capacity slightly ahead of schedule, resulting in finished shipments of 36.6 million compared to 31.9 million in the prior quarter.

In our manufacturing operations, we continue our strong execution with excellent yields and productivity leading to excellent margins.

It is important to remember that this was done while we were aggressively increasing our capacity, qualifying a wide range of many new products, adjusting to significant change to both customer and product mix due to the acquisition of Maxtor by Seagate.

With the current consolidation schedule for new equipment, we expect to have finished disk capacity of approximately 39 million in Q3.

In addition, we continue to proceed with our plans for capacity of 43 million per quarter by the time we exit Q4 ’06.

Our capacity expansions are being done in the modular fashion.

Total capital spending in 2006 is currently expected to approximate $300 million.

It is important to remember that our capacity expansion plans are part of a strategic supply agreement we signed with each of our major customers.

In these agreements Komag has made commitments to deliver certain levels of media.

And our customers have made commitments to purchase certain levels of media.

In addition, our customers are making certain pre-payments for media to help mitigate the cash cost of the capacity expansion.

With the acquisition of Maxtor by Seagate now complete, we expect that our total shipments to Seagate have a combination of both with Seagate and Maxtor product lines will increase from the Q2 levels.

This is consistent with a strategic agreement in place between Komag and Seagate and reaffirmed separately with the May 22nd press release.

We are close to finishing qualification and beginning to ramp production for new media customers.

Our position as a key strategic supplier of aluminum based media to the disk drive industry provides us with a unique opportunity to focus on the increasing overall demand for aluminum based media without being restricted by any particular shift among our customer market shares.

I would like to thank all of our employees for their continuing extraordinary efforts to make these outstanding results possible.

Q2 was a particularly operationally challenging quarter with aggressive increase of new capacity, the ramp of many new products, and a major shift of customer mix and products.

Any one of these could have been an excuse for impaired performance.

Our employees rose to address each of these challenges in a way that exemplified the commitment to continuing excellent performance and for that, on behalf of the management [from] the Board, I salute them.

Looking forward, indicators for overall market demand in 2006 remain very strong and media and substrate capacity remain tight.

With our expansion plans and capital demand, we expect that total revenue for the third quarter of 2006 could increase approximately 5% from the second quarter as we continue to run at full capacity.

In addition, based on expected market demand, our increasing capacity and our strategy agreements, we will expect to see further quarterly sequential revenue growth in quarter four.

With expected level of revenue in the third quarter, continuing high level of development work, increase our capacity, [inaudible] multiple new programs, and excellent high productivity, we will expect margins to remain at very solid levels.

Due to the ongoing customer mix shift further reducing our enterprise program [indiscernible] ESP should remain flat to down slightly.

With this and the multiple complex activities required as we ramp new capacity and new programs, we would expect net margins to be in the range of 16 to 17%.

We remain very optimistic about the continuing 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 such as, PVR, DVR, HDTV, external storage, gaming, 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, I believe that our ongoing results demonstrate that we have the right financial model.

We are committed to maintaining low cost manufacturing, technology leadership, growing our business, and providing ongoing strong financial performance.

[Operator Instructions].

We’ll take our first question of the day from Mark Miller at Brean Murray and Carret Company.

Congratulations for another record quarter.

Just a question.

Seagate kind of stunned some of us when they announced they were taking the Max Media production offline to retro fit.

Are you experiencing - - you did say counter to what a lot of people believe that the revenues, combined revenues from Seagate to Maxtor will continue to increase.

Do you see any upside or is this factored into your current thoughts right now from this decision from where you were at last quarter?

This is – we have written this into our play, and obviously this is a macro view [inaudible - highly accented language] the reduction of our 20 million disk capacity for the market is reinforcing what many people have been saying relative to Seagate and Western Digital and we have been saying, that the demand and supply will be very tight moving forward next year and beyond.

Just -- can you give us anymore color?

Like you said this was 18 to 20 million disks a quarter.

Is a significant percentage of that going to be coming to you I assume?

Well we cannot give you the [inaudible] breakdown, but what I said in my statement was that the increased revenue going forward compared to Q2 is the fact.

And the macro picture as just outlined the reduction of our capacity just reinforces that.

OK, Mike mentioned that you were shipping meaningful quantities of 65 millimeters and aluminum nickel [phos] substrates.

I’m just wondering.

I thought you had some times earlier this where you were looking at that as possibly meaning in the few millions numbers of disks for this year.

Can you give us any color or was that correct or are you still holding to that?

Yeah, I expect that we will ship in the several millions of units this year before the year is over on the 65 Almag into the mobile type applications.

You mentioned another customer.

Are there other people possibly coming to you now besides customer addition?

Are other people now looking at other applications besides the ones that you’re either in qual for or shipping on?

Yes there are.

There are several entities that are approaching us to look at 65 millimeter Almag media for various applications.

Thank you and congratulations again.

Thank you.

We’ll take our next question from James Poynter with Hapoalim Securities.

Good afternoon, guys.

I was wondering if you could give us a little more characterization of -- with revenue guidance in the next quarter what you think your overall mix will lead you to in terms of gross margin for the quarter.

I know that can be pretty sensitive given the mix, but if you could give us a little bit of an idea because it was down a little bit sequentially on the good unit volume.

I’m just curious as what your thoughts are there.

Yeah, on gross margin normally we basically refer to net margin.

So we’ve basically given the overall net margin guidance of 16 to 17%.

And that somewhat will be driven by, as you said, the mix of products and that’s about all we have to say.

Are you -- I take it you’re expecting your operating expenses, R&D in particular, to be up in the quarter over second quarter levels.

Is that correct?

We said that they should remain at similar levels as a percentage of sales.

And again, and also the SG&A basically includes the stock compensation, as well as, the accelerated comp.

And our net margin guidance includes all of the stock compensation.

Right.

Given the seasonality of business going into the second half, would you anticipate that your total inventory would come down some in absolute dollars in the third quarter?

The total inventory, as we said, is primarily raw materials.

And that’s based on the continuing demand and increasing needs.

So I mean we would expect that things will continue to be tight from a raw materials standpoint.

So we would think the levels will probably continue.

I’m sorry.

The levels will continue --

Raw materials will continue to be a little bit higher than they were prior to the last quarter from a raw materials standpoint.

The 7 million in finished goods that was roughly the same, as I recall, from the first quarter is that right?

That was up slightly.

It was up about a million from last quarter.

And it’s less than a week of inventory.

Right.

Alright, thank you.

From Craig-Hallum Capital Group, Christian Schwab.

Great quarter, guys.

Thank you.

Thank you.

Just follow up on that following question, just simple math to make sure I understood right.

If R&D as a percentage of sales is the same and SG&A is the same, then obviously the potential decrease in net margin is all based on gross margin.

There’s nothing in other income, for example, that would skew that?

I think you’re looking at it the right way.

Thank you.

The strength in Hitachi is there any market share gains there by you other than on their 100% desktop share that you’ve enjoyed previously?

Or is that strength driven by their market share gains in the market?

Yeah, I would say given by their market share; we are the only external supplier of media to Hitachi.

So they don’t have any other vendors.

If they gain, then we gain.

Fabulous.

And then as we go to Q4, forgot to mention it, but R&D was higher this quarter but expected to return to historical levels by the end of Q4.

I assume you’re talking about on an absolute dollar basis.

What would that be?

Basically, I mean we were basically the comment was on percentage of sales.

So I mean the percentage on sales of R&D has been a little bit higher in the last two quarters than it was prior to that, so we’re expecting R&D as a percentage of sales to drop a little bit by the end of the year.

OK.

Should we anticipate an improvement in net margins as a result?

Or as we look to Q4, are we still going to be in that probably 16 to 17%?

Can you comment on that?

I think there’s opportunity.

I mean we haven’t changed our model, our overall model.

And so as we go through some of the activities and the extra -- add the extra work, we would expect that to still hold.

Great.

And then back to my first question and then I promise it will be my last.

The decrease in gross margin, is that due to the capacity depreciation that we are adding?

Or is there something else we should think about?

Yeah, I think a lot of it is just all the activity.

I mean the things that we were trying to highlight is that we’ve been bringing up new equipment and all the new products.

So while you’re going through that there’s a little bit of extra cost or a little bit less efficiency.

Perfect.

Thank you.

You’re welcome.

Thank you.

Take our next question from Rich Kugele at Needham & Company.

Thank you.

I guess first, TH, when looking at your capacity exiting 2006 without adding any new lines, what type of capacity do you think you could generate off the existing lines assuming some type of operational efficiency improvements?

Well, we have been able to do that over the last two years.

We grew beyond the installed capacity to use [inaudible - highly accented] and we expect more of such.

Besides the number [inaudible - highly accented].

So it’s probably fair to say that any type of improvements then would only further effectively reduce the depreciation drain on those machines since you are getting more out of them right?

Yeah, you are right.

This is a high fixed cost difference.

And at the same time since you’re not announcing any new capacity, you’re probably going to be generating a fair amount of cash flow in 2007.

Is that within your plans right now?

Yeah, [inaudible - highly accented] you know how much cash we are actually generating this year, but we are spending, so we use our money along with the customers to be able to mitigate the cash flow progress [inaudible - highly accented] expansion with all the cash that we generate.

So if you don’t expand the spend rate in 2007, okay?

Simple math will follow and that will generate more cash.

OK.

And just lastly you did mention that media would remain tight throughout 2007 if not longer.

Investors continue to focus on the customer mix and the risk that customers ultimately take business in house or something.

Could you update us on the timing of the agreements with the three major customers you have today on when those I guess without renewals would technically expire?

And for modeling purposes as you look into 2007, since no new factors are really coming online until the end of the year, what you think that customer mix might look like in ‘07.

OK, first of all the agreements we signed with our customers are multi years [inaudible - highly accented] ramp over many years.

The mix is a question of we’re bringing new customer online.

We like to keep the volume we have with existing customers then grow with the new customer, that’s the way we want to do.

Okay, then as we create the [inaudible - highly accented] productivity improvement and as the industry grows, 15% a year, we will do, too.

We are not going to stay stagnant.

And as we grow we’ll go back to the customer and keep together.

That’s the strategy.

So we expect new customers will be added to our portfolio; that’s one point [inaudible - highly accented ] and grow the new one faster than the existing one and we’ll grow the existing ones in tandem with the industry group.

OK.

So it’s probably fair to say that if a customer were to go and take more in house in ’08, that extra capacity would then be used to ramp someone else?

Absolutely.

Okay.

Alright.

Thank you very much.

Thank you.

From Robert W. Baird & Company, Joel Inmann.

Thank you.

First of all could you talk about your enterprise shipment decline.

Where do you see that going over the --

It’s very simple; it’s very simple.

We were putting our -- we are sole source to one customer, okay? [inaudible - highly accented] is the price, okay?

And as a result of the consolidation, this customer is [inaudible - highly accented], their programs are terminated.

That’s why the decline happened.

We are getting out the end of life.

OK.

And then you’ve previously talked about lead times on your media being around 18 months or so.

Is that still the same?

Don’t ask us; you ask Seagate.

If Seagate tell you it is tough now, [inaudible - highly accented] capacity to be [indiscernible] end of 2007, that’s 18 months, right?

I mean, you can ask anybody in the industry [inaudible - highly accented] 18 months from now.

OK.

And then finally can you talk about any update on your CEO search?

It’s ongoing.

We will let you know.

At the moment we have no answers.

Thank you for asking.

OK.

Thank you.

Our next question will come from Kevin Hunt at Thomas Weisel Partners.

Hi.

Thank you.

A couple questions.

Going back to the stock option question, Kathy, you mentioned you have a basis of acceleration of options and so forth and then the mix.

When will that kind of go out of the mix and when -- you know if we go out maybe two or three quarters, what will that option number be running compared to like the 3.1 you said this quarter?

Yeah, we have, as we said, in the first we had accelerated stock option compensation also in the second quarter.

And we expect to continue to have it into the third quarter and then -- I mean the acceleration is pretty much, it’s based upon the 8-K that we filed in January related to the CEO resolutions.

So the timing of acceleration is basically similar.

OK.

But I mean, the question I guess is it going to stay 3 million or in two quarters is it going to be down to like 1 million or something like that?

Well, we haven’t give a projection for beyond Q3, Kevin.

So it’s going to be at the same rate for Q3.

OK.

It sounds like some of these things are one time issues.

Because I think the issue I’m trying to make here is everyone seems to be focusing on net margin guidance which is including this.

And they seem to be missing the fact that maybe this will be going substantially down in the future.

Is that a right way to be looking at it?

Yeah, I think that’s a fair statement.

OK.

And then the second question I had was the -- you talked about looking at an additional cost -- the additional 10% of the industry you’re not addressing.

I think Rich kind of had a similar question.

How long would it take to sort of bring in a new customer in house?

Is that something you could do next quarter if you wanted to or something that takes six months or --

OK.

As Mike said, we are already deep into the second customers qual, deep into that.

And we’re not going to make any projection whether this a mutual [inaudible - highly accented ] have to say at the same time.

So I would say watch next couple of quarters, okay?

That will be the best answer.

OK.

Thanks a lot.

Thanks a lot, Kevin.

Next we’ll hear from Steven Fox, Merrill Lynch.

Hi.

Good afternoon.

Just getting back to the gross margin question, if you look at the 50 basis point decline, could you break that down?

I mean I’m sure you got benefits from the higher unit volumes offset by the expansion activities.

Can you sort of put rough numbers around how much each benefited or anything else that might have impacted gross margins?

I don’t think we have a -- we really don’t have any breakout of that.

Again it’s a combination of lots of activities and complexity and a little bit less efficiency as you’re bringing out equipment.

Right.

And then just a clarification, I missed the D&A number for the quarter.

You broke up on that.

Yeah, we said depreciation was, I think it was 18.3 million.

And then last question.

On the 2.5 inch programs, how does that affect the profitability of your business?

Is that too soon to have an enriching effect on the profits or would it even over the longer term?

Can you just talk about that a little bit?

Yeah, we think - - well, first of all it’s not first time we make 2.5 inch aluminum base media.

We make them all the time for enterprise, okay?

So, number one.

Number two, when the factory is fully utilized, it doesn’t make sense for us to take the space of the 95 millimeter that’s making good money and replace it with a less margin product.

It doesn’t make sense at all.

OK, so that should give you some idea.

The way we price a product, the value that it will bring to the customer ultimately will be in the form of helping the customer save money and we are not going to have a negative impact.

All right?

That’s the way we run our business.

Every single spindle, every single machine has to produce and we are already running at full capacity, full utilization, so it doesn’t make sense for us to build anything less profitable.

OK.

Thank you.

OK.

[Operator Instructions].

Next we’ll hear from Mark Moskowitz at JP Morgan.

Yes, hi.

Thank you.

Good afternoon.

A few questions if I may.

The first -- I want to go back to depreciation.

I believe, Kathy, the last time we spoke on the earnings call you indicated without quantifying specifically that the depreciation increases could be around the same levels as we saw in the prior quarter which I believe is about 2 million sequentially back in March and this time you’re up about 4 million, I believe.

How should we think about the trajectory going forward just given that you are doing quite well in terms of your capacity build out and thereby the unit increases that you are realizing versus your peers?

Yeah.

Hi, Mark, this is Kathy.

The -- basically I mean I think I said - - I think I said this maybe last time.

But what we’re looking at from a depreciation standpoint is, is when we started adding capacity and the amount of dollars of additional depreciation is about $0.80 per 1 million of new capacity.

And so if you kind of look at where we started before we started the new capacity expansion, we had 27.5 million capacity.

We shipped 33.6, that’s a 9 million increase in total unit volume.

And depreciation is increased about 7 million.

So that’s about -- yeah that’s kind of the ratio.

And that’s where we see it.

OK.

So how should we think about the coming couple of quarters then as you move closer to 43?

Same relationship.

Still track that that relationship?

OK, appreciate that.

Secondly, you mentioned as far as some of the other puts and takes on the gross margin of some inefficiencies.

Can you comment on -- without getting too specific, are these types of one quarter events or is this going to extend throughout the rest of ’06 and then I have a follow up.

I think it’s just at this point it’s just a combination of ramping so many new programs and the change in the customer mix.

So whether or not it’s -- you know it’s not going to resolve itself in one quarter.

But as we finish the bring above the new equipment, then you should start seeing some resolution.

Let me add to that; again, when Kathy says it’s a result of customer mix shift, okay, what we mean, the effort we spend on Maxtor’s enterprise products, we spend a lot of money, you know?

And we have now not seen any return. [inaudible - highly accented] to qualify the Seagate program.

This is the cost of continuing on, but we thank God that we have options [inaudible - highly accented ] such a wide base of customers, or they are not accepted by the customer or they are acquired by their old customers.

We are happy that we have [inaudible] jump through hoops, qualified new programs of multiple tools so they can give the customer who requires [inaudible - highly accented ] flexibility.

Sure we spent money, but it takes money to make money.

And we still grow our budget and we still do very well.

We continue on for a while because this is a year of transition.

Key product transitions by many customers, okay?

So give you some flavor, some color.

Sure, I appreciate that.

Now moving back to Seagate then as far as cost qualifications and what not, can you comment a little more on how we should think about the enterprise exposure there?

Obviously your Maxtor units seem to be on a trajectory to go to zero.

And Seagate, their enterprise is their bread and butter from a profit perspective.

How do you view your likelihood of getting into that program?

Our policy and our customers agree with us, that we will run things that are launch worthy.

We’re talking multi-million programs.

There is the way we can add value the most.

So those are our internal capacity they can handle the smaller programs.

So we think Seagate we have a very clear strategy we are executing.

Large volume vendors, but there are many large-volume vendors [inaudible] Seagate, as you know.

They launch so many products at the same time, that many changes for us to make [inaudible - highly accented] the large-volume vendors.

The enterprise is their bread and butter and they have already been doing it for a long time so – and you know, their volumes are not that large. [inaudible - highly accented] trying to do for them.

OK, so you could have some offsets whereby later this year you have some pretty good uptick or uplift from 65 millimeter, but you could lose some of your enterprise exposure here going forward.

Is that fair?

Yeah, no I think you have to look at, as TH said, we are primarily a 95 millimeter automatic house, OK?

We’ve had because of contractual commitments with Maxtor we had enterprise business.

But as we allow our customers such as Seagate to focus on those more specialized products, we will benefit from their need to, in a sense, offload the 95 millimeter as everybody’s demand goes up.

So we’re matching the demand that’s going up into the 95 millimeter.

And we do expect -- we’ve said this before -- we expect that both the Seagate and Maxtor product lines, you know the combination, will increase.

Total volume will increase from what we had last quarter.

OK.

I appreciate it, that’s helpful.

One last question and I promise I’ll cede the floor here.

Obviously Komag has really put together an impressive thing here in terms of how you’re getting a lock around the biggest players in the market with all your volume purchase streams in the past year.

Recently we did come across Western Digital, one of your bigger customers now, make an announcement about [Shoa-Danko] in terms of their relationship expanding.

Can you just comment about what type of competitive risk you see going forward now as more capacity will be coming online as we move into ’07?

On the contrary, this year [inaudible - highly accented] Western Digital is one of the largest die companies that do not have die media as you know.

And that strategy and the [inaudible - highly accented] communicated to us [inaudible - highly accented] to us and have something to show up, is to line up the two largest media makers for themselves for multiple years.

Given where we stand, [inaudible - highly accented] at this time.

So we sign up, okay? [inaudible - highly accented ] we make 3 amendments to the same [inaudible] in the last 12 months, OK?

And that is to say how closely we know Western Digital’s needs [inaudible - highly accented] goes up and we want to do [inaudible], we sign a new amendment, okay?

The same thing is happening now, maybe a year later, but it’s happening. [inaudible - highly accented] Komag.

There are many [inaudible - highly accented] Western Digital is securing for themselves, you know, their media supply.

They are doing exactly what they say we are doing.

We are very comfortable with that.

We’re also very comfortable with how [inaudible] is executing and they are very prudent in their capacity increase.

And everything is based on need, is geared to needs.

OK?

And then one final [inaudible] talking point, and you can take it from here, we are the biggest in the aluminum based media supply right? [Inaudible] has about 60/40, about 60 [inaudible] and 40 of aluminum.

And [inaudible] doesn’t have a sure source of their aluminum substrate.

They are not interested in that yet.

So it makes sense for Western Digital to be sure that as they are going forward, they secure a graph base of media from [inaudible].

And of course we are happy to be their [go-between] because we are the preferred aluminum based supplier.

So we feel very comfortable this will allow us exactly what we expect.

We are wondering why it takes so long [inaudible - highly accented] amendment.

OK.

Thank you.

Next we’ll hear from Jon Lopez, OTA Asset Management.

Hi.

Thanks so much.

I have a couple quick ones if I could.

Can I ask you just to repeat the breakdown on the inventory between finished goods and raw material?

OK.

The breakdown?

Let’s see I didn’t give the exact breakdown but the breakdown is about -- for the second quarter raw materials is about 58 million.

Work in-process is just under 10.

And finished is about 7.

OK, great.

Your other substrate business which is small, obviously, but it’s been growing for a couple quarters and it actually declined sequentially this quarter.

And I was just wondering if there was anything there?

If you could comment at all on that smaller part of the business?

We have said it many times, but let me say it one more time.

We’re a media company, right?

The only reason why we sell substrates, is that some customers were [internal] and they need our substrates [inaudible - highly accented] and there is also a contractual agreement in terms of, we bought a competition’s substrate products, and we said, we need to sell them [inaudible - highly accented], otherwise they are our capacity.

So [indiscernible –- highly accented language] we sell substrate.

We [indiscernible – highly accented language] substrate into media and make more money, OK.

And that’s really something for us to grow, our substrate business, but we are obligated either to contractual agreement like the one I just mentioned [inaudible - highly accented] or because our customers need our substrates to compliment their own supplies and we should have [inaudible - highly accented] situation. [inaudible - highly accented]

OK.

So going forward should one assume that that business is basically flat plus or minus?

Yeah, I think you can say that because [inaudible - highly accented].

OK, great.

The third question is related to your ASPs.

I guess the one thing I don’t understand completely is your -- your business in 120 gig and over you’ve effectively doubled sequentially and your ASP was, you know, down a penny so it’s actually flat.

Why after a couple quarters of the ASP increasing and the mix shift continuing to be positive is the ASP trend no longer up?

Well, the enterprise, [inaudible - highly accented] the enterprise has a lot higher ASP.

So as enterprise reduce due to the customer consolidation, [inaudible - highly accented] the increase in the blended ASPs.

OK.

But even March your enterprise business was -- you shipped about 2.2 million enterprise SKUs versus December which was 2.1 and your ASP went up $0.10 from March to December.

So it just doesn’t seem like the math actually -- unless I’m missing details beneath the surface, it would seem that that couldn’t necessarily explain the flattening of ASPs.

Well our December to March quarter is different than the [inaudible - highly accented] where it is [inaudible - highly accented] so now we are 130 and above [inaudible - highly accented] but what you should be looking at is this -- how we manage our bottom line, OK, our net margin, how we handle that.

And along with a few points we made by [inaudible - highly accented] underneath the [inaudible - highly accented] accelerated comp [indiscernible – highly accented language] to the upside, and as the R&D activities come to a [indiscernible] plateau, [indiscernible] outside [indiscernible – highly accented language] ROA, a bit more.

We can do better.

That’s called things you should look at, what’s important is the net.

OK.

That’s helpful, thank you.

Just -- sorry before I leave the topic.

Would one assume that if your enterprise business recovers in the next two calendar quarters that we would see an upward resumption in the ASP trends all else equal?

Well everything depends on mix, OK? [inaudible - highly accented] we manage our bottom line.

EPS, and our net income, shareholder value, OK?

Those are the key things. [inaudible - highly accented]

Very helpful.

Two more very quick ones, I apologize.

Could you just repeat, you had given some detail on the incremental depreciation relative to each something.

And I couldn’t tell if you were talking about each incremental CapEx dollar, or could you just repeat that ratio?

Yeah, what I said is when we started expanding basically our capacity, the difference in the number of units that we sold before we started expanding capacity we were about 27.5 million units per quarter.

Q2 is 36.6, so we’ve taken our unit volumes up by $9.1 million.

9.1 million units?

9.1 million units, that’s correct.

And then from the depreciation standpoint, depreciation has gone up about $7 million over that same period.

So what I was saying is for every 1 million additional units of capacity, it’s about $0.80.

I guess the one thing I don’t --

I’m sorry --

No, no, no.

I understand.

I understand.

I guess the one thing I don’t understand of the dynamic is, while that certainly makes sense, the acceleration -- the trajectory on your Cap Ex is obviously materially faster than the trajectory in either of the two metrics that you just referenced.

And so on a sequential basis, your Cap Ex -- I’m sorry your depreciation actually increased about 26% sequentially which is the fastest rate in over 12 to 14 quarters.

And with your Cap Ex continuing to exceed your depreciation by so much it would seem to me that you would actually have to see an acceleration in depreciation to catch it.

Am I misthinking that?

No, I mean as we’re looking at it today, I mean that’s basically the relationship that we’re seeing over the next few quarters as we finish out the capacity expansion.

I believe you are missing something.

In no other Cap Ex group did the quarterly depreciate on the same rate.

So they all do things, they all land on different rates.

So what we are showing you is the last three quarters increase and we’re telling you that you can use the same net for the next quarter or two.

We have announced what our capacity will be in for third quarter, for the time we’re in, and for the fourth quarter [inaudible - highly accented] you can do your own math.

That’s great, very helpful.

The last question is just the tax rate.

Can you just give some preliminary thoughts about 2007 as far as the tax rate goes?

Should be similar.

About 2.5% on a quarterly basis?

Yeah, we’re saying about 3% for 2006 and so it should be similar.

And can you just remind me when you’ll become a full tax payer?

And just remind me and tell me why the rate is so low again.

We mention in the script basically we have all of the operations are in Malaysia under tax holiday through 2016.

OK.

Sure has been helpful.

Thanks a lot.

Congratulations.

We’ll take our final question of the day from Andrew Neff at Bear Stearns.

Just a question on, I guess, to follow-up on something you were saying about the mix just to have a better sense.

Given your supply constraints, why don’t you have the ability to sort of get your customers to mix up a little more to a greater extent?

You’re essentially selling out; why not just try to take the business which is higher ASP or higher margin?

Well, we providing certain customer [inaudible - highly accented] relationship.

So I don’t see what you’re talking about, reduce – don’t help [inaudible - highly accented] I won’t cherrypick we do this and you do that.

We do things that make the most sense for both companies.

Alright, [inaudible - highly accented] so we are as I said, we treat the large-volume vendors [indiscernible] lowest cost [inaudible - highly accented] cost saving for the customer by doing that.

So, the ASPs for large-volume vendors may not be as high as some specialty product, but it doesn’t make sense for us to do specialty products, even though the ASP may be high [indiscernible] not efficient.

So, I don’t see where the [inaudible - highly accented] for capacity should be used as a weapon to try to increase ASP.

I think that we are already doing good job [inaudible - highly accented] to suit their need.

We do things that meet their needs.

Great, Thank you very much.

Thank you, Andrew.

Alright, I believe that’s it.

Thank you very much, all of you.

Looking forward next quarter.

Thank you.

That does conclude the day’s conference.

We thank you all for joining us.